Five golden rules every beginner must know before investing in stocks
Investing in stock markets is a great way to grow your wealth over the long term. However, it is not as simple as depositing funds and just hitting the buy button on any random stock. If you have never invested before, the good news is that the process is now much simpler and easily accessible from anywhere in the world. The olden days of paying hefty fees to brokers, who may or may not have had our best interests at heart, are now behind us.
Moreover, you don’t need to have a boatload of money to start investing in stocks. A small investment, made consistently over a long period, cumulatively yields great returns over time. Here’s what you must consider before setting foot into the world of stocks.
Don’t let emotions get the better of you: “Success in investing doesn’t correlate with IQ; what you need is the temperament to control the urges that get other people into trouble while investing.” says investment guru and chairman of Berkshire Hathaway, Warren Buffet. Investment decisions are driven by your gut, not your brain; don’t let emotions trigger impulsive reactions. It is a sure shot method of cutting the branch you’ve been resting on.
Tip: Know your fundamentals, read up on companies, and trust your instincts even if it means going against the trend.
Identify your risk-taking appetite before you start investing: This is a measure of “how much you are willing to lose if the market capsizes” and is one of the most important factors that influence your investment strategy. For example, if you are saving for your child’s future, you will be driven to make less risky investments to protect it from market shocks. Long-term investments undoubtedly yield good returns, but the returns depend on the investments you make over time. The more rewarding the investment, the riskier it is.
Tip: Invest in multiple sectors. As a beginner, you can reduce risk by diversifying your portfolio. It is called ‘hedging’.
Choose performers, not ticker symbols: The most reliable investment is an investment in a company that consistently delivers results. When you embark upon your investment journey, an overwhelming amount of information can appear on your screen and cajole you into making the wrong move. Stocks that rise and fall rapidly when the market sentiment changes are not rewarding but “volatile”. The fall hurts as much as the rise rewards. In order to construct a reliable portfolio, enter stocks of companies that are guaranteed to perform even under challenging circumstances.
Tip: Investing in a stock makes you a part-owner of the company. Therefore, prefer investing in established companies (blue chip stocks) that are aligned with your goals and values.
Plan to avoid the classic gaffe - buying high & selling low: Intelligent investing based on fundamentals seldom goes wrong. Unless unforeseen catastrophes such as the Covid-19 pandemic hit (from which we are recovering at a steady rate as well), this will help all beginners.
Making a BUY decision: As a beginner, you can note down the metrics you measure a company by, or ask yourself ‘What attracts me to this particular company?’ For example, the market strategy, the dividend yield, positive consumer sentiment, etc. As long as the company satisfies your criteria, you should remain invested in it.
Making a SELL decision: For this, your reason cannot be the drop in the price of that particular stock. All stocks rise and fall but you must see it through. A sell decision must be based on fundamental changes in the business that you think reduce the worth of that company. Example, losing a large customer or change in the leadership, etc.
Tip: Your reasons to enter or exit a stock do not have to match with anybody else’s. Every person measures a company’s performance on the basis of different metrics. If the decision is hard, read rule number 1.
Build your portfolio gradually: Time, and not timing is an investor’s best friend. Most investors grow their portfolios expecting to reap the benefits over the years through dividends and price appreciations. This means that an investor can take all the time he needs to buy stocks. Here are a few strategies to use when building your portfolio:
- Balance out average cost: Invest a fixed amount of money in the stock at regular intervals. Over the long term, this strategy will balance out your average cost of purchasing.
- Buying in thirds: Divide the funds you have at your disposal into three equal parts and decide three price points to buy the stock. This ensures that you do not invest too much headspace into the brainstorming exercise and just firmly stick with the plan. Fore example, invest the first one-third into a company before a product launch. If the product is a hit, pump in the next two-thirds, else divert the money elsewhere.
- Basket buying: If you’re unsure about which stock to invest in, just pick up all the top performers from that sector with the funds at your disposal. This is just another way of diversifying your portfolio and minimise risk.
Beginners tend to be excited and over-protective of their investments. It’s okay to get jittery, but do not check on your investments too often and expose yourself to multiple emotional shocks. Check your investments once in a few months or once every quarter, unless the company you invested in comes out with important revelations that could potentially impact its stock prices negatively and harshly. Investing is a game of patience and resilience. Possessing both qualities yields the returns you desire.
The writer is founder, Gaurav Bhagat Academy