Saturday, 15 March 2014

10 golden rules of investing in stock markets

1. Avoid the herd mentality
The typical buyer’s decision is usually heavily influenced by the actions of his acquaintances, neighbours or relatives. Thus, if everybody around is investing in a particular stock, the tendency for potential investors is to do the same. But this strategy is bound to backfire in the long run.

No need to say that you should always avoid having the herd mentality if you don’t want to lose your hard-earned money in stock markets. The world’s greatest investor Warren Buffett was surely not wrong when he said, ‘Be fearful when others are greedy, and be greedy when others are fearful!’

2. Take informed decision
Proper research should always be undertaken before investing in stocks. But that is rarely done. Investors generally go by the name of a company or the industry they belong to. This is, however, not the right way of putting one’s money into the stock market.

If you don’t have time or temperament for studying the markets, you may even take the help of a suitable financial advisor. ‘Shares sooner or later reach their fair market value.

So, if you are able to identify shares quoting at a significant discount to their realistic value, you can go ahead and invest in them. Conversely, if some shares in your portfolio have moved significantly higher than their true value, it may a good time to book profits,’ says Ashish Kapur, CEO, Invest Shoppe India Ltd

3. Invest in business you understand
Never invest in a stock. Invest in a business instead. And invest in a business you understand. In other words, before investing in a company, you should know what business the company is in.

Understand, for instance, what they buy and sell, and how they make money. Thus, the more you understand the business of the company, the better you will be able to monitor your investment.

Also keep in mind the past performance of a company. That is because if a company has performed well in the past, it has a better chance of performing well in the future too.

4. Don’t try to time the market
One thing that even Warren Buffett doesn't do is to try to time the stock market, although he does have a very strong view on the price levels appropriate to individual shares. A majority of investors, however, do just the opposite, something that financial planners have always been warning them to avoid, and thus lose their hard-earned money in the process.

‘So, you should never try to time the market. In fact, nobody has ever done this successfully and consistently over multiple business or stock market cycles. Catching the tops and bottoms is a myth. It is so till today and will remain so in the future. In fact, in doing so, more people have lost far more money than people who have made money,’ says Anil Chopra, group CEO and director, Bajaj Capital.

5. Follow a disciplined investment approach
Historically it has been witnessed that even great bull runs have shown bouts of panic moments. The volatility witnessed in the markets has inevitably made investors lose money despite the great bull runs.

However, the investors who put in money systematically, in the right shares and held on to their investments patiently have been seen generating outstanding returns. Hence, it is prudent to have patience and follow a disciplined investment approach besides keeping a long-term broad picture in mind.

6. Do not let emotions cloud your judgement
Many investors have been losing money in stock markets due to their inability to control emotions, particularly fear and greed. In a bull market, the lure of quick wealth is difficult to resist. Greed augments when investors hear stories of fabulous returns being made in the stock market in a short period of time. ‘This leads them to speculate, buy shares of unknown companies or create heavy positions in the futures segment without really understanding the risks involved,’ says Kapur.

Instead of creating wealth, these investors thus burn their fingers very badly the moment the sentiment in the market reverses. In a bear market, on the other hand, investors panic and sell their shares at rock-bottom prices. Thus, fear and greed are the worst emotions to feel when investing, and it is better not to be guided by them.

7. Create a broad portfolio
Diversification of portfolio across asset classes and instruments is the key factor to earn optimum returns on investments with minimum risk. The reason for the relatively poor performance of portfolios of individual investors even in greatest of bull runs has been lots of variation in market breadth. Different industries have participated at different points of time in taking the markets up.

There have been periods running into several months when the entire rally has been led by a handful of large, front-line stocks. On other occasions, mid caps have generated remarkable returns and made large caps look pale in comparison. So, it becomes imperative to diversify your portfolio across sectors and market capitalization.

8. Have realistic expectations
There’s nothing wrong with hoping for the ‘best’ from your investments, but you could be heading for trouble if your financial goals are based on unrealistic assumptions. For instance, lots of stocks have generated more than 50 per cent returns during the great bull run of recent years.

However, it doesn't mean that you should always expect the same kind of return from the stock markets. Therefore, when Warren Buffett says that earning more than 12 per cent in stock is pure dumb luck and you laugh at it, you’re surely inviting trouble for yourself.

9. Invest only your surplus funds
If you want to take risk in a volatile market like this, then see whether you have surplus funds which you can afford to lose. It is not necessary that you will lose money in the present scenario. You investments can give you huge gains too in the months to come.

But no one can be hundred percent sure. That is why you will have to take risk. No need to say that invest only if you are flush with surplus funds.

10. Monitor rigorously
We are living in a global village. Any important event happening in any part of the world has an impact on our financial markets. Hence we need to constantly monitor our portfolio and keep affecting the desired changes in it.

If you can’t review your portfolio due to time constraint or lack of knowledge, then you should take the help of a good financial planner or someone who is capable of doing that. ‘If you can’t even do that, then stock investing is not for you. Better put your money in safe or less-risky instruments,’ advises Kapur.

What is a Hedge Fund?

Quote for the day

"It would seem the difference between investment and speculation is not very clear in the minds of most market participants. At market extremes - after prolonged bullish advances or bearish retreats - the confusion between investment and speculation appears to be universal. . . We have no idea what will happen to the market. . . What is certain, however, is that market participants need to be reminded of Graham's investment / speculation distinction; confusion over the concepts is as widespread as it has ever been." - Dennis Butler