- Posted by: admin
- Category: Stock Market
“Someone’s sitting in the shade today because someone planted a tree a long time ago.” ~ Warren Buffett.
If you are new to investing and stock markets then, terms such as stocks, bonds, yield, P/E ratio, mutual funds may overwhelm you in the beginning. That’s understandable and it’s fine. Some people jump in to stock markets by listening to some success stories but fail to realise that investing is an art and it can be mastered with proper understanding and education of the markets. Usually, with dedication, one can get mastery over the art of investing in stocks, however for some it may take years to understand, but you’re not alone.
To start investing you must gather as many facts and details apart from knowledge of stock markets. One should also learn to deal with the fact that you may not know everything. As Buffett, rightly said “Risk comes from not knowing what you are doing.”
Investing is another means to earn money other than doing a 9-5 job. In simple terms, investing is putting your money to use to generate additional income on the same. Investing is neither gambling nor speculation. Gambling is the activity of risking money on an uncertain outcome hoping to make money. Speculation involves trading a financial instrument involving high risk, in expectation of significant returns. The motive is to take maximum advantage from fluctuations in the market.
Investing is necessary so that after your retirement, you can live off funds earned from these investments. It shields you against rising inflation and provides a sense of financial security to fall back on.
There are various investment vehicles for the investors to choose from. But for today let’s just stick to mutual funds and stocks and understand how they differ from each other, even though they both relate to investing in company stocks.
So where have you heard the word “Mutual Funds” before?
“Mutual Fund investments are subject to market risks, read all scheme-related documents carefully.”
Still not striking a chord? More often than not this disclaimer is heard or seen on television, radios, hoardings, billboards, etc. The advertisements are engaging and eye-catching with their slogans like “Aim to achieve long term goals”, “Looking for long term investment?”, “Invest and enjoy the benefits of tax free dividend”.
However the disclaimer is promptly ignored before it is completely read or heard. As per the Securities and Exchange Board of India rules, this disclaimer is a must for every mutual fund scheme advertisement and is basically intended to communicate the risks that mutual fund schemes are usually exposed to.
A mutual fund is nothing more than a collection of stocks and/or bonds. It can also be understood as a pool of money from various investors who wish to save or make money just like you by investing their money in stocks, bonds, and other securities. Each investor owns shares, which represent a portion of the holdings of the fund.
Each fund’s investments are chosen and monitored by qualified professionals who use this money to create a portfolio. That portfolio could consist of stocks, bonds, money market instruments or a combination of the above. Investors purchase funds because they do not have the time or the expertise to manage their own portfolios.
Types of Mutual Funds:
The mutual funds industry of India is continuously evolving. The mutual funds are categorised in order to enable the investors to choose a scheme based on the risk they are willing to take, the investable amount, their goals, the investment term, etc.
On the basis of maturity period of investment, mutual fund schemes can be classified into three categories as shown below.
Let us look into some of the pros and cons of investing in mutual funds :
- Mutual Funds are managed by professional fund managers, responsible for making wise investments according to market movements and trend analysis. The role of the fund manager and his approach plays a crucial role along with market risks as the key issue is how a fund manager mitigates these risks without significantly impacting the performance of the scheme of a fund.
- Mutual Funds allow you to invest your savings across a variety of securities and diversify your assets according to your objectives and risk tolerance. Buying a widely diversified basket of stocks can be difficult for all but the wealthiest investor. Small investors are better off buying a quality stock mutual fund. Diversification is not putting all the eggs in one basket but spreading them over a number of baskets thereby reducing the possibility of losing an egg for any reason possible.
- Mutual funds enable you to make transactions on a much larger scale for comparatively less money. This can also be called as economies of scale. When you purchase more than one unit of a product, the manufacturer is able to cover his costs by producing more goods that too at a lesser rate. For example, when the service provider for a telephone line has to cater to only one customer, his costs incurred on setting up the infrastructure will not be covered by the fees paid by the only customer. Hence he may charge higher than usual. However when the number of customers increase he is able to cover the same cost by reducing the fees charged per customer. The fees payable by the consumers gets divided thus reducing the cost.
- Over-diversification can also be a danger. It occurs when investors acquire many funds that are highly related and as a result, end up losing the benefit of reduction in the risk.
According to Warren Buffett, “Wide diversification is only required when investors do not understand what they are doing.” Basically, if you diversify too much, you may not lose much, but neither will you gain much.
- Costs are the major drawback of mutual funds. These costs may eat up your returns and cause sub-par performance of the funds. Fees can be broken down into two categories :
- Ongoing yearly fees to keep you invested in the fund.
- Transaction fees paid when you buy or sell shares in a fund.
Apart from mutual funds, there are various other financial instruments for the investors to choose from like Stocks, Debt Funds, Fixed Deposits, Exchange Traded Fund.
The stock market in India consists of the NSE and BSE. The Bombay Stock Exchange (BSE) and the National Stock Exchange of India Ltd (NSE) are the two primary exchanges in India. In addition, there are 22 Regional Stock Exchanges.
Stock market is defined as the market in which shares of publicly held companies are issued and traded either through exchanges or over-the-counter markets.
In order to begin investing in the stock market, you must have the following :
- Pan Card
- Demat and Trading Account
- Buying and Selling
Types of stocks:
There are two main types of stocks:
- Common Stock
- Preferred Stock
Let us take a look at some of the merits and the demerits of investing in the stock market:
The stock market is a volatile market and a company’s share price fluctuates very frequently all within a day. The risk factor in investing in stocks is high as one moment, the prices are high, the other moment they may fall. However, greater the risk taken, greater are the chances of earning exceedingly good returns in a short time. Along with the returns that you earn, some stocks do provide income in the form of dividends.
- Stock Market Knowledge:
Mutual Funds, are professionally managed by fund managers who are well versed with the market conditions at all times. Hence, the need for an investor to personally monitor the stocks is almost eliminated and this is a major drawback as the investor will not be much aware with the terms like stock analysis, valuation, EPS, intrinsic value calculation.
- Legal liabilities are restricted :
Since you are a passive holder of common stocks, your liability to a company is limited. Any problems that arise beyond a stockholder’s financial investment, will not affect you.
- Volatile Investments :
On one hand this may be seen as benefit, as investors do not mind volatility upside however downward volatility can result in a severe loss. The market is uncertain and constant monitoring is required in order to minimise the losses.
This is probably the major demerit of investing in stock market. If a company files for bankruptcy, you will not be paid till those who rank high on the priority ladder aren’t paid. The company has to cover the costs that come up as a part of bankruptcy. The law firm, the accountants, the auction services and other services involved in winding up the company are payable followed by creditors.
- High Brokerage costs:
Buying and selling stocks costs money in the form of brokerage commissions and many brokerage firms charge account maintenance fees as well. This might end up using all your profits earned in the stock market.
From the above, we can conclude the following:
- No investment is risk-free. There is not just a single risk involved but various like market risk, inflation risk, credit risk, interest rate risk, exchange risk, etc.
- Where on one hand, mutual funds have a lower risk, they also have relatively lower returns in proportion to the stocks which possess high risk.
- Investing in stock market includes both investing in stocks/shares as well as investing in equity mutual funds. We have always heard that investing in company stocks is risky, but so is investing in mutual funds as they are just a basket of company stocks.
However this is where the difference arises because the characteristics of investing in mutual funds differ widely from the characteristics of investing in shares.
- The investors with limited time, money or expertise may find mutual funds a suitable investment vehicle. It provides the benefit of diversification which involves mixing of investments within a portfolio and is used to manage risk.
- Stocks are not the magic answer to instant wealth with no risk. The key to protecting yourself in the stock market is to understand where you are putting your money. You can lose all of your investment with stocks if you don’t do a detailed analysis and invest blindly on the basis of the rumours or unverified information or tips.