Basic advice for early investors

It started with me joking to some of my friends that I had lost so much money in the stock market, that I was eminently qualified to advice people on what not to do, rather than what they should be doing! Turns out some of them were keen on hearing what I had to say and I guess it makes sense, rather than learning through burning 🙂 So here goes.

The entire space of investing is a complex area. But here are some of my basic learnings for people struggling with so called portfolio management services, wealth advisors etc, and still not making money like they thought they would :

1. Firstly, the harsh fact is that almost all Portfolio Management Services suck, especially in their offerings for entry and mid level investors. All of them have an internal caste system and their best advisors are reserved for HNI’s (say people investing upwards of 50 crore). But even then, there are no guarantees. In my experience, people typically jump from one PMS to another for a while, before realizing they are all equally bad, and settle for someone who does not at least indulge in unethical practices.

What is an unethical practice? If your PMS takes a power of attorney from you and carries out transactions without telling you. Makes losses, then tries to cover it up by playing more risky games and screws things up totally, that’s unethical in my book. Don’t ever give that power to a wealth manager. Ensure they have to take consent before each transaction.

2. Just think about it. If your assigned “wealth manager” was really a genius, he would be employing someone to manage his money. Not the other way round. Or at least he would be a fancy fund manager at a mutual fund. Most often they are just MBA kids who have learnt the jargon. That’s all. You can learn it too… if you read enough and engage for a few months.

What is clear is that at end of the day nobody cares as much for your money as you do! But the funny thing is, if we want to by a 20K phone, we do days of research ourselves. But when buying 1 lac worth of stock, we blindly follow the “wealth managers” advice. It is highly recommended that we do our research ourselves, and decide which industries and companies look most promising to us. Talk to people within those companies, use our own sense of confidence in how businesses are being run, read financial reports and then yes, we can take inputs from the wealth manager as well. But only to shore up our own research.

for e.g. if someone wants to invest into the airline industry. Its not too difficult today to figure out that X airline is the only firm posting some kind of profits among listed airlines. If you travel often, you know which airline is being run well operationally and looks healthy. So your instinct tells you that in the long run this company will do well. But your wealth manager may pop up and say “sir, Y has been beaten to the dumps now. But we believe foreign investors are going to take a big stake in it. So suggest buy tons of Y”. In such a scenario, it helps to have done your own research and have your own point of view.

At the end of the day, I feel it’s important to select certain sectors and companies that you understand and track them carefully. Yes, its quite possible that there will be some other stocks zooming on the side. But its better not to get diverted by them, because that’s a quick way of becoming part of “the herd” that gets slaughtered at the end of every bull run 🙂

3. In my book, day trading is a no-no. I am yet to see a retail investor who has consistently made money through short term trading over a period of time. You get lucky, then you get unlucky and over 2 or 3 yrs you find its mostly evened out. To create wealth, you’ve got to be willing to buy and hold. And when you hold for more than a year, you don’t pay capital gains tax (as of now) either. So that’s a big plus as well.

Now it follows that if you are holding for the long run, you simply cant afford to be leveraged. i.e. Invest only your own money that you can afford to spare. Taking a loan or using money that may be needed urgently and trying to go long is a recipe for disaster.

4. It helps to have discipline in terms of “book profits” and even stricter “stop loss” levels. What this means is that when you buy a scrip, you need to have a mental goal of how much money you want to make from it. Say you want 20% after tax. Then exit it when it gets to that level, even if the world tells you its gonna zoom to 50%. Even more importantly, suppose you decide that you will exit if it falls to a 10% loss, do it! Its now proven that the aversion to lose your hard earned money is an even stronger emotion than greed. Its very very difficult to take a loss instead of holding on, hoping that its gonna magically improve. But if you can do this, your overall losses will be limited in the long run.

5. There is more to investing than just equities. There are mutual funds, debt funds, liquid funds, bonds, NIFTY BEES, Gold ETFs, Funds that invest directly into Real Estate projects, art funds, ULIPS etc etc. Depending on risk appetite, one could try and have a spread across these instruments (except ULIP which I suggest avoid like the plague:). For that we need to understand them, because each of them has a different risk profile and reward ratio.

Once you understand them, you can smartly move from one to the other, depending on the economic scenario. So if the market is in a bull run, you may stay in equities. But if you feel its going to the bears, or there is a crash in the offing, you can actually move to gold and bonds which are safer instruments.

6. I am not getting into the category of Futures & Options here, because its a level of complexity that is not suited to early retail investors, if you ask me. In short it consists of trying to predict where a particular stock or market will be at a future point of time, and buying the right to either buy or sell at that level, on that date. People will tell you that you can make a lot of money on options, but they wont tell you that you can also lose as much, and that its as close to gambling as you can get. Yes, some people do make money through F&O, but they tend to be seasoned players who are stuck to multiple market screens all the time.

7. Digressing a bit to insurance. The broad opinion now seems to be that don’t mix investments and insurance. If you want to insure yourself for the sake of your family, stick to a straight term insurance that has clear premium and applies it fully against life cover. Don’t look for returns from insurance, because all the companies are doing in that case, is to take a certain amount of money from you and internally splitting it as insurance and investment. And in the process come in a whole bunch of hidden charges that you cant even control.

There is however, one exception to this. Some companies design a traditional debt or equity fund and just add on a very minor insurance cover, so that it shows as insurance in government regulations and attracts no tax. This is ok. But in such cases the life cover will be very very small as compared to the investment amount.

8. Enjoy the stress free magic of SIPs. If after reading all this, the whole activity is starting to sound a bit daunting, then the best route to simplify life is often the Systematic Investment Plan. What this means is that you select either a mutual fund or a stock and set it up with your agent to invest small amounts of money into it at regular investments. Say 10 K per month into a mutual fund. Over the long term, as you keep putting in 10K pm, irrespective of whether markets are down or up, it averages out the effect of bad times. So if you hold for a long enough period and exit at one of the good times, you are certain to make decent rate of return. It will never be spectacular, but it is not likely to be a disaster either, as long as you don’t exit too early, or in the midst of a crash.

9. In general, its good to understand the concept of “fair value of markets”. What this means is that there is always a reasonable fair value for a given market, based on the strength of the economy and GDP growth. What we need to remember is that in the long run, markets always return to fair value. So if the markets are riding high on euphoria and have have run way ahead of fair value, then sooner or later its going to drop down. Similarly if the sentiment is way too pessimistic and markets are below FV, then sooner or later its going to move up. Sounds simple enough. But in practice 90% of people join the bull party, after its well underway. Which means its closer to the peak and will start tumbling sometime. If we accept the logic of fair value, then its obvious that the best time to enter is when doom and gloom pervades all around. Even then, there may be further downward movement left, but if you hold long enough, it should recoup and then move above the levels you entered at. But the converse is not true. You enter high. It rises a little more and then starts a downward journey. You sit tight because you missed exiting on the rise and you don’t want to lose money. But the market keeps traveling downward and you never know if it will ever bounce back to the levels you entered at. This is a classic trap!

10. Finally, when do you really lose big time in shares?
a. You have chosen a fundamentally flawed stock that crashes because the promoters sink the company
b. You panic when times go bad, hold on for a while, and exit after your investment has lost significant value.
c. You play short term trading tactics or F&O

So the converse is also true. That if you have the ability to hold for long enough, chosen fundamentally strong stocks and either apply strict stop loss/book profit limits or sit tight without panicking, then you will get opportunities to exit at a decent profit. If fact almost any portfolio viewed over a 5 to 10 year period will show several points at which the investor can exit for excellent returns. Interestingly, in the long run equity has been shown to even outpace gold in terms of returns, which is contrary to popular opinion.

So my advice is simple. Don’t sit out of the party. But don’t jump into the game without a long term commitment and without knowing how to play it. And don’t just depend on a coach shouting instructions from the sidelines either 🙂

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