The stock market attracts investors in large numbers, called direct investors. Similarly, some investors participate via the indirect route like mutual funds. The euphoria caused by rising indices and the fear of missing out (FOMO) is amongst the most popular reasons for mounting direct retail interest in the stock market. Of course, investors desirous of meeting their saving goals co-exist. Are you an investor and want to participate in the capital markets? Have you recently embarked on the investment journey, or will you soon do so? This note on investing in the stock market for beginners, will undoubtedly help lead your thoughts in the right direction.
Investing in the stock market is an integral part of our investing journey. According to the reports, approximately 1.3-1.5 crore new retail investors registered in India in fiscal 2021. As a result, the total retail ownership of shares rose to an all-time high, and one can expect the trend to continue. Furthermore, the total market value of retail investors portfolio rose to over Rs 16 Lakh crores, again a high. The point, though, is not to emphasize the statistics. Instead, it is to stress how vital retail investors are. And, at the same time, also to indicate how famous the stock market is as an avenue to invest.
We indeed emphasize that you should invest, whether directly or indirectly. And remain invested for the long-term. However, as we say this, we also encourage you to identify your motivation to invest. In other words, unless you have a purpose or an end goal, the outcome from investing activity will never give satisfaction.
Why do you want to invest in the stock market?
One step at a time, and first things first. As an investor, you must answer this question (to yourself) as to why you want to invest in the stock market? There can be many reasons – some could be thoughtful while others with no great deal of thought. For instance:
- It is easy to invest in stocks
- Friends and relatives invest in shares, and you are inspired to do it
- Stocks earn higher returns
- Accumulate a target corpus to meet an identified goal
- Protect the value of money by making more than the inflation
- Fixed risk-free return is not enough for the risk tolerance you have
- There is a genuine belief in long-term investing and the benefits of it given our fast-growing economy
- You believe in the prospect of a company where you want to invest
In other words, whatever be that reason, you must identify your motivation. Worthwhile to note, this is a long-term journey, and that is a given, whatever be your inspiration.
How much do you want to invest?
The next step is to gauge what is the right amount to invest. Of course, the investment amount is a subset of the amount one saves. For all practical purposes, keeping cash beyond a point is unnecessary. In other words, as it turns out, saving is usually equal to investment.
How much should you save?
Savings is always a percentage of income. Therefore, savings should never be residual of inflows left after meeting expenses.
Simply put, your investment goals will determine the amount you need to save to meet the objectives. However, to know whether you are saving enough or not, the below chart will help. We have attempted to establish a thumb rule around what should be the savings-to-income ratio (S2I ratio). But, of course, the ratio changes as you age and progress in life.
|Up to 25 years
|26 – 35 years
|36 – 45 years
|46 – 60 years
The above is the suggested minimum savings percentage of your net earnings. In other words, you can save more if possible at every stage.
Target to save at least 10% of your income as soon as you earn. Then, gradually as your income increases, you must double your S2I ratio. It is possible to double your savings % because your income grows in more proportion than expenses. Also, increasing your savings is more relevant because you are likely to take on more responsibilities in life. In the 36 – 45Yrs age bracket, your income rises, and so does the financial liabilities. Still, you must continue to save adequately to meet your long-term financial goals.
How much to invest in equities?
Equity is considered a volatile asset class. One question keeps many puzzled – how much should I invest in equities? Since investment into equity is straightforward from an execution perspective, it is crucial to draw a line and know your limits. Therefore, following an age-based approach that assumes that your risk tolerance is indirectly proportional to your age is worth adopting.
The proportion of your investment into equity = 2 times the balance earning years
|Earning years left
|(Earning age = 65years)
|(2X years left)
Above all, risk appetite does not necessarily reduce to NIL as you age. Still, it is prudent to minimize allocating new investible funds into equities. In the case of a self-employed investor, it is necessary to boil down to an age up to which you can work full steam. Consider that age as the retirement age.
Different avenues to invest in the stock market
The key instruments where you can invest in the stock market are as follows:
- Investing in Equity shares equals investing in a company and becoming a part-owner to the extent of shares purchased. The rights of ownership like voting power, right to transfer ownership, dividends, bonus, split, etc., come with the purchase of shares of a company
- Bonds – companies, government bodies, loan issuers, etc., issue instruments at a fixed interest rate for a fixed tenure. Hence, these instruments are known as debt instruments or fixed income instruments
- A mutual fund is a large pool of money that invests in securities, bonds, money market instruments, and other assets. Professionals who manage that pool of funds are called Asset Managers, and they attempt to generate income and appreciation in the investment value
- Exchange-Traded Funds (ETFs) are gaining incremental popularity. In an ETF, a portfolio mirroring the benchmark index gets created. First, it consists of the securities that form part of the benchmark index. Second, the ETF gets listed on the stock exchange. After that, it allows investors to trade in the ETF like any other stock
- Derivatives – having an underlying asset value linked to stocks, bonds, indices, commodities, currencies, interest rates, etc. are available to invest
What to keep in mind while you choose stocks?
There are several factors, and summarizing in a few lines is impossible. However, we have attempted to recapitulate. Below are a few overarching themes you must keep in mind before making a selection:
- Focus on diversification
- Invest in stocks and sectors that you understand. You may miss a few opportunities, but you are always confident of the investment you made. Note that even some of the world’s greatest investors have successfully followed this strategy. They invested in industries well understood by them and avoided venturing into unknown territories
- Avoid penny stocks – a great strategy when you start investing in stocks. It is easier said than done, as these stocks appear as multi-baggers, but all that glitters is not gold
- Share markets are volatile, and a few securities could be even nastier. Naïve investors should not invest in volatile stocks, at least until they have gained a good understanding
- Direct investing in stocks necessarily requires some understanding of the market. Unless you are comfortable understanding basic financial metrics and can evaluate and compare companies, direct investing can be risky and better avoided
Do not let the recent performance influence allocation strategy
In general, investment decisions serve financial goals over the long term. The performance of an asset class is dependent on factors like the state of the economy, political stability, and many global factors. Undue importance or otherwise due to the recent performance by any asset class may lead to a suboptimal allocation strategy. Therefore, it is critical to consider only the long-term sustainable return of an investment.
Take a recent example wherein after the national lockdown got announced in early-mid 2020, equities significantly underperformed while gold rose. This blip can be an investment opportunity for a few. In contrast, others could panic in this situation and cease to make investments out of anxiety. In other words, never let any temporary phenomenon or fear influence your long-term strategy.
Other factors affecting the decision
Several other factors influence asset allocation decisions. For instance:
- Goals – the flexibility of target allows you to better plan investments
- Risk tolerance – plan returns based on risk tolerance levels
- Financial situation – your financial background as an individual & as a family is a critical factor
- Time horizon plays a vital role
- Constraints – investors have preferences towards specific assets. They might not choose one asset class despite its advantages
- Age is a critical factor in determining the time at hand to invest and grow investment value
Basics of investing in the stock market – how to invest?
A stock market is where shares get traded, where buyers and sellers meet. An investor must have a trading and Demat account to conduct the transaction. Here are some more details.
- Permanent Account Number (PAN)
- Aadhar card
- Cancelled cheque of an active bank account
- Proof of residence
- Income proof
- Passport-size photographs
Demat account, aka dematerialized account, holds the shares, securities, bonds, etc., in electric format. Essentially, the Demat account statement shows the debit, credit, balance history of holdings, just like a standard bank account would exhibit for the money held in it.
In the context of Demat, let us also understand Depository and Depository Participant (DP).
A depository is an organization that electronically holds securities of investors. Currently, there are two SEBI registered depositories. Central Depository Services Limited (CDSL) and National Securities Depository Limited (NSDL). These agencies electronically hold the pre-verified shares and provide Demat services through intermediaries.
A DP is an agent, an interface between the Depository and the investors. Essentially, the Depository provides services through a Depository Participant. Any financial institution registered with the SEBI can act as a DP. In other words, a DP can be a financial institution, scheduled commercial or foreign bank operating in India, a stockbroker, a clearinghouse, a state finance corporation, a non-banking financial institution, etc. Each DP is assigned a unique code.
A trading account goes hand in hand with the Demat account. And the trading account is required to carry out the transactions.
Most companies get themselves listed on both BSE and NSE. Still, there are instances when security is listed only on one of the stock exchanges. However, we recommend preferring an account that offers trading in both BSE and NSE. That is to ensure you never miss trading in a share if the security is listed only on one of the exchanges.
Linked bank account
As an investor, you would require to transfer funds in (for purchase) and out (after selling). You must have a bank account linked to the trading account to move funds.
Costs associated with investing in the stock market
Transaction costs refer to the brokerage paid to the broker. Many discount brokers offer services at dearth low prices, leading to a constant reduction in these costs. Taxes are applicable here, such as securities transaction tax and GST. These costs are incremental expenses.
Demat account charges are payable to depositories (CDSL, NSDL). However, these charges are usually nominal.
Capital gains accrue as you sell the shares. Short-term or long-term capital gain tax gets levied depending on the duration of ownership of a specific security.
Investing in mutual funds
In mutual funds, a set of professionals called asset managers manage the pool of money. The investors subscribe to a mutual fund and contribute money. The fund managers invest in shares, bonds, commodities, etc., as per the mutual fund’s objective. The money gets invested into a large base of stocks that fulfil the fund’s investment objective. Here are some of the advantages and features of mutual fund investing.
Diversification through mutual funds
Irrespective of the investment size, investing in mutual funds provide diversification. For instance, even if the investor subscribes to one scheme, the amount gets invested in 20 to 40 stocks. Such diversification is almost impossible through direct equity investment with the same investment.
Essential to note that we must not invest in similar schemes across multiple fund houses. For example, subscribing to large-cap schemes across fund houses will not classify as diversification. That is because each fund would have invested in a similar set of companies, albeit in different proportions. Still, the exposure is in the same security. That is similar to holding the same share but through multiple brokerage houses.
Systematic Investing through mutual funds inculcates savings discipline
The investor contributes a fixed amount over time through a Systematic Investment Plan (SIP). In other words, systematic investment forces the investor to save that specific amount. Also, since SIP’s are long-term, the investor gains from lower average cost of ownership and returns from compounding gains.
Here are some features of SIP:
- An equal sum gets invested regularly on specific dates
- SIPs apply the concept of cost averaging and deliver the best returns when pursuing a long-term
- No market understanding is required as asset and portfolio managers make investment decisions
- Imposes discipline on savings, especially for those with irregular inflows
- Interest/dividend gets reinvested in growth plans providing compounding returns
- Highly liquid
Ample investment choices
Based on the criteria below, investors can choose a mutual fund that suits their investment objectives.
- Duration – short term or long term horizon. Capital gains tax on income from the investment will also depend on the period of ownership
- Regularity of income – recurring current income required or accumulate gains through reinvesting
- Risk tolerance – swinging returns (high or low) or consistent returns (can be relatively moderate)
- Liquidity – if you expect any early fund requirements, choose the funds accordingly. In other words, select such an investment option that does not destroy value if withdrawn early
- Preference – investors can choose to split their between pure equity, a mix of equity and debt, etc. by selecting the right mutual fund
To know more about the benefits of mutual fund investing, read here.
Which one is better – direct stock market investing or mutual funds?
Subscribing to a mutual fund means splitting the investment across dozens of securities. Any movement in the value reflects average movement across this large set of shares. On the other hand, investment in stocks would only be in a few for the same investment amount.
Since the mutual fund comprises many shares held together, the returns are less volatile when compared to returns of just a handful of stocks invested directly.
Also, price movement in stocks gets easily highlighted in the case of direct holdings. In contrast, the outcome is an average of many stocks’ prices in a mutual fund. If there is a massive return on any specific stock, the investor gets tempted to sell and realize the gains. Similarly, in case of a steep fall, the investor may want to eliminate the risky share. However, constant buying and selling of specific stocks will lead to churn, increasing volatility.
Here are some of the positives are negative of investing in stocks and mutual funds.
Investing in mutual funds:
1. Easy diversification
2. Professionals manage the investments
3. Highly convenient
4. Less time and energy spent to identify avenues to invest
5. Investing is possible with a minimal amount
6. A good option for novice investors
7. Dividend reinvesting happens in a growth plan, earning compounding returns
8. No place for an individual bias
1. Higher expense ratio can get unnoticed
2. Trade happens as per the cut-off time, and investors cannot influence the timing of investment
3. Tax-saving mutual funds (ELSS) come with a lock-in period
4. It is not possible to dictate which companies to invest into, thereby limiting choices
Investing in stocks
1. Stocks are more liquid than mutual funds
2. Lower transaction costs
3. Complete control over companies where to invest
4. The option of whether to reinvest dividends or not lies with the investor
5. Ability to determine the price and timing to make a transaction
1. Riskier compared to mutual fund
2. Requires a reasonable amount to make any meaningful investment
3. Diversification could be capital intensive
4. Finding the right stock is a time-consuming process
5. Individual bias may unduly influence the investment decisions
Refer to the link here to read more about the differences between stocks vs mutual funds.
Investing in the stock market for beginners – the bottom line
The two most important reasons to invest in the stock market are higher returns and financial discipline. When compared to basic instruments like fixed deposits, equities deliver higher returns. That is because there is a direct correlation between risk and return. In other words, stocks are risky, and hence they provide better returns. Further, regular investing inculcate financial discipline.
Investors must decide based on the risk appetite. Several factors affect risk appetite like financial assets and liabilities, age, number of dependents, income level, etc.
Once you have zeroed on any investment, invest regularly and believe in your assessment. Further, it is vital to set a courageous savings target and chalk out an investment strategy. Therefore, a Systematic Investment Plan (SIP) investment route is an excellent option for beginners.
You must diversify your portfolio by investing in a wide range of assets. In other words, the concentration of investments in a handful of equities is a risky proposition and not a preferred investment strategy.
As you progress, the priorities change and your investment strategy must reflect the same. As an investor, you must continuously amend the goals to reflect the right circumstances.
Whatever you do, you must continue to invest and remain invested. Remember, art is not to earn money but to grow money.
About the author
The author is a senior finance professional with over fifteen years of work experience in corporate finance. He has an affinity for matters relating to personal finance and investment management. The author wants to share his knowledge and understanding of the subject through his writing.
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