How to invest in stocks in India, and also manage the associated risks?
Stock investing is considered risky. The risk is so threatening for many that they avoid investing in stocks all-together.
But is it the right approach?
Returns generated by stocks is always higher than other investment vehicles (debt linked etc).
Generally people find comfort to park their money in the following plans:
- Bank deposits,
- Tax saving options,
- Retirement plans etc.
But in reality these are more of a “savings” option than an investment vehicle.
If the objective is to have fast growth, one must know how to invest in stocks.
It is true that not many know how to invest in stocks. Hence they opt for the above listed alternatives.
But there is also an other side of the story.
Investing in debt plans are like no-brainer.
It is easy for people to buy a recurring deposits and fixed deposits of banks.
People can just log-in to their internet banking account and subscribe to deposits.
The amounts thus invested stay safe and visible in ones internet banking account.
This is what makes people so comfortable with debt linked plans.
But this “comfort with debt plans” comes at a cost.
The returns generated by debt linked plans are too modest (low).
Not only debt linked plans, even the following investment options generates yield which is not as good:
- Real estate,
- Real estate trusts,
- Precious metals etc..
The returns are low and they hardly beat inflation.
Hence, it becomes prudent to learn how to invest in stocks.
#1. Why people are apprehensive of stocks?
If objective of investment is to earn fast growth, stocks cannot be ignored.
But investing in stocks is not as simple as buying bank deposits or an insurance plan.
How we buy our normal debt linked plans?
- Deposits can be purchased online.
- Insurance can be purchased online.
- Agents/Fund managers can come at our doorsteps to sell. etc…
Apart from the ease of buying, risk of loss is also negligible in debt linked plans.
But when it comes to stocks, hurdles are many.
Firstly, people do not know where to buy it.
Stocks are not as accessible as bank deposits.
Moreover, the returns that stocks offer are not assured (they are volatile).
We hear more news of people losing money in stock market, than people making money.
These all factors adds to the negative sentiment and fear related to stock investing.
So what is the way out?
Fear related to stocks are only superficial apprehensions. People who know how to invest in stocks, swear about its success.
It is true that stock investing cannot be practiced casually. There is a procedure to invest in stocks.
To make money in stocks, following the right procedure is mandatory.
A detailed procedures are laid out specifically in my another blog post related to value investing.
But before one takes a plunge into the intricacies of value investing, lets brush-up few basics related to stocks:
- Where to buy stocks?
- Which stocks are good?
Though these questions may look too basic, but getting “right” answers for these is necessary.
If one can answer these two questions, one can go ahead and start buying stocks.
#2. Where to buy stocks?
In India there are two main stock exchange:
- National Stock Exchange (NSE) and,
- Bombay Stocks Exchange (BSE).
In these two major stock exchange, stocks of all publicly traded companies of India are listed.
To invest in stocks, one must first get an access to these listed stocks.
Once the access is obtained, one can easily buy and sell stocks online even from the comfort of home.
How to gain this access?
The access to NSE and BSE stocks are provided by brokers.
Through brokers, anyone can buy and sell stocks.
When we say brokers, these days there are no physical brokers. Online brokers have replaced them.
Opening trading accounts with these “online brokers” is what needs to be done.
Few online stock brokers in India who provides this facility are:
- ICICI Direct,
- HDFC Securities,
- Axis Direct,
- Geojit BNP Paribus,
- FundsIndia etc.
Account opening is a procedure which can take 3-4 days.
Account opening is also not free, but charges are very nominal (Rs.1,000 approx).
These online trading platforms are very user friendly.
Operating these trading platforms are anyways easy. But if someone needs help, online demo can clarify all doubts.
The procedure is so simple that just after 2/3 transactions, one can start feeling comfortable.
[Read more about how to buy stocks online in India]
#3. Which stocks are good?
How should a beginner start with stock investing?
Opening an online trading account is step 1, but this is not sufficient.
To become a successful stock investors, one must also know which stocks to buy.
Do we know which stocks to buy? Yes we think so…. ?
“Buy famous stocks which experts are advising on TV and Newspapers.”
This way to stock investing is not right.
Looking only at the following parameters says noting about the stock being good or bad:
- Market price of stocks, and
- Brand name
If one wants to know if a stock is good or bad, looking at its price or name is not enough.
What must be done?
In stock market, there are thousands of stocks available for trading.
It is essential to screen the stocks using the following 2 basic stock screeners:
- Step 1 – Identify fundamentally strong stocks.
- Step 2 – Identify undervalued stocks from step 1.
Out of all stocks available in stock market, 95% are not suitable for purchase. Why?
Because, they are either:
- They represent bad business or,
- They trade at overvalued price levels.
To invest in stocks successfully, one must first become aware of this fact:
Prevent self from buying overvalued valued stocks and shares of bad business.
I use my stock analysis worksheet to screen good stocks from other.
#3.1 Blue chip stocks
One must buy stocks of only fundamentally strong business.
But this is also true that, for a beginner, evaluating stock’s fundamentals is not easy.
What is the way out?
Buy stocks of such companies whose fundamentals are unquestionable.
Where are such stocks? They are often referred as blue chip stocks.
A newbie can opt to buy stocks of only blue chip companies.
A beginner can buy such stocks and hold it for next 36 months minimum.
This can be a good starting point.
#3.2 Hold them for long term
It is also important to know the significance of 36 months holding time.
They provide following two benefits:
- Avoids the cost related to frequent trading.
- Gives time to the stocks to grow.
People who buy and sell too frequently, for them the cost of trading is high.
Every time one transacts, brokerage charges and taxes/duties are levied.
So less trading means, more savings.
Moreover, the price growth of stocks are not linear.
In short term, price of stocks remain very unpredictable. This happens due to frequent and incessant trading happening in it.
In long term, price of stocks become more predictable.
This is because, the influence of the “underlying business” on its stock price becomes more dominant.
- In short term, trading dominates the price.
- In long term, business dominates the price.
So, when one holds on to stocks for period like 36 months or more, a “good business” will ensure that its stock price only moves up.
So what is the key for beginners who want to invest in stocks?
- Buy Blue chip stocks (good business).
- Hold them 36 months (long term holding).
#3.3 What about undervalued stocks?
In points #3.1 and #3.2, what we saw?
“Buy blue chip stocks and hold them for 36 months”.
Is this all? In most cases yes.
But this method will not work when stock market is trading very bullish.
Like in these days (Mar-Apr’2018), Sensex has been trading at 34,000 levels.
In such bullish markets, blue chip stocks (specially) trade at exorbitant price levels.
Buying stocks at this price levels, is like a crime.
So what one can do?
There are two options:
- Wait and do nothing, or
- Use fundamentals analysis to identify undervalued stocks.
For people who do not know fundamentals analysis, “waiting” is a better strategy.
Patient people make more money in stock market than even ‘expert fund managers’.
[I use my stock analysis worksheet to do fundamental analysis of stocks.]
#4. Indirect investing in stocks
I would like to confess a fact here.
Buying blue chip stocks, long term holding, detailed fundamental analysis may sound pleasant to ears, but practically they are not simple to execute.
For a common man, who neither has time nor expertise, what he can do?
He can decide to invest in stocks indirectly.
Indirect way of investing in stocks is safer.
When one buy equity linked mutual funds, they are actually buying stocks indirectly.
What people buy here are mutual fund units.
Each unit of mutual fund represent a fraction of the total stock portfolio of a mutual fund.
A typical stock portfolio of mutual fund consist of 30-100 individual shares in different proportions.
The idea behind accumulating so many shares in portfolio is to maintain a diversified portfolio.
Different stocks belong to different sectors. When one sector performs badly, other good operating sectors compensates the loss.
This is what is called diversification.
Potential losses are greatly decreased when portfolio is well diversified.
#4.1 Exchange Traded Funds (ETF)
Individual stocks cannot provide diversification. To diversify, the investor must hold several stocks of non-related sectors.
Conventional mutual funds are great vehicle of equity investing. They provide excellent diversification.
But this is also a fact that public loves to invest in stocks.
The possibility to buy a stock, at different price levels, within one hour, makes it so exciting.
People love this momentum.
Mutual funds cannot offer this kind of momentum.
Then, experts devised another invaluable financial product.
It is called Exchange Traded Funds (ETFs).
They offer the following advantages:
- They can be traded like stocks.
- They are as diversified as mutual funds.
[Read more about exchange traded funds operating in India in 2018]
Like mutual funds, ETF’s are another alternative to invest in stocks, indirectly.
#5. How to invest in stocks : Tips?
With advent of technology, putting money in stock market has become perhaps too easy.
This is also one reason why, bad investments are happening too often.
But on flip side, good information about stocks are also available for free.
For an investor, it has becomes much easier to get access to reliable information about stocks from internet.
In addition to this, a common man can follow the below procedures to invest in stocks successfully.
#5.1 Have clear goals.
To ensure more effective stock investing, one must clearly spell out the ‘goals’ first.
Before buying the first stock, the person must know why he/she is buying that stock at all.
Defining clear and quantifiable goal is a key.
[Read more about goal based investments here]
Never buy a stock without assigning a purpose/goal to it.
#5.2 Take calculated risks.
Be aware of your risk taking capability.
Following people, in general, can take more risks:
- Person with a bigger emergency fund can typically take more risk.
- A person who is carrying less debt can take more risk.
- Bachelors can take more risk than family men.
What means by bigger emergency fund?
A person who has 6 months worth of monthly expense as savings is more poised to take risks in stock market.
Suppose ones monthly expense is Rs.50,000.
If this person has Rs.300,000 (50000×6) parked in fixed deposit (emergency fund), he can take more risk with stocks.
Caution: Never touch the emergency fund to buy stocks.
#5.3 Use free cash to buy stocks.
First build a big enough savings, and then never touch this savings to buy stocks.
Once this milestone is reached, start saving from your paycheck.
Save at least 20% of your income.
Keep aside 5% for buying stocks. Balance 15% use for other needs.
Give a name to this 5% saving. What name?
Name it as “free cash”. What is free cash?
It is that money, which even when falls down the drain, will not effect your standard of living adversely.
This is “Free” cash is real sense.
People who earn more will have bigger “free cash” and vice versa.
Use only your free cash to buy stock. Never touch your paycheck or savings.
#5.4 Build your own list of good stocks
I use my stock analysis worksheet to do identify my list of good stocks.
I use this tool to analyse stocks.
The stocks which I find are good, but is overvalued, I add it to my watch list.
When price of these stocks falls, I buy them.
This is an easy and effective way to buy stocks and also make money from it.
People who do not want to enter the hassle of stock analysis, can buy mutual fund units using step-up systematic investment plan (SIP).
How to invest in stocks in a wrong way?
Buy stocks which others have suggested you to invest in.
If being successful in investment was possible only on basis of advice, probably everyone would be a millionaire by now.
But only the reverse is true, right?
People who are successful in stocks have found their own unique way to invest in them.
You can also find your own way.
Use the broad guidelines provided in this article.
To sum-up what we have read in this article:
- Stocks are risky.
- Debt linked plans offer less risk.
- Stock can give higher returns.
- Learn to buy good stocks.
- Open a online trading account.
- Buy undervalued stocks of good business.
- Holding Blue chip stocks for long term is a good strategy.
- Use Mutual Funds or ETF’s to buy stock indirectly.
- Buy stocks directly. But before that, fix a goal.
- Take calculated risks, & use only free cash to buy stocks.
- Build your own list of preferred stocks.
Have a happy investing…