It appears there has never been a better time to invest in stocks. Media is abuzz with reports of record-breaking returns of benchmark indices. Market watchers hold forth on how investing money in stock market can help you create wealth. Not to be outdone, social media lists FOMO-inducing virtues of stock investments that make you wonder how to invest in stocks.
Here is a primer on how to begin investing in stocks. Let’s dig in.
What is stock market?
Stock market is where investors and traders can buy and sell shares of listed companies. Collectively, the term refers to a set of exchanges such as the National Stock Exchange (NSE) and the Bombay Stock Exchange (BSE) in India. Companies list their shares and other securities for trading. The stock market consists of a primary market and a secondary market.
Primary market
The primary market is where shares and other tradable securities are sold to investors for the first time. Initial Public Offerings (IPOs) comprise the primary market. Once the stock is listed on the stock exchange, any further trading in the stock will happen in the secondary market.
Secondary market
The secondary market is where investors and traders buy securities. In the secondary market, trades happen between investors and traders rather than between the issuing company and the investor. The Indian exchanges NSE and BSE are secondary markets.
Benchmark indices such as the Sensex, Nifty50, and Nifty Midcap provide an overview of the market performance. So, when you read a media report titled “market was up today,” it generally means that the benchmark indices gained that day. While the top indices represent some of the top traded stocks in India, they are not the market per se as hundreds of listed companies trade on exchanges.
For instance, NSE’s Nifty50 has 50 stocks and BSE’s Sensex has 30 stocks. You can begin your stock investment journey by following the steps outlined below.
How to invest in stocks: Nine tips for beginners
Stock market returns can sound enticing, but the investment process is anything but simple, something that demands due diligence. Here is how you can start your stock investments as a beginner.
1. Buy the right investment
Buying the right stock is easier said than done. Selecting a stock from hundreds of stocks listed on the NSE can be daunting. Anyone can judge a stock based on its past performance, but selecting a stock that will perform well in the future is a different ball game. That is why it is said that hindsight is always 20/20 when it comes to stock selection.
Choosing the right stock for the future involves doing in-depth market research. First, select stocks that are performing well in a particular market or segment. Analyze its fundamentals such as price-to-book ratio and price-to-earnings ratio. Conduct technical analysis and read the charts to understand the price trends of the stock to make an informed investing decision.
Your investment decision should be based on research rather than emotional factors such as buying in your favorite company or industry. Also, overreliance on past performance should be avoided as it does not guarantee future performance.
2. Avoid individual stocks if you’re a beginner
We have all heard stories of a big stock win or a great stock pick. But rarely do people talk about the not-so-well-performing investments that they hold in their portfolio. Tales of great wins can set unrealistic expectations when investing in stocks.
Picking stocks that will make money in the future is more technical. It is advisable to avoid individual stocks if you are doing stock market investment for the first time.
Investing money in index mutual funds would be a better alternative for novice equity investors. Mutual fund investments can help you benefit from market movements, not to mention expert management by fund managers.
3. Create a diversified portfolio
When building a stock portfolio, diversification is important as it helps hedge risks from concentrating your investments in one stock or one industry.
Mutual fund investments can help you achieve the diversification goal as well. When you invest in an index fund, you will indirectly hold stocks in index constituents spread across industries. You can also opt for sectoral mutual funds to benefit from the growth of a sector with reasonable diversification in multiple companies active in the sector.
Diversification can help hedge risk and thus creating a diversified portfolio is of utmost importance.
4. Be prepared for a downturn
Losses are as much a part of investments as profits. The primary issue with stock market investments is investors’ inability to stomach losses arising from inherent stock market volatility and company-specific problems.
If you have a well-diversified portfolio, facing losses in a single stock should not have a huge impact on your overall portfolio performance. Additionally, when the markets are in a downturn or a correction phase, it is important not to sell your stocks in panic as it can hurt your chances of gains once the situation normalizes.
Do remember this rule of thumb while investing money in the stock market. Principal is not guaranteed and it is probable that you will lose money if the stock does not perform well. If you are looking to get guaranteed returns, it is advisable to invest your money in fixed-income securities or a high-yield fixed deposit.
5. Try a stock market simulator before investing real money
Using a stock simulator is a good way to enter the world of stock market investments. A simulator will enable you to invest with virtual money so that you can test your stock selection and judgment without putting in real money.
You can start investing with actual money once you have tested your stock selection prowess and investment strategy and gained confidence.
6. Stay committed to your long-term portfolio
Stock markets are cyclical in nature, with fluctuations in prices over a period of time. These periods of volatility can induce panic selling, interfering with your long-term investment goals. As an investor, you should be very cautious and thoughtful before making sell decisions during phases of market volatility.
Staying invested for an extended period can help in wealth creation. That is why one should avoid emotional decisions based on panic or fear of loss.
7. Start now
Right now is always the best time to invest. This is because, when investing for the long term, the market price fluctuations will even out in the long run, making the buying price relatively less important.
Additionally, starting early is more important than starting big. Therefore, as an investor, you should start as early as you can even if you have a very small amount to invest every month. The compounding can work wonders for your investment over time. Therefore, starting right now is more important than waiting for the right time or waiting till you have a sizable capital to invest.
8. Avoid short-term trading
Investment and trading are two different things. Do not confuse between them and if you are starting with stock investments, it is advisable not to indulge in trading as it will put you at a greater risk of losing your capital.
For a new investor, frequent buying and selling can get expensive as all transactions have associated costs. The costs can eat up your profits, reduce them or add to the loss.
9. Keep investing over time
Wealth creators keep on adding money to their investments over time. This means you would require greater discipline in terms of saving from each paycheck to increase your investments every month.
As time goes by and your income increases, your contribution to investment should also increase. A good way to attain investment discipline is automating the investment process so that you can keep your emotions and spending in check.
How the stock market works for beginners
The stock market is a place where investors and brokers exchange stock for money or vice versa. The buyers expect the price of a stock to rise in the future while the seller expects the stock to fall or not rise considerably in the future. Essentially, the stock market is a zero-sum game.
Stock market allows you to speculate on the future of the company. All market participants collectively set the price of the stock. This is because the stock price is determined by demand and supply and all market participants influence the demand and supply of the stock.
While demand and supply impact the price of the stock in the short run, fundamental factors such as company performance, sales growth, and revenue numbers influence the price in the long run. In short, it is the company that influences the demand and supply of the stock.
The underlying point here is that the stock market is forward-looking in nature as stocks are priced based on the expectation of their future performance.
Risks and benefits of investing in stocks
Equity shareholders are the owners of the company. The stock allows investors to own a small portion of some of the best companies in the country. The golden rule in investing is: higher the risk, the higher the return. Therefore, while the stock market offers higher returns, it poses a significant risk.
It is important to understand the risks associated with equity investments before investing your savings into the stock market.
Equity shareholders are the owners of the company and therefore, stock investments mirror the risks of a business. That is, in the event of liquidation, equity investors have the last right to liquidation proceeds after all the debt is paid off.
Furthermore, stock investments do not promise a fixed return. While some companies choose to distribute a part of their profits as dividends to shareholders, there is no compulsion to do so. The appreciation in the share price over time is the reward that a stock investor gets. But this reward is not assured as the price of a stock may fall over time as well, in which case the investor will make a loss.
Historical market statistics show that stock investors make money over a long period, but choosing the right stock requires skills that may take years to develop and hone. Thus, new equity investors would do well by investing money in index mutual funds.
