Started investing in direct equity? – Vary of potential pitfalls
This write-up is especially directed towards retail investors (especially youngsters) who have been new to Indian equity markets but looking to invest in equity markets to create wealth over a long-term and also old times who are looking beyond PPF, NSC, bank FD’s as investment options.
Indian equity markets have come a long way since their inception. Slowly but surely, retail investors are coming at terms with the significance of investing in equities to achieve their long-term goals. Investor education programs, electronic, print and social media are all contributing to the goal of encouraging retail investors to achieve their financial goals by investing in equity markets. A lot of new investors have started investing in equity mutual funds via Systematic Investment Plan (SIP) which can be initiated with as low as 500/- per month. This is an encouraging sign. In addition, there have been no major redemptions from retail investors in equity mutual funds during the last two months. Having said that, for a certain proportion of retail investors, investing in mutual funds doesn’t excite much. Possible reasons may be attributed to the notion that mutual funds take a lot of time to create meaningful wealth, NAV’s of mutual funds don’t carry the fancy of a stock price fluctuating every single moment during trading hours, you can create a lot of wealth quickly via direct equity to name a few.
As the legendary investor Mr. Warren Buffett has said:
Rule No.1: Never lose money. Rule No.2: Never forget rule No.1. – Warren Buffett
Before you invest in any financial instrument your hard earned money, you should be well aware of the risks and the common pitfalls associated with that particular investment avenue. Learning from mistakes which other investors have made in the past and be aware of them is always beneficial. If you have decided to take a plunge or have recently taken a plunge in direct equity, please take care of the below points:
(1) Decide firsthand which hat you will be wearing (investor, trader, investor-trader) – Many first time investors come with the mindset of a long-term investor – they end up making some quick money in a very short time and unknowingly gets into frequent buy-sell (trader) mindset and eventually ends up being a trader. There are also first timers you unknowingly buy junk stocks in bulk at the beginning followed by the stock price plunging immediately and they become long-term investors by compulsion.
It is neither wrong to be a buy and hold kind of a long-term investor or a trader or have a balance between the two (have a core portfolio and at the same time have some funds for trading as well) but it is of utmost importance to decide beforehand what kind of investor you intend to be. What will dictate the decision – probably how much time you have at your avail daily, how much knowledge you have about trading or investing, goals which are looking to achieve, how much investible surplus you have at avail and most importantly your risk profile? If you barely have amount to invest, then putting it in a direct equity is a no-no.
If you are a full time working professional and don’t much have much time on avail for markets, then trading at the same time doesn’t seem practical. Also, you need to ensure you have some adequate knowledge before venturing into it. Be realistic of how practical it is in your daily life. Such a decision will dictate the kind of stocks you will buy and hold in your portfolio. Mutual funds are managed by fund manager specialized in that particular role.
Even if you are good at direct equity, take a staggered exposure and don’t commit big money at one go in the beginning.
(2) Vary of the risks associated with direct equity – This point is not to scare readers about investing in direct equity but one much be aware of the risks associated while investing in direct equity via a mutual fund route (which has diversification in the basket of stocks). If you are a first timer in equity markets, mutual funds should be the way to go via SIP mode. If you are looking to achieve your long-term goals by investing month on month, SIP should be the way to do. Once you get used to the volatility of equity markets and have developed the patience to hold on to a fund for a long-term and investing regularly in it, you can reevaluate your decision to invest via direct equity. For a retail investor recently started investing, investing in mutual funds via Systematic Investment Plan is the way to do.
Investing in a company is analogous to owning the part of the business. Make yourself were well versed with the basic principles of equity investing. Investing blindly in random companies without knowing about their business, growth outlook, sector positioning, free cash flows, capex requirement, quality of management to name a few will be analogous to gambling. Do proper research before investing in equities. Go for well-established businesses first before even thinking of venturing in mid and small cap stocks. Quality of business you own should be impeccable. In a bull market, every other stock gives good returns but when the tide turns very few are left standing.
(3) Have a core mutual fund portfolio before venturing into direct equity – Though this point is debatable but for a retail investor, it is better to have a well-diversified mutual fund portfolio (5-6 funds) directed as part of goal-based planning constructed and enforce for a couple of years first before one thinks of venturing into direct equity. Mutual funds, primarily work on the power of compounding. Earlier you start, bigger the corpus you will be able to create. Make sure your uncompromisable goals are covered as part of SIP’s so that they keep doing their own compounding job over the years irrespective of your direct equity investments. SIP’s also will teach you vital traits such as investing regularly and patiently, navigating through volatilities of the market, not to panic during market downturns, how the power of compounding works wonder etc.
(4) Choose a broker with less brokerage – Be varies of brokerage of the demat account against services it is providing before opening a demat amount. A high brokerage can eat into your returns. For instance, ICICI Direct has a great user interface to work with and a good research desk with loads of information but charges reasonably high brokerage. On another hand, Zerodha has zero brokerage for delivery trades but the user interface is not as rich as ICICI Direct and nor the research. So take your call accordingly and avoid opening multiple demat accounts. Investors normally open demat account casually, only to discover brokerage costs afterward. They then open another demat account but last opened account never gets closed leading to yearly charges charged on that accounting year on year. Do your homework beforehand only. Close dormant demat accounts if you had in the past and you don’t plan to use them.
(5) Don’t stop your SIP’s if you are venturing into direct equity – You as an investor will be doing a great disservice to yours if you decide to stop your SIP’s to make way for the investible money to be invested in direct equity. Don’t destroy your compounding story and keep investing via sips.
(6) Make a virtual stock portfolio and invest – As an investor, you can always make a virtual stock portfolio of stocks you thought of buying at a particular amount of time without investing real money. You can track it going forward. Such an activity will give you vital inputs as to what you did right and wrong. This is a useful activity you can do for 3-6 months before actually taking the plunge with real money.
To conclude, it’s your hard earned money, so be very wary of which strong businesses and compounding stories you are looking to invest over a long term. Have enormous patience, invest and track the business year on year. Do proper homework before investing and ignore stock tips, recommendations, suggestions of friends, experts, tv channels etc. Do your own research. No one cares for your money more than you yourself. Never invest casually in some stock thinking its just a few thousand rupees. Look for steady compounding and progressive stories and don’t try to invest in businesses which have questionable management, business model and highly leveraged balance sheet. It’s more of developing an investment methodology for yourself which will reward or ruin your financial health in the long run.
Stay invested, Stay positive!
Disclaimer: The write-up is for information purpose only and is not a recommendation of any sort to the readers. Mutual funds are subject to market risks. Please consult your financial advisor before taking any financial decisions. The author is investing in mutual funds via SIP mode as well as direct equities.