Thinking what to know about stocks before investing? There are several basics that you should always know before taking the plunge. If you have considerable experience and expertise then you can always directly invest in equities while if you are a beginner or do not want the hassles of regular tracking and portfolio management, you can choose equity mutual fund investments via SIPs (systematic investment plans). Here are some points that you should always keep in mind before deploying your investments.
10 Things to know before investing in stocks
Stock market investments are not rocket science but there should be a few basic aspects absorbed by you before venturing into the same. Here’s looking at the same:
- Allocation to Equity– This is the first and most basic aspect you need to be familiar with. Every investor has a specific appetite/tolerance for risk along with a certain ability to take on risks as well. With regard to investments in equity, you should go by your own abilities to withstand risks. Your allocation towards equity will go up or reduce on the basis of your prevalent need towards wealth creation and also on the basis of factors like your liabilities, age, opportunities present in the market and so on.
- Stock or Market Risks– Making investments in stocks will always mean higher levels of risks. There are risks pertaining to macroeconomic aspects such as rates of interest, inflation and movements in currencies along with other risks pertaining to volatility and liquidity among other factors. Then there are risks specific towards business sectors and stocks. The first two risks are systematic risks while the third risk is unsystematic in nature. Whenever you purchase a stock, you should be aware of the risks mentioned above. Index funds are suitable if you are okay with only systematic risks; otherwise, you should decide accordingly.
- Stock Volumes in the Portfolio– There is no regulation on the number of stocks that you should possess in your portfolio. The benchmark is usually around 10-12 stocks in the same since if you have too few of them, then you will not benefit from a diversified investment. If you create a portfolio that has too many stocks in it, you will not be able to track the same effectively and they will not have diversification value as well.
- Stocks that pay out dividends– You should ask yourself whether you should purchase stocks with higher yields through dividends. People usually buy stocks for gains in the long haul and not majorly for earning dividends. These indicate liquidation (partial) of the company and lowers values of the same as well. Companies that reinvest profits and earn higher returns on investments usually have higher valuations (PE ratio) in India in comparison to those that pay the dividends frequently.
- Understanding the stocks in your portfolio– Buy only those stocks which you understand intrinsically. Stick to areas where you have knowledge and expertise or at least a basic idea. When you purchase any stock, you will have to track figures, performance, industry, news and so on. Unless you have a basic understanding of the industry, this will not be possible. You should not purchase random stocks for your portfolio.
- Expectations- Whenever you invest money in equities, you should be mentally prepared to incur losses. Historically speaking, even seasoned stock market experts are spot on probably 20-30% of the time. The remainder is usually flat in terms of returns and even losses at times. Whenever you get it wrong, make a fast exit from the stock and do not annualize expected returns. 10% returns in a particular month will not mean 120% returns in a year’s time. Keep your expectations more practical and realistic regarding returns from your investments.
- Problematic Aspects of Stocks– These aspects of the problem areas of specific stocks are usually known as red flags and you should evaluate the same carefully before investing. Some of the red flags include continual tax based inquiries from the authorities, losses made on a consistent basis, objections from bodies like SEBI and other regulators, defaulting on bonds or credit default spread and objections linked to audits. Several stocks have often taken sizable hits on valuations/prices whenever any such problem area manifested into a major issue. Such aspects should be warnings for you with regard to not investing in these companies.
- Do not go blindly by tips– You will not become rich overnight by purchasing a stock at a price of Rs. 100 and selling at Rs. 300 within a few days. These are mostly one-off or rare scenarios. In most cases, penny stocks are not worth a lot and you should always avoid their temptations as much as possible. Do not go by market rumours and sudden blind tips. Most of these tips and rumours have their own agendas and will serve to distract you from your objectives and goals. Trust only your own judgment, your broker/advisor’s knowledge/research and your core competencies.
- Doing homework– It is always necessary to do your homework thoroughly before investing. Carry our research on the stocks to be purchased including leverage, profits, overall efficiency, future prospects, ratings, returns historically generated, margins and so on. You need not always be an industry expert or top-notch analyst. Simple homework and research will help you make decisions that are more practical and informed.
- Avoid timing the market– Do not go for timing the market since it is not vital and mostly impossible to perfectly catch the bottom/top ends of the market. If you take your time and deploy investments regularly in diversified and high-performing equity funds and remain financially disciplined/committed for a longer time period, you can create handsome wealth for the future. This should be your core focus at all times.
There are several other aspects worth remembering whenever you invest in stocks. Yet, prior to venturing into the share market, make sure that you do your research and consult financial/market experts accordingly.