Disclaimer: The following content by Wealthfare is for informational purposes only and should not be construed as financial advice.
Everyone is searching for a quick and easy way to wealth. It appears to be a human attribute to constantly search for a hidden key or some esoteric bit of knowledge that suddenly leads to the end of the rainbow.
In India, people usually buy a common stock (a blue chip) that quadruples and more in a year, which is extremely unlikely, since relying on luck is an investment strategy that only the foolish or most desperate person would choose to follow.
Being a beginner, your quest for success often overlooks the most effective tools available to us: time and the magic of compounding, which is the eighth wonder of the world.
Other than the power of compounding you need to avoid unnecessary financial risk, regular investment and letting your money work for you, while you are asleep over a period.
Here are some certain ways to amass significant wealth.
Here are some pointers that can be followed by beginning investors:
- Set Long-Term Goals
Being a rookie, you first need to ask yourself: Why are you investing in the stock market? For how long are you willing to hold your investment? What are you saving for: is it retirement, future college expenses or purchasing a home?
Before investing your hard-earned money, you should know your purpose and the time in the future when you may need the funds.
Keeping a long investment horizon always proves to be beneficial for an investor. It is likely for your investments to get multiplied 3-5x..
The growth of your portfolio depends upon three interdependent factors:
- Capital- The amount you invest
- Annual Return- The amount of net annual earnings on your capital
- Period- Years of your investment
Ideally, you should start saving from a young age if possible, save as much as you can, and receive the highest return possible consistent with your risk theories.
2. Understand Your Risk Appetite
In layperson terms, risk appetite is the level of risk that you are willing to incur in the pursuit of your objectives. Everyone’s risk tolerance depends upon a few factors:
- Age- It is advisable to start investing from a young age, as your risk tolerance is high and you get a long period to hold your investment.
- Capital– If the capital which you are investing is your only saving, then the risk tolerance is low.
- Perception- Risk varies from perception to perception, a person who has complete knowledge about the stock market will consider it as a less risky affair while on the other hand, a person with limited understanding will feel it risky.
Generally speaking, never invest in a company’s share which keeps you awake at night. The investor with a calm and composed mind who understands the analytics and the risk comes out as a winner.
3. Diversify Your Investments
Never put all eggs in one basket. This idiom is best described in the stock market.
Every investor, be it a beginner or a professional, should try to diversify their portfolio. Diversification helps you to mitigate risk and can enhance the performance of your portfolio.
Let us understand it with 2 cases-
Company A suffers a loss of ₹120
Company B gains ₹90
Company C gains ₹80
|CASE 1 (Narendra)||CASE 2 (Rahul)|
|Capital- ₹100||Capital- ₹100|
|Invested in company A- ₹40 (loss- ₹80)||Invested in company A- ₹100|
|Invested in company B- ₹30 (profit- ₹60)|
|Invested in company C- ₹30 (profit- ₹50)|
|Receives gain of ₹30||Suffers loss of ₹20|
Hence, the popular way to manage risk is to diversify. Prudent investors own stocks of different companies of different industries, sometimes in different countries with the expectation that not even a single bad event will affect the holdings.
4. Control Your Emotions
The biggest obstacle you’ll face in the stock market is the inability to control your emotions and make logical decisions. The emotions get reflected in the prices of the shares if the majority of investors are worried about a company, its stock price is likely to decline and vice versa.
These movements are driven by panic, rumours and speculation, rather than logic or systematic analysis of the company assets, management and past trends.
When you buy a stock, you should not think that you are purchasing a share, you should have a good reason for doing so because it’s not just a share, it is a business which you are purchasing and if you cannot see your portfolio value going down by 50% then you should not be investing.
5. Handle Basics First
Half knowledge is dangerous, we all have heard this phrase and when money is involved, it becomes much more dangerous. Before making your first investment, take time to learn the basics of the stock market.
And for investing you need to do a fundamental analysis of the company.
The areas with which you need to be familiar before making your first investment include:
- Financial ratios – Firstly you need to be well versed with the workings of financial metrics like P/E ratio, ROE, ROCE and CAGR. Only after knowing this, you will be able to evaluate the company.
- Market strategies – Learn about different strategies that can help you predict the market and help you earn returns.
- Different investment avenues – Know about other investment options like futures and options (F/O), currency markets, commodity markets.
As Warren Buffett rightly said, “Risk comes from not knowing what you are doing.”
The hardest part is the willingness to invest time and to take initiative.