Investing for financial security and wealth building is imperative. However, investing without keeping in mind certain important aspects can result in a loss thereby defeating the entire purpose of investing. Here are 5 cues that you must follow while investing:
1: Reduce investment risk through diversification
Diversification is nothing but spreading your money across various investment options to reduce risk. Different investment options carry different levels of risk and return potential. By diversifying, you earn optimal investment returns while reducing risk.
But how should one diversify? Diversification should be done across investment classes (equity, debt, gold, property, etc.) and across investment options (under equity investing, diversifying across equity of companies in different industries, under mutual funds, diversifying across different types of schemes, etc).
More importantly, diversification should be done by keeping in mind your risk profile. For example, if you want to take minimum risk, a major part of your money should be invested in debt and money market instruments, which are safe investments offering low-to-medium returns.
To understand how diversification helps, let’s consider the case of Rohit. Rohit likes taking risks to earn higher returns, and hence, prefers equities over other asset classes. However, diversification will help Rohit reduce risk while giving him optimal returns. See Rohit’s portfolio before and after diversification.
Rohit’s investment portfolio
Now let’s consider that the market price of equity shares of XYZ falls by 40%. Rohit’s portfolio value will reduce considerably if he does not diversify. See the impact of this 40% fall in the share price of XYZ on his portfolio before and after diversification.
Diversification helps reduce investment risk.
2: Invest regularly to overcome market ups and downs
Anyone telling you to ‘buy when the market is down and sell when the market is up’ is giving you advice that is difficult to carry out. Most of us will not have the courage to buy when the market sentiment is bad and prices are low. Similarly, selling when the market sentiment is good and prices are moving up is equally difficult. The best way to overcome this is to invest regularly without being concerned about whether the markets are up or down. This helps in 3 ways:
- You no longer need to keep track of market ups and downs;
- You maintain investment discipline (since you will be investing regularly and not irregularly) and,
- You can invest small amounts instead of large amounts, which put a strain on your cash flows.
The best way to invest regularly is by opting for ‘SIP’ (Systematic Investment Plan) investing through mutual funds. In case of SIP investing, you invest a fixed amount periodically (every week, fortnight, month, etc.) at the prevailing NAV. When the markets are high, you end up getting lesser units and when the markets are down, you will get more units. Over the long term, your cost of investment will invariably be lower than the market value of your investment.
3: Avoid investing directly in the market – invest through mutual funds
Glitzy advertisements can make you believe that growing wealth in the market is as easy as sipping coffee at leisure. But the realities are different and making a fortune in the stock market is anything but easy. Investing in the market has its own share of risks. You need considerable knowledge on how to pick the right stocks and understand market trends (how the market is going to perform) to make profits from your investments. However, you can avoid the need to become an investment expert by investing through mutual funds. Mutual funds offer a number of benefits such as:
- You don’t need to select stocks, track markets, etc. The mutual fund manager does all this for you.
- You have available, at a very low cost, investment expertise and experience of the mutual fund’s research and investment team to make your investments.
- You don’t need a large investment outlay to invest in mutual funds. You can start off with a modest amount.
- Mutual funds are well regulated and transparent in their operations.
- Investing through mutual funds offers a number of tax benefits.
In other words, you can ‘have your cake and eat it too!’ by investing through mutual funds.
4: Invest for the long term
Creating wealth is no ‘Twenty-20’ match where cricketers recklessly swing their bats to either make a six or get out. Instead it’s more like a 5-day Test Match where your patience and commitment towards winning will be tested and rewarded.
Long-term investing has emerged as one of the best ways for capital appreciation in the stock markets. By investing for a longer period, investors can enjoy superior returns and experience peace of mind. Investors who start panicking over short-term market dips often spend time predicting where the market is headed next. Frequent buying and selling based on highs and lows in the market harms the earning potential of your investments.
5: Ignore market sentiment
Read newspapers and magazines. Watch business news channels. Keep yourself updated with what’s happening around in the stock markets and the world. But don’t droop with every fall in the market. Remember you are not a speculator who thrives on daily market movements. Instead you are an investor who is equipped with sound investment strategies and are there for the long term. Therefore, keep a watch on the market but don’t get too clued into the market on a daily basis.
Daily market movements are a result of many external and internal factors which impact the prices of stocks. Budget and taxation, stability of the Government, global trends, etc. are some of the factors which affect the markets. Although markets undergo ups and downs daily, over a long time horizon, the value has trended upward.
Clearly, your motto should be – ignore market sentiment and focus on investing regularly to grow your wealth and achieve financial security.
Team FinanceInsights
September 2022
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