How common investors can invest in the stock market

By Investment Blogger, on August 25th, 2010

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Stock market is a puzzle for majority of population. How a common person can effectively invest in the stock market is discussed in this article. The price of stock market keeps on falling and rising every day. This volatility of stock prices makes people very uncomfortable and unsure. But there are people in this world who are using this volatility of stock prices to their advantage. These are same people who have made fortunes in stock market. One of the big name who have used this price volatility to make money is the great Warren Buffett. It is known that Warren Buffett uses Value Investing principles to buy stocks. Value investing focuses on price fluctuations of stocks. At times, stock prices of fundamentally strong companies fall below reasonable limits making market value of stocks very lucrative for buying. This is true for companies who are already well established and has shown above average returns in the past. Warren Buffett focuses on large cap companies, who have big brand names, whose business is easy to understand and is run by strong managers. Warren Buffett has kept his investment strategies as simple as possible. I personally believe that Warren Buffett’s way is to invest in the stock market is more with logic than on speculation and emotions. But common people does just the opposite, they buy stocks on emotions and advice instead of doing the fundamental analysis of the company.

Do not worry I am not going to gives lectures on fundamental analysis of stocks in this article. Instead I will suggest few easy tips common people can use to invest in the stock market. There is no doubt that these tips are easy to understand and implement. But the only problem is that these tips are so simple that people psychology often ignores it as unimportant. But let me remind my readers that these are all age old rules and are identified as golden rules to invest in the stock market.

(1) Show patience & accumulate savings for every stock market correction
All across the world you will hear people harping on necessity to save and invest systematically. The hype of systematic investment strategy is created by the mutual fund industry. High commission is earned by agents who market the systematic investment scheme. Total Mutual fund industry is dependent of systematic Investment Plan (SIP) of small investors. Instead of saving, people consider it wise to lock their money. They invest in the stock market through SIP schemes. They fear that liquid money will get spent anyhow. They are not wrong, but this is where Warren Buffett stands away form the crowd. He probably does not believe in systematic investment theory all together. He only believes in value investing and follows it to the core. Till the stocks are valued correctly he will never buy an equity or any equity linked schemes (mutual funds etc). The time when he is not investing he is only accumulating his funds. His objective is to have enough cash-in-hand when he eyes a value stock. Let’s take an example, there are two brothers Jack & Jill. Jack believes in systematic investing and Jill believes in Value investing. Both the brothers decide to save $100 each month to invest in the stock market. As jack believes in systematic investing, he contacted a mutual fund company and stared SIP. In twelve months time he invested $1200 and got a return of 15% on his deposits. This made his investment value increase form $1200 to $1380. On the other hand Jill saved $100 per month to accumulate $1200 in a year. He invested nothing for one year; instead he was waiting for the stock market to crash. Fortunately for him within a year the stock market corrected itself and crashed. He was prompt to invest in the stock market during this fall and bought a share which was priced at $35 before crash at $15. The number of shares he bought was 80 nos. It took the market some four months to regain back its initial level of $35. The stock was now worth 80 x $35 = $2800. The return is astounding 133%. This is the reason why value investing is considered such a fool’s proof way of investing in the stock market. But important is to have control. Value investor shall be patient and keep accumulating savings for every market corrections.

But the point is how to know when the market is correcting itself. Every time we cannot have global financial crisis of USA. If it would have been the case then we could have known about it in our news channels. But small and medium corrections are not reported in news channels like an alarm. I will give you a solution. Take a situation of today, Sensex is hovering around 18,300 levels. Open an account in Google finance and prepare a portfolio of hot stocks of Bombay Stock Exchange (BSE) as per existing market price of these 100 stocks. After you have entered all 100 stocks in the portfolio, at least each week you can log into your Google finance account and see the performance of these stocks. There will be days when you will see that all stocks are in red (their prices are falling). Please keep it in mind that you have to invest in stocks on each correction which is more than 35% (as a rule of thumb). Generally stock prices fluctuate from 1% to 10% maximum. But in cases when the prices have fallen more than 35% it means there is a genuine correction. All value investors wait for such moments and take quick actions to invest in the stock market. During global economic crisis of year 2008 in USA few stocks fell by more than 150% to 200%. Google finance is a great tool that will track all stock market corrections and keep you up to date. Invest in the stock market with help of Google Finance and your will see the benefits in times to come.

(2) Keep on reading Business news and put your money in business showing future prospects.
What I am trying to say is; imagine yourself who knew to invest in the stock market during early days of Microsoft. Consider buying shares of Microsoft during its inception. History says that by this time you would have made 2500% on your investment. If you would have bought shares of Microsoft on Oct’1990 its rate was only $0.89. Today it is trading at $24. If you would have invested $1000 in year 1990, it would have become $26,000 dollars in 20 years. Please note that we have not considered the dividends and bonus shares issued to investors in these years. The results are outstanding. So when I say that keep on reading news, I intend to say that keep track of future Microsoft’s. Like in today’s world, alternative energy sources are every body punch line. People are speaking about green vehicles, green buildings, green energy and what not. Today’s investors can invest in the stock market companies that are developing environmental friendly products. In India infrastructure industry, financial sectors, power, utilities and tourism are showing immense scope of growth in times to come.

But in order to realize a pattern of industries/ business showing strong future prospects, one must be updated with the daily news of industry. I know, today’s generation is not good in reading business news papers. Instead they would prefer reading them on their apple tablet. Young investors can create a Google Alert for Investment news and get live news each day in their mail box. People can also use Google News forum to read local as well as international updates. During first few months, just go through the headlines and main points, but gradually when you will learn to build links, you will start to enjoy. Within a year or two, you will start to see pattern between information’s. Daily news may also give some quick leads on how to invest in the stock market and buy future stocks. For me Google News works best.

(3) Focus on creating a substantial portfolio first. Then maintain a portfolio turnover of maximum 10%
I will give an example for more clarity. A friend of mine was very motivated one day and he managed to invest in the stock market by buying stocks worth $1000. Fortunately he also bagged a good return of 20% within a year. But at the end of the year he managed to sell 100% of his portfolio ($1000+20%) to buy hi-tech gadget for his house. The effort he made to generate and invest those $1000 in a year all was spent in a day. This is one of the bad examples of how to invest in the stock market. Now, let me give you a good example, one of my other friend, saves $200 each month as recurring deposit in his bank. He did this for nearly twenty years and occasionally during market corrections he invested and bought value stocks. By the end of twenty years his principal invested amount was equal to $48,000 ($200x12x20). As he was occasionally buying only value stock, his was able to earn an interest of 18% CAGR during this twenty years. By the end of twentieth year his investment value was $4,15,000. Within this twenty years he never touched his portfolio and he kept on saving and buying value stocks. But after twenty years he decided to take premature retirement form his job. He decided at each year he will draw 10% money form his portfolio of stock worth $4,15,000. Means he will sell his stocks worth 10% by value equal to $4,1500. This will give him approximately $3,500 each month in his pocket. As value of stocks can also be assumed to grow at least at the stock of 105 each year, means he has an unlimited deposit form which he is taking 10% return each year. This ten percent money is known as his portfolio turnover.

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