There are millions of investment articles published on internet for beginners. Some are so detailed that people can follow them as a bible.
But while I was doing my research on a potential topic on which I could write, I found a very strange revelation. I will tell you what was that.
While I was researching my topic I found that most of the articles are either too detailed for a beginner or they lacked the depth.
Another problem with topics of finance is that, it can tend to get too tough-to-understand for a beginner.
So how a beginner can learn the process of investing money?
Beginners has plethora of questions in their mind regarding investment. Some questions are ‘important’ and some are result of mere lack of understanding.
When beginners read more about investing money, their understanding about investment increases. As result their questions start getting answered on their own.
But the important questions may not get the right answers just by reading reference books. The problem is, reference books are too detailed and can confuse the beginner.
In such cases, it is good for beginners to read blog posts like this one. Bloggers try to explain difficult topics in the most colloquial way. This makes the understanding by beginners very easy.
Out of all the difficult topics that I come across during my study, the most common topic faced by beginners is related to investment risk management.
Beginners have huge potential to take risks. Due to their young age they can take much higher risks. But they still feel afraid to invest money. The reason being, lack of clarity about risk management.
If beginners only know the right answers to the following ‘questions’, they will practice investment fearlessly.
Q#1. What is my risk taking capability?
If a person knows accurately their risk taking capability, they will invest very wisely. Invariably, wise investments gives full satisfaction to its investors.
But how ‘knowing’ ones risk taking capability leads to ‘full satisfaction’?
Majority simply jumps into investments without doing this essential check. This they do in sheer ignorance, as they do not know the ‘power of investing within ones risk taking zone’.
Lets take an example to understand the concept of investing within ones risk tolerance.
We know what it means to drive a car. But different people drive cars at different speeds. People who are more skilful can take risk to drive cars at say 150km/hr. People who are averaged skilled can risk to drive car only at 100Km/hr. A beginner is advised to drive car below 60Km/hr.
The same car’s analogy is applicable for investments as well. People who are more knowledge able about investing, can afford to invest in high risk securities (like direct equity).
But a beginner, who has least investing exposure shall invest in less risky options like balanced funds or debt linked funds.
So the important questions a beginner can ask to self is, his comfortable speed is 150Km/hr, 100Km/hr or 60Km/hr?
To get this answer, one has to drive the car first.
Start investing from today. As a starting point a beginner can buy the following:
1 Stock – worth Rs.1,000
2 ETF /Index fund – Rs.1,000
3 Equity mutual funds, – Rs.1,000
4 Index fund – Rs.1,000
5 Balanced mutual fund- Rs.1,000,
6 Fixed deposit (6month) – Rs.1,000
7 Keep money parked in savings account.
Allow yourself 2-3 months to accumulate these assets. If you have funds, buy all in first month itself.
All these assets together makes your investment portfolio. Start observing your portfolio every 3 days. You will have the following observations:
- EQUITY – Stock price, ETF/Index fund & equity mutual fund fluctuates the most.
- BALANCED – Balanced mutual fund are relatively stable.
- DEBT – Fixed deposit and savings in banks are most stable.
Equity movements makes you excited? Slow gradual movement of balanced funds are not interesting? Fixed deposits and savings look like useless option?
If these answers are YES, you are an aggressive investor. You can invest in direct equity and take high risks.
If these answers are NO, you are a defensive investor. You can invest in balanced funds for better returns.
There are people who only find solace by investing in debt linked investments only. For them even balanced funds are risky.
This is one very effective way to learn ones risk taking capability.
Q#2. How risky investments like stock give high returns?
Stocks are risky because their price fluctuate every second. As these prices are so volatile, hence a person who invests in stocks for short term, has very high chances of incurring loss.
But the same stock price, when viewed with long term perspective, will show a definite growth curve.
How this is possible? On one side its is risky in short term, but it gives high returns in long term? Is this judgement logical or its just a farce statement made to promote stocks?
By no means this statement is farce. Stock are not just any piece of paper, they are basically a business divided into its smallest entities.
Each stock represents a proportional ownership in a business. If I hold 1,100 number stocks of BOSCH, it means I have 0.0035% ownership in this company.
So an entity like stocks, which has such powers to make an individual an owner of a big company like BOSCH cannot be termed as farce.
But considering that stocks represent a big business behind it, it takes time for it to show growth.
Generally, a good company shows consistent growth each year. But the same growth may not be reflected in its stock price. So does it mean that stock is bad?
Not at all.
One must understand that stocks prices are derivative of only one factor “its demand and supply”. When demand of stock is more than its supply, its price will go up. When demand of stocks is less than its supply, its price will go down.
In lay man terms, when more people are buying stocks, its price goes up. When more people are selling stocks, its price goes down.
So market price movement is just an end result of demand and supply.
But as an investor we must know, what triggers the demand and supply of stocks. Following factor effects stocks prices in a major way:
a) Business fundamentals
b) Domestic and global environment
Both these factors effects the demand and supply of stocks. Lets take an example.
Suppose a company posted a 15% growth in its profits on YOY basis. In this case more investors will like to buy its stocks. Means its demand will go up. This will immediately reflect in its market price.
Suppose another company posts a loss on YOY basis. In this case there will be more sellers of this stocks than buyers. It means its supply will increase. Price of this stock will fall.
Suppose there is a problem like BREXIT in Europe. In such situations, investors mood are down. In such a mood people do not buy new stocks. Instead, they sell their stock holdings and keep their money parked in safer investment options. In such gloomy environment, demand for stocks will be less than its supply. Hence price will fall.
Suppose a strong Prime Minister like Narendra Modi is appointed in a country. Such events immediately lifts the mood of investors. You can see the result today. Sennsex has already crossed 30,000 mark.
So, stocks which is backed by strong business fundamentals and good operating environment is bound to see growth in long term.
The only care an investor has to take is: (1) buy stocks of good companies & (2) hold it for long term (>5 years).
This way stocks will automatically give high returns.
But what it means by high returns? Can one double money in 1 year in stock market?
In India, in last 19 years, stocks market has averaged a return of 9.5% per annum. When one holds on to stocks for such a long time, this kind of return is almost certain. At rate of 9.5% p.a. return, money doubles every 7.5 years.
If 9.5% is looking low, compare it will average return of debt linked instruments. A typical debt linked instrument would have given a return of less than 7% in last 19 years. Adjust it for inflation and this value will go down further.
Q#3. How a beginner should invest in stocks
For a common man, stock investing is very exciting but they avoid it due to the risks involved with it. The risk associated with stock investing can be minimised by learning more about stock analysis.
But not many has time nor patience to learn the skill of stock analysis.
So what is the alternative?
There is a fantastic financial instrument available for common man using which they can invest fearlessly in equity market.
I am talking about mutual funds. Expert fund managers buy stocks on behalf of us. Hence we are spared the headache of doing complicated analysis and stock purchasing.
To make equity investing even more risk free, one can invest in mutual funds through systematic investment plans (SIP’s).
Through SIP’s one does not invest all the money at a time. Lump sum amount is distributed into smaller sums of money and invested gradually over several months.
Suppose you have $6,000 to invest in mutual fund. Normally people would buy mutual fund units worth $6,000 in one go.
But in SIP, instead of investing all $6000 at a time, $500 is invested for next 12 months. Means, to invest $6000, SIP will need a time span of 12 months. This type of investing further reduces the investment risk. How?
We know that price of equity is very volatile. It moves up and down unprecedentedly. In such a scenario, for an average investor, it is very difficult to decide a good buying point.
Hence instead of waiting for ONE ‘best time to invest’, SIP’s keeps buying mutual fund units all the time (once every month).
This way, when market price is low, more units are purchased. When market price is higher, less units are purchased.
So the end result is, average returns. In long term, this average returns can also be quite phenomenal, like 12-16% per annum.
Q#4. How I can create a risk free investment portfolio
It is not possible to build a risk free portfolio and also earn high returns.
If one desires high returns, one must buy riskier investment options like stocks, equity mutual funds etc.
But do not worry, there is a way to build a balanced investment portfolio.
One must target to keep several types of assets in ones investment portfolio.
When one is buying stock, he must also buy bank deposits. When one is buying equity mutual funds, one must also buy gold. When one is buying bonds and debentures, one must also buy real estate property.
If this sounds too complicated, I will suggest a more understandable and implementable solution.
Generally people invest their money to gain capital appreciation. This is a more risky form of investing.
If idea is to minimise the risk, focus should be on buying “income generating assets” instead of capital appreciation.
Income generating assets are less risky and they also give decent returns.
Few income generating assets are as follows:
a) dividend paying stocks
b) rent yielding real estate property
c) MIP offered by mutual fund companies
d) MIP offered by India post office
e) Savings a/c and fixed deposit accounts in banks
Another easy and reliable alternative to maintain a low-risk investment portfolio (and also not compromise too much on returns) is to invest in balanced mutual funds.
When a beginner is investing money (young people), there is not much at stake. At that stage of life one can invest almost fearlessly.
In fact it is that age where one can afford to be fearless. By no means I am promoting reckless investing, but investing is a skill that builds with experience.
If one has the basics of investing, practice will make the person perfect.
The only care one has to take is to ask right questions before investing.
Above listed are those questions beginners must ask before investing their hard earned money.
These are not just questions, there are complete investing lessons.
At the outset it might look like they are simple, basic questions, but while searching for answers for these 4 questions, one can in fact learn the most intricate details about investment.
Read my explanations that I have provided in above 4 questions. Try to compare my answers with other articles published on internet by other authors.
I firmly believe that if people can master the answers for these 4 questions, they become half investor.
Keep reading and keep growing.
Have a happy investing.