The stock market is a place where many rags to riches stories are made. Investors like Harshad Mehta, Rakesh Jhunjhunwala, Warren Buffet and many others have earned billions starting from a very paltry sum.
Such stories entice both the young and the old, who dream of making it big in the markets. However, along with the success, there are innumerable stories of failure, where investors have lost their hard earned money playing in the stock market.
Hence, the journey into the markets should be measured and calculated. Questions like how much money should I invest, where all should I invest, and the different asset classes where one should invest, haunt the newcomers. This article will provide the answers to all the above questions, so that you don’t lose your capital in the stock markets.
Learn the art and science of investing
There is no short cut to success and there is no way you will earn money in the long-term if you depend on tips. Many newcomers believe that they can earn the riches piggybacking on somebody else’s tips. Nonetheless, this is the first thing that new investors should learn, never invest on tips.
Investing is a combination of both science and art. The science part includes studying the numbers, understanding the results and searching for the loopholes. However, only studying the numbers can’t make one a great investor because the stock markets price a stock on its future prospects. Anticipating the sector and the stocks which will outperform the stock market is art. Every great investor uses both the techniques to find successful stocks.
Learn investing by paper trading
Never invest all your savings in the stock market. As a newcomer, you should start with paper trading. Paper trading or mock trading allows you to learn the tricks of the trade without putting your hard earned money at risk.
You should solidify your investment principles and your money management skills while paper trading. Once you earn consistent profits while paper trading, it’s time to take the leap into the world of trading withreal money.
Start with the amount you can afford to lose
Though paper trading will prepare you for live trading, still emotions run high when you invest real money in the markets. Every rise fills you with hope of a better future, but every loss brings you disappointment. Chances are that you will lose a considerable amount of your money, if you are not well prepared and start investing directly without any paper trading experience.
However, even with some mock trading experience, you stand to lose a part of your capital because losses are part of winning in the stock markets. You lose some, you win some, but at the end of it, if your losses are small and winners are big, you will be a profitable trader or investor.
Always take care that this learning process should not ruin you financially. Hence, as a newcomer, invest only a part of your savings, which you can afford to lose without affecting your current standard of living and disturbing your finances.
If you don’t have that kind of money, then don’t invest. Take some more time to save and then start investing.
Should you invest in large-caps or mid-caps?
We have dedicated a whole article on this topic, which guides you whether you should invest in large-caps, blue-chips, mid-caps or penny stocks.
Invest in the area of your expertise
If you are a doctor and you want to start investing, you should start with the business that you understand. It can be hospital stocks, pharma stocks, medical equipment companies etc., because, you can easily pick the company which has a great business and a great future, as you understand the business.
On the other hand, if you are asked to pick the best metal stock or energy stock, it will be difficult and you will have to spend a considerable amount of time studying their businesses.
Warren Buffet does not invest in companies whose business he doesn’t understand. Hence, he did not invest in either Microsoft, Google or Apple, all multibaggers. Yet he is among the richest people in the world.
The stock market is filled with numerous opportunities, always use the one which offers you the best chance of success.
Don’t leave your day job
Many newcomers have a stroke of beginner’s luck and they leave their day jobs expecting to make a living by trading. Though there are numerous traders who earn millions by trading, it takes a lot of time, effort, and sacrifice to reach there.
Always start trading part-time and when you start earning equal to your day job for almost a year, you can consider leaving your day job to become a full-time trader.
Diversify your investments
“Never keep all your eggs in one basket,” is an old saying and this applies to investingas well.
The first larger approach is that one should diversify his investment portfolio and it should be a mix of stocks, precious metals, money market funds, fixed deposits, etc. Such an approach will keep your portfolio balanced during both market upturns and downturns.
During a bearish trend in the stock market, precious metals usually do well. Hence, a certain amount of gold and silver in the portfolio is a good approach. Fixed deposits provide a steady source of income every month, hence, some amount of money should always be parked in FDs.
Diversification in the stock markets
Similar to diversification of investments, the stock market portfolio should also be diversified. It should be a good balance of dividend-paying stocks and growth stocks.
The growth stocks outperform the index during bull markets and the dividend stocks ensure both price appreciation and handsome dividends.
Along with this, the structure of the portfolio should consist of core holding and a trading portfolio. The core holdings are stocks, which you plan to hold for many years.
These stocks are not sold for small market aberrations. A sell is triggered only when the stocks fundamentals don’t support holding it. These are the stocks which return astronomical profits if held over a long time. However, it also needs patience to watch the stock gyrate more than 20-30% during the holding period.
The second set of holdings is made of a trading portfolio. These stocks are held only for their momentum due to some positive news or other development. These stocks are often sold after a certain price objective is reached.
Allocation of an investment portfolio
The allocation can vary depending on the type of markets. An example of an investment portfolio is
Total investment portfolio=Rs.100.00
Portion allocated to stocks= Rs.70.00
Portion for buying gold and silver=Rs.15.00
Portion for fixed deposits=Rs.15.00
However, during roaring bull markets, the fixed deposits and precious metals allocation can be reduced and the allocation for the stocks can be increased, but this should be done only by expert investors.
Allocation of a stock portfolio
Total stock allocation=Rs.70.00
For growth stocks=Rs.50.00
For dividend stocks=Rs.20.00
Changing allocations after watching market conditions
The above-mentioned examples of investment and stock market portfolio are just a broad guide, on how one should approach their investments. At times, the expert investors can change the allocation to suit the prevailing market conditions.
During roaring bull markets, the allocation should be skewed towards growth stocks, because stocks outperform all kinds of investments during a strong bull market.
During bear markets, the allocation to dividend stocks should be increased as growth stocks perform poorly in bear markets. The allocation to fixed deposits should also be increased in a down trending market, as capital protection is the major goal during bear markets.
During a crisis, precious metals like gold and silver are known to outperform all asset classes, as the investors seek the safety of the precious metals. A recent example was the outperformance of the yellow metal during the financial meltdown in 2007.
Stock markets are the best place to maximize your returns by investing smartly, however, expecting quick profits is a wrong way to approach investing.
10. Approach investing as a business and not as a gamble.
Tags: penny stocks, large caps, middle caps,bull markets,bear markets