Tuesday, 27 November 2012

Importance of Stock Investments

Almost all of us are familiar with stock markets to some degree. With so many television channels exclusively covering the market movements on a daily basis and bombarding us with huge amounts of information regarding stocks and their price movements, we are sure to get affected by the buzz.

Still, the importance of parking your money in stocks is not understood very clearly.
Beginners to stock investing still use the terms “Stock Trading” and Stock Investments” interchangeably. For many of us, the idea of investing in stock markets is equal to washing your hands off your money. Such prevalent misconceptions make it even more difficult for any beginner to stock markets, to understand the things clearly. In this post we try to dispel the doubts and give you a correct perspective.

Why should we invest?

Simple as this may sound, this is the most fundamental question that many of us never think about. Many of us start our investments, simply because our other colleagues are doing so. Have we tried to understand the necessity? So, let us start with this simple question.

We need to invest to take care of our current and future financial commitments and also to tide over the increasing cost of living. Whatever your present earnings, assuming it is enough to cover your needs for now, it needs some augmentation so that your future needs too are taken care of. Even if you have a very conservative lifestyle with minimum expenditure, you still need to invest to offset the effects of inflation. Also, you need to think of your financial security for the years you will spend after your working life is over.

Different horizons of investments :

  • Fixed Deposits : These can be bank fixed deposits which approximately offer a interest rate of 8% to 9% depending on the bank. Also, there are corporate fixed deposits offered by some companies which offer higher interest rates.Strictly speaking, these are not investments. These instruments only give you a fixed interest rate on your principal amount but not any other returns. These should strictly be called savings. As the banks and the companies expand and grow, there is no proportionate growth in your savings with them. The interest rate remains fixed.
  • Investment in Property : Depending on the location and other facilities near the property, the returns on such investments can be very high or there is a consolidation of the value. Also, liquidating the assets can be very easy or very tough. If there is no buyer for the property at the offered price, the owner may have to wait for long periods before he can liquidate the property. One of the biggest drawbacks of property investments is the need of large amounts of initial capital for investing which may not be available at all times.
  • Mutual Funds : These can be debt based, equity based or a mixture of both in some proportion. On an average, during a 1yr period, a good MF can give returns upto 10-12% easily. Also, you can redeem your amount whenever you want. Very good investment option compared to those mentioned above.
  • Stock Investments : These are investment in stocks of individual companies. Investments in stocks offer all the advantages of MFs mentioned above. There is practically no limit to the returns earned. Invest in a good stock and you can earn multifold returns easily in the long run. If, on the other hand, you invest in some stocks without researching well, your money can easily go down the drain. This is the perceived risk in stock investments.
Is it not risky to invest in stocks?

Only if you don't do proper study before investing.
If you invest in a good company, your investments will definitely grow as the performance of the company improves. The perceived risk in stock investments is due to improper knowledge of the fundamentals of the company. Studying the company is very important before investing. Learning to invest in stocks is easy too. We have given some basis for beginners to stocks, on which you can know about a company.

Why to invest in stocks?

  • A common question among beginners to stock investments. The singlemost important advantage of stock investments is the possibility to earn huge returns by investing in good companies.
  • Returns apart, good companies regularly give dividends to their shareholders thus rewarding them for their continued engagement with the company. Overtime, the investor can recover at-least a percentage of the initial stock investments in the form of dividends itself.
  • The liquidity and ease of investment offered by electronic platforms of various banks are added advantages to stock market investments.
  • You don’t need a treasure-trove for stock investments. Regular and disciplined investments of small amounts over a period of time in good companies will do the trick. Its like putting money in a Recurrent Deposit (RD). Only the returns will be higher and better.

We don't profess investing in stocks exclusively.
Diversify your portfolio and give importance to other investment instruments too. But, give equal importance to stock investments.

Stock Trading and Stock Investing :

There are many misconceptions due to usage of these two terms interchangeably. Better have a clear understanding now before it is too late.

  • Trading is a term generally used for short term investments in stocks. The duration can vary from a day to a week to some months. The principle here is to speculate the price movements correctly to earn fast bucks.
  • As opposed to trading, investing in stocks is for a longer duration after studying the companies quite a bit. To get good returns, you need to stay invested for a period of 3yrs to 5yrs on an average. In this way, it is similar to FDs and other instruments which also are of long duration but offer fixed interest rates only. However, good stocks offer more returns which can be even more than the average returns offered by MFs.

Though we have nothing against trading in stocks, this blog is about Stock Investments as opposed to trading and should be read in that light.

Misconceptions about stock investments:

Many of the misconceptions regarding stock investments which confuse beginners, have aroused due to the ambiguity between trading in stocks and investing in stocks for the longer term. Some of the misconceptions are :

  • Putting money in stocks is akin to gambling : This is somewhat true for short-term speculative trading in stocks but not for long-term investments. One enters for a long-term investment after comprehensive study of the company and hence is not gambling.
  • Almost always the money is lost in stocks : Again, the risk of losing money is more when you depend on speculations only. For long-term investments, you mandatorily have to study the company, just like you study a life insurance policy document or a property details. Learn to invest in stocks of good companies only. Invest in a good company and you will definitely get handsome returns.
  • Investing in stocks is full-time job : You need almost as much time to study a stock as you would spend before buying a good life insurance policy. So, if you have bought a good insurance for yourself, then you definitely have time to invest in good stocks.
  • We need to constantly monitor the portfolio : Not constantly but periodically. Investing in stocks is like investing in somebody's business. Once in a while you do need to keep a tab on the companies in which you have invested to know whether they are running properly. Studying the quarterly and yearly reports and watching out for news related to the companies and industry should be enough.

Compared to the earlier times, when investing in stocks was really difficult due to the manual processes involved, the present day electronic transactions and facilities offered by various banks have made investing in stocks easy and transparent process. There is no reason why we should give a step-motherly treatment to this investment horizon. Learn to invest in stocks correctly and stand to gain good returns on your stock investments.