Stock markets have always caught the fancy of investors looking at inflation-beating returns and wealth generation. However, making money in equities is not that straightforward. It requires patience (a lot of it), an inherent understanding of the way the market functions, and in-depth research and analysis, among other things. If we take a quick look at the way the markets have responded to the pandemic in the last few months, it has been a roller-coaster ride. With high market volatility and an uncertain outlook, most investors found themselves grasping at straws to make the right investment decision.
Such events highlight the volatility of stock markets and the risks associated with stock investments. However, to be in better control of your investments and ensure that your financial goals are met, you need to approach stock investing in a planned and strategic manner. Here are some share market tips that you should know before investing in stocks.
In this article
- 1. Understand Your Investor Profile
- 2. Avoid Emotion-Driven Investment Decisions
- 3. Diversify
- 4. Be Careful Before Using Borrowed Money to Invest
- 5. Don’t Follow Market Trends or Experts Blindly
- 6. Avoid Trying to Time or Predict the Market
- 7. Keep Realistic Return Expectations
- 8. Monitor Your Investments Regularly
1. Understand Your Investor Profile
Every investor is unique and has a specific investment requirement to fulfill his/her financial goals.
Let’s say that there are two investors ‘A’, and ‘B’ who are planning to invest in the stock market with a financial goal of accumulating around 15 lakhs for the higher education of their children. ‘A’ has a high-risk appetite and wants to raise the amount in 7 years. On the other hand, ‘B’ has a medium-risk appetite and has 10 years before he would need the money. Also, both ‘A’ and ‘B’ are active investors with an investment portfolio consisting of mutual funds, fixed deposits, etc.
Can the same investment approach work for both ‘A’ and ‘B’? You don’t need to be an investment expert to answer this question. They both would need different investment strategies to fulfill their financial goals.
Before you start investing, ask yourself these three fundamental questions:
What are My Financial Goals?
Am I creating a nest egg for retirement? Or, are these investments being made to raise a corpus for buying a house? Your financial goals will help you understand the investment horizon and risks that you are willing to take.
For How Long Can I Stay Invested?
If we look at the historical data, then stock investments have generated good returns over the long-term. Hence, an investment horizon of 7-10 years is considered ideal. If your financial goals demand a shorter horizon, then you might want to create a diversified portfolio that helps you fulfill your goals within the stipulated time.
What is My Risk Tolerance?
Understanding investment risks and your tolerance level is critical for successful investing. Every individual has a different tolerance to risk. When you invest in the stock market, your principal amount is exposed to several risks like market risk, liquidity risk, concentration risk, inflation risk, etc. These risks indicate the possibility of losing a part of your invested capital due to various reasons.
There is a simple equation that you need to keep in mind: Higher Risks = Higher possible Returns and vice versa. Hence, understanding how much risk you are comfortable taking is crucial. If you push yourself beyond your tolerance limit, then you will make emotion-based decisions when the market starts moving unfavorably.
The answers to these questions will help you define your investor profile and create an investment plan that is tailored to you. This is one of the most important share market investment tips you will ever receive.
2. Avoid Emotion-Driven Investment Decisions
In March, when the stock markets crashed due to the lockdown and pandemic, many investors panicked and sold their stocks to minimize their losses. While this seemed like the best thing to do, it was not an informed decision but an emotional reaction to a stressful situation.
Within a couple of months, the markets have started recovering and on course to bounce back. While some companies suffered due to the economy coming to a standstill, stocks of fundamentally strong companies survived the crisis and began their path to recovery. If investors wouldn’t have panicked and analyzed the stocks that they need to sell and the ones that they should hold on to, their losses could have been curbed.
Stock markets are volatile by nature. Hence, if you keep making investment decisions based on market volatility, you will always be exposed to the risk of buying/selling at the wrong time. So, a more prudent approach is to create an investment plan and stick to it while making minor changes based on data-driven analysis. Emotion-based decisions are usually counterproductive.
Smart investors are constantly looking for ways to earn better returns while reducing risks. While avoiding risks is not possible, you can always create a portfolio that is designed to limit your risk exposure and offer an excellent opportunity to grow your wealth.
Diversification is a process of investing in securities that have zero or low correlation with your portfolio. In simpler terms, the performance of one security should have little or no impact on the overall returns of your investment portfolio. Ranking high on the list of share market tips for beginners, diversification should be learned early in your investment journey.
Your investment portfolio must be diversified across various asset classes like equities, debt, gold, commodities, real estate, etc. Within each asset class, you need to ensure maximum diversification too. There are many ways to diversify your stock investments:
- Across market capitalization – In the simplest terms, market capitalization is the size of the company. When you purchase stocks, ensure that you buy stocks of large, medium, and small companies. Stocks of large companies are usually less risky and offer lower returns than those of small companies.
- Across sectors – Many first-time investors tend to invest in stocks of companies belonging to the sector they work in. For example, an automobile engineer tends to invest in the automobile sector since he understands it well. While this is a good place to start, he must ensure that he also invests in sectors that are not impacted if the automobile sector crashes.
- Across geographies – Stock markets tend to respond strongly to political and macroeconomic situations in the country. Hence, many investors invest a portion of their investible corpus in stocks of companies belonging to different countries.
Ensure that you diversify based on your risk tolerance.
4. Be Careful Before Using Borrowed Money to Invest
Most first-time investors open a margin trading account where the brokerage firm lends money to invest in stocks, This is usually around 50 percent of the purchase value of the stocks. While this seems like a great way to invest, the risks are far greater than the benefits of using this facility. Here is an example to help you understand:
Let’s say that you wanted to buy 1000 shares of a stock that is trading at Rs. 100. The total cost of the purchase is Rs. 1,00,000. The brokerage firm could loan you Rs. 50,000 to complete this purchase.
There are two possibilities:
- The stock price increases to Rs.200
- The stock price drops to Rs.50
Scenario 1. The stock moves to Rs. 200 a share and you sell it
If you had used your own money exclusively, your return would be 100% on your investment [(Rs. 2,00,000 – Rs. 1,00,000) / Rs. 1,00,000].
If you had borrowed Rs. 50,000 to buy the stock and sold at Rs. 200 per share, your return would be 300 % [(Rs. 2,00,000-Rs. 50,000) / Rs. 50,000] after repaying the Rs. 50,000 loan and excluding the cost of interest paid to the broker.
It sounds great when the stock moves upward but think about the other scenario.
Scenario 2. The stock falls to Rs. 50 per share
If you had borrowed Rs. 50,000 to buy the stock and sold at Rs.50 per share, your loss would be 100% of your initial investment, plus the cost of interest to the broker [(Rs. 50,000 – Rs. 50,000) / Rs. 50,000].
Leverage is a tool best used after you acquire experience and confidence in your decision-making abilities. Limit your risk when you are starting out to make sure you can profit over the long term. Of all the stock market tips, this important aspect is usually missed by most investors.
Also Read: How to Invest in Share Market
5. Don’t Follow Market Trends or Experts Blindly
How do you decide to buy or sell a share? If you switch on to any finance TV channel, you will find an expert analyzing the market and offering recommendations on stocks that investors can consider. You will also find many people following them and claiming massive gains on social media platforms. Following such experts blindly or following market trends without analyzing whether the recommendation fits into your investment plan can be dangerous.
Most investors react to market conditions. Hence, when the markets are surging, the majority of investors invest more under the speculation that they will rise further. On the other hand, a few days of falls can start panic selling.
If you follow advice or trends without thinking, then you will often find yourself selling stocks that you wanted to keep or buying ones that you didn’t want. Hence, ensure that you make decisions without being influenced by these factors.
6. Avoid Trying to Time or Predict the Market
A successful investor stays away from speculation and bases his investment decisions on data and fundamental factors of the company.
Most new investors look at stocks with a simple perspective of buying low and selling high. This ensures profit and saves them the effort of researching the company or going through pages of financial statements, etc.
However, this is a dangerous approach since it forces them to guess the lows and the highs. While you can get lucky once or twice, this cannot be an investment strategy over the long-term.
In fact, most people lose money in the stock markets because they try to time their purchases and redemptions to match the lows and highs respectively.
Avoiding this approach will benefit you. Investing systematically in the same stock at regular intervals can be a good option in a falling market scenario.
For example, if you want to purchase 1000 stocks of ABC India Ltd., then you can start by buying 100 and waiting until the price drops when you can buy another 100 stocks. You can continue this process as long as the markets are crashing and if you believe that the company is fundamentally strong to survive the reason behind the crash. Don’t make investment decisions based on stock price alone. One of the best share market tips is to always keep the financials of the company in mind before buying.
Also Read: Best Intraday Tips
7. Keep Realistic Return Expectations
Stocks are known to generate the best returns among all investment avenues available. Typically, one can expect to earn returns in the range of 15-25% over the long-term. The internet is full of stories of stocks that gave more than 100% returns. While these stories might be true, they are also rare and unpredictable.
Hence, while investing in stocks, ensure that you keep your return expectations real based on the risk element of the investment.
8. Monitor Your Investments Regularly
A stock market is a volatile place. Every major event happening in any part of the world impacts the performance of stocks in all countries. Hence, when the trade war was at its peak between the US and China in 2019, stocks in India were responding to the positive/negative news.
A prudent stock investor keeps track of all such major global and national events and keeps rebalancing his portfolio as needed.
Stocks have been the preferred investment avenues for decades since they allow investors flexibility, liquidity, transparency, and a highly regulated environment keeping fraudsters at bay.
While stock investments can help generate wealth, it requires time and effort to evolve from a novice into a successful investor. Hence, start young and slow, keep the risks in check, and slowly ease yourself into this world.
Finally, remember that stock investing is not gambling. You are not taking chances but making informed decisions. Hence, keep all speculations away and grow into an expert investor with time. We hope that these free share market tips help you in your journey.
Disclaimer: The views expressed in this post are that of the author and not those of Groww