While a long-term investment is an excellent path to generate wealth, it’s not unusual to experience occasional losses as investment values go up and down. Investing in the stock market is more like a marathon and is not a ‘get quick rich’ scheme. So, investors should not expect to earn money overnight. Success in the stock market comes from careful planning and knowledge and the ability to stay out of emotion while making decisions. Greed, an intrinsic emotion of every human being, is mostly responsible for losses one suffers in the financial world. Most investors put money in stocks without knowing the business. Proper knowledge of a business can help investors understand how earnings can grow with any changing business dynamics.
As an investor you might be thinking of a million ways to grow your money, and for this the most important thing is not to lose your hard-earned money first. Here we have charted out a few ways in which you can avoid losing out on it:
1. Gain some understanding of the market
Before investing, gain some understanding of the market and its relationship with the economy. People lose money in the markets because they simple jump to the market without understanding the economic and investment market cycles.
Remember that business and economic cycles keep on changing. As inflation creeps up, prices rise, and GDP growth slows. So, the stock market declines in value. The time to invest in the market is when the economy is in a boom cycle. A short-term fall in the market can be a perfect time to enter as the markets rise and fall due to domestic and global short-term events. Also, if you are already invested, don’t react and sell your stocks when there is short panic in the market. To avoid losing money during a market-wide drop, your best bet is to just sit tight and wait for your investments to rebound.
2. Investing is not a get-rich-quick scheme
People lose money in the markets because they think continuously follow day-trading strategies and outrageous claims of penny stocks. From 1997 through 2016, the average active stock market investor earned 3.98 percent annually, while the S&P 500 index returned 10.16 percent in returns. The reasons are simple: Investors practice frequent buying and selling in an attempt to make superior gains. To avoid losing money in the markets, stick with proven investment approaches for the long term instead of choosing “can’t miss” pitches and strategies. Though you might lose a bit in the short term, ultimately the slow-and-steady approach will win the financial race.
3. Never buy a stock based on its past performance, buy on stock fundamentals
It is always good to know the past performance of a company’s stock performance, but it is risky to depend completely on it. A stock that gave certain returns the previous year, may not give similar returns in the current year. The returns will depend not only on the company’s movement, but also on market conditions and the performance of the economy.
One should always compare the stock valuation with its peers or industry average before investing. Select quality stocks by looking at the history and the price-to-earning (P/E) ratio which is one of the important factor among many others. The ratio indicates whether a stock is over-valued or under-valued. Comparing a set of stocks on the parameter of PE ratio gives investors a fair idea of how expensive or cheap a stock is on a relative basis.
Avoid investing in companies which have yet to strategize a way to earn revenue. A company which has had a strong earnings history does not mean the company will always do so, but it potentially will be in a financially healthier position than a company that has yet to earn revenue.
4. Don’t let your emotions drive your investing
Some investors emotionally attached to specific stocks, ignoring their changing fundamentals. They remain often biased on their investing decision and are unable to exit at the right time or enter without any supporting fundamental of the business. It is always advisable to set apart your emotion and investment and take decision only on underlying factors. Avoid pumped up stocks and do your own research before buying.
5. Don’t be swayed by unfavourable events
It is not necessary that an unfavourable event results in a negative impact on the stock market. It actually depends on the nature of the event. It is important to analyze the possible impact it could have on the economy overall, and then come to a logical conclusion on the impact it can have on the stock market.
Gujarat earthquake, for instance. Everybody had speculated that the earthquake would devastate the country’s economy and make the stock market stumble because Gujarat has the largest number of investors. Interestingly, the market reacted in a different way by recovering all the losses later on. In this case, the event boosted the economy as reconstruction had to be taken up in a big way, giving a boost to the cement and construction industry.
6. Don’t hurry up in booking profits
It may be alluring to book profits early sometimes. But most investors who have made money in the stock market have worked on ‘buy’ and ‘hold’ strategy. For securing profits, you should continue in stages, thereby keeping some scope to take advantage of the rest of the move. The ideal mix should include small losses, small profits and big profits. Selling a quality stock on the smallest of negative news is one of the worst decisions an investor can take. Negative news can increase the volatility in a particular stock in the short run. However, one should not sell a stock in panic.
7. Treat every trade as just another trade
Every trade is just another trade and only normal profits should be expected every time. Supernormal profits do occur, perhaps rarely, but should not be expected. Remember, you should increase your risk only when your equity grows enough to service that risk.
8. Beware of the herd
In investing, herd mentality is one of the worst. Herding in investing occurs when you follow the group, without evaluating current information and underlying stocks. In the late 1990s venture capitalists and individual investors were pouring money into internet dot com companies, driving their values sky high. Most of these companies lacked fundamentals and sustainability. Investors, afraid of missing out, continued to follow the herd with their investment and ended lost heavily. To avoid losing money in the markets, therefore, don’t follow the crowd and don’t buy into overvalued assets. Instead, create a sensible investment plan, and follow it.
9. Diversify, but don’t overdo it
Never put all your eggs in one basket; invest in a variety of stocks and asset classes. Avoid putting all your money in a single stock because if it performs, you win; if not, your investment is gone. Diversification helps investors in reducing the volatility and protect portfolio with sudden changes in market environment. It will help you under such circumstances where even if 1 or 2 sectors underperform, then this loss might be offset by gains in other sectors. Diversification of investment is a must to mitigate risk. However, do not over-diversify as having too many stocks in a portfolio may not create a significant value for you. There are chances of depriving yourself of the gains from profitable investments.
10. Evaluate your portfolio regularly
Evaluate your portfolio regularly and adjust your holdings accordingly to your set exit points. The stocks which are not moving anywhere should be sold so that you can free up the cash for other opportunities.
Keeping all the above points in mind will help you avoid losses in the market. However, one last important thing that may help you remain a stress-free investor is to ‘only invest what you can afford‘.
Never invest money you cannot afford to lose. Investment is done to generate even more money, but do not invest all your emergency money in the stock market. Investing emergency money will increase the likelihood that you will be emotionally attached when making decisions as you cannot live without the fund you are trading with. This may put you in a risky position and may cause you to make irrational decisions.
(By Rahul Agarwal, Director, Wealth Discovery)