EspressoLogy

The Indian stock market is a mature market, and the recent highs despite the ongoing Second Wave of the pandemic is indicative of this stability. But irrespective of the market’s performance, investing in stocks is a good way to accumulate wealth. Don’t wait for the tide to turn to jump in. Start investing now and stick around for the long run to benefit from your decision.

How does the market work

Companies in India list their shares on the NSE or BSE by issuing an IPO. Investors or traders buy or sell these shares either because they believe their prices will go up or down in the future because of various reasons, including expectations of improvement or worsening in their business prospects.

With that out of the way, here are a few pointers you should keep in mind as you prepare to enter the stock market in 2021.

#1 – Ask yourself why you want to be in the stock market

If you believe the stock market is a way to get rich quickly, you will not succeed. Don’t expect to become rich overnight, or think that you’re going to make a fortune investing in the stock market. While it is true that you can make good profits, this happens only if you invest time and hard work to develop your investing or trading framework and stick to it with discipline and patience.

#2 – Complete your financial plan

Speaking of financial planning, before starting to invest in stocks, it is always important to make sure you qualify. A good thumb rule for this is that you should have set aside an amount for emergency purposes (say six months’ expenses) and have covered key risks using insurance.

If you have large credit card bills that you’ve been clearing with minimum payments, it’s better to clear the bill completely before you start investing. You will never be able to beat the 42% or so interest charged by credit cards. 

#3 – The power of discipline and long-term investing

It's important to remember that, over the long term, stocks on average tend to give better returns than most other asset classes. And that's something most people know, but they do not always fully appreciate the difference this makes.

Consider this hypothetical example: if you invest Rs 1 lakh in an FD at 6% while reinvesting the interest, in 25 years, you will have Rs 4.3 lakhs. But had your investment grown at 12% instead of 6%, you will end up with Rs 17 lakhs.

The best way to take advantage of long-term investing is by consistently investing small amounts in companies that you understand or are satisfied consumers of (another option is bluechip companies). Investing on a regular basis will average out your cost of purchases and reduce volatility risk while allowing your investment to grow in line with the company's earnings.

#4 – Define your asset allocation and return expectations

You can expect 5-6% compounded returns from FDs and 10-12% from just buying and holding the index (based on NIFTY’s historical performance). If you’re doing active stock investments, it means you hope to beat the index’s returns. If you fail to clear that benchmark, you will want to step back and examine if this is even for you. An asset allocation plan, best created by a financial planner, will tell you how much you should be investing in stocks, FDs and other asset classes.

#5 – Define your risk appetite and investing timeframe

A related concept is risk appetite and investment timeframe, which will also be part of your financial plan. It will dictate how much risk you are comfortable taking. As a youngster, you can afford to make high-risk investments, as you have lots of time to recover from probable losses. The converse will be true if you start investing late in life.

#6 – Read up on the basics of trading, investing and behavioural finance

There’s a saying by Confucius, “Knowledge without practice is useless. Practice without knowledge is dangerous”. Read the top five books on investing and trading before you take the plunge. Getting a basic understanding of how to read financial statements or stock charts will give you a lay of the terrain. Look at online videos that will help familiarise you with the market infrastructure: demat accounts, limit orders and the like.

#7 – Build a basic investment framework

Once you know the basics, it will be essential to create a framework on how you will pick stocks. The simplest, most reliable way is to create a portfolio comprising of bluechip (recognised, financially sound) companies. Another approach is to buy consumer-oriented companies whose products are used popularly. It’s also important to remember that such investments compound over the years.

#8 – Trader or investor?

As opposed to buying and holding well-run businesses for a long time, you can choose to become a trader, where you will buy and sell stocks with the intention of holding them for only weeks, days or even minutes. Trading can give you higher profits but is also a lot riskier. As important as it is to develop your framework, it is even more important to keep learning and upgrading it.

#9 – Do not borrow to invest

Borrowing to invest is a highly risky idea that even seasoned investors tread on very cautiously. The thumb rule with investing in stocks is: invest money that you won’t need over the next few years. You should be able to take a 20% loss on your investments immediately or in the near future without flinching.

#10 – Understand taxation

Understanding how capital gains are taxed in the long and short term can help you save on tax. If you sell your equity fund units before the holding period of a year, the gains are treated as Short Term Capital Gains (STCG) and are taxed at 15%. Alternatively, if you sell your units after a year, your gains are treated as Long Term Capital Gains (LTCG) and attract a tax of 10% if they exceed Rs 1 lakh.

Long term capital losses can be adjusted against LTCG or can be carried forward for setting off for up to 8 assessment years. Short term capital losses, on the other hand, can be set off against STCG and LTCG.

Now that you have a primer on investing in the stock market, we hope you seize the day and start investing!