Aaradhya sat by the window reading a book. She had a notepad next to her where she was jotting points from the book titled ‘Equity investments made easy.’ Aaradhya looked up from the book towards the television, which featured the stock market channel. She heard the TV host mention the name of a stock that she had been tracking, and made a mental note to review this share. With the New Year round the corner, Aaradhya had made a resolution that she intended to adhere to with all her determination. She was going to learn about the stock markets and grow her wealth by investing in equity.
Investing from small savings
Aaradhya was a homemaker who had been regularly saving small sums from the household budget. She had accumulated a tidy amount. In the past, she had regularly invested in gold jewellery and fixed deposits, but realized that this did not help her grow her wealth to the extent she desired. Her friend, Jeevika, who was a software professional, had been sharing information with Aaradhya on how she had been building her wealth by investing in equity. Jeevika had been encouraging Aaradhya to do likewise. She also explained to Aaradhya that with interest rates falling, investing in fixed deposits did not grow capital. Then, she explained the concept of real returns. Real returns are computed by reducing the inflation rate from the fixed deposit interest rate. For example, if a fixed deposit gave 5 percent interest per annum and inflation is at 6 percent, your real return is (-)1 percent (5 percent minus 6 percent). With interest income earned on fixed deposits being taxable, the real returns fall further. Negative real returns result in capital erosion. In other words, the real value of your capital reduces over time. Aaradhya realized her folly of investing in these traditional investments and decided to stay away from them from the New Year.
The New Year would provide Aaradhya a start to her journey to wealth building through equity investments. Just like Aaradhya, you too could start your equity investment journey from 2021. Here are a few pointers that you should keep in mind.
Learn the basics: Read up on the basics of equity investing. You must understand what equity investing is, how it works, why companies list on the stock markets, the difference between debt and equity, why equity offers greater returns potential, how to select stocks (fundamentals, ratios, etc.), the risks involved and ways to lower risk, holding period, etc.
Open the necessary accounts: Open a broking account, demat account and link them to your bank account. These accounts are necessary for your equity investments. It’s preferable to use an online broking account that is a DIY (do it yourself) type, allowing you can make your equity investments independently.
Asset allocation: Asset allocation implies deciding how much to invest in each asset class (equity, debt, real estate, etc.), which is based on your risk profile, financial goals and liquidity needs. Based on your risk profile assessment, you can decide how much of your capital should be invested in equity.
Equity investment strategies: There are a number of investment strategies. The two most popular are value and growth investing. When you buy a stock below its intrinsic value, it’s termed as value investing. However, the stock may be quoting at a low due to valid reasons such as low growth prospects, poor promoter reputation, etc. When you buy a stock that’s expected to grow at an above-average rate, it’s termed as growth investing. However, you need to time your entry and exit, which is very difficult; it results in higher risk. Among all equity investing strategies, ‘Quality investing’ offers optimal returns while lowering equity risk. This concept implies looking for companies that are fundamentally strong with an established track record, quality products/services, leaders in their industry and run by management with outstanding credentials and experience. The idea is to invest in these companies and stay put over a long period, through all the ups and downs that the market may experience.
Investors stand to build serious wealth while taking on lower risk by investing in such quality stocks. The parameters to select a ‘quality’ stock are: it should have market capitalization of over Rs 1,000 crore (Market capitalization = number of shares outstanding multiplied by market price per share); the company should have been in existence for at least 10 years and should have delivered Revenue/Sales growth of at least 10 percent and Return on Capital Employed (ROCE) of at least 14 percent consistently over the last 10 years; the management should be able to foresee expected shifts in the business scenario and reposition the company to keep its products/services relevant; the industry/sector the company operates in should have strong growth prospects; the company should be in the B2C (Business to Consumer) market segment, which facilitates building brands, customer loyalty, expanding across geographies and products, etc. thereby increasing the company’s equity valuations; it’s best to avoid PSU stocks and cyclicals such as commodity companies.
Taking advantage of volatility: Stock markets are becoming increasingly volatile. To take advantage of volatility, make your investments over a period of time (and not at one go). This will help you average down your investment cost. In fact, it makes sense to create a Systematic Investment Plan or SIP in direct equity. This means you invest a fixed amount every week, month, quarter, etc. in the stocks of your choice. This is an effective remedy to lower the cost of your investment.
Your equity portfolio: Your equity portfolio should not comprise of more than 10-15 stocks. Exceeding this will make monitoring your portfolio difficult.
Monitor your investments: Read up research reports of the stocks you own, keep abreast of the quarterly results and other macro and micro developments related to your investments.
The key is to hold for the long term (10-plus years). However, regularly monitoring your investments is a must so that if there is an adverse event related to a stock that you hold, which could impact the long term prospects of the stock, you can exit in a timely manner.
Aaradhya read the last page of the book and put the book down with a look of satisfaction. She was ready to start investing in equity. She promised herself that 2021 would be a turning point in her journey towards prosperity.
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