Although no sure-shot formula has been discovered yet for success in equity markets, still you can make good money by making your investment decisions with due diligence.
Investing in stock markets may seem easy, but it is challenging. More because it not only requires a sound understanding of the market, but also oodles of patience and discipline, among others. Although no sure-shot formula has been discovered yet for success in equity markets, still you can make good money by making your investment decisions with due diligence.
Here are some important rules you need to remember while investing in the market:
1. Don’t deviate from your financial plan
When you make your financial plan that is directed towards your long-term goals, the focus should be on managing all kinds of market situations and risks. Your long-term plan typically has certain in-built checks like regular investing, asset allocation and rebalancing to take care of these basic issues pertaining to market volatility. When you say that your equity funds will create wealth over a period of 10-15 years, you are obviously factoring in all these possibilities into your calculation. Just because the equity markets become volatile, you do not have to take a call to exit equities. Maintain your discipline with respect to your long-term goals.
2. Never get into a trade without a stop loss and profit target
Any trade or investment made by you is a risk-return trade-off. That means for a given level of returns, you are only going to take so much risk. Even when you invest for the long term, there is a mental stop loss you require at which point you will reverse your position. It could be a structural issue with the company or the maximum capital you are willing to risk on the stock. Similarly, have a profit target in mind. Of course, you can keep extending these targets, if the situation demands, with the help of trailing stop losses.
3. You will typically make profits in equity only in the long term
This is something you must be clear at the very outset. There are odd occasions when your investments will double in 3 months. These are the exceptions not the rule. Ideally, equity investment will yield attractive returns only over a period of 3-5 years. Keep your patience levels high and take a long-term perspective. Other than that, investing periodically will also help you in grabbing better buying opportunities or limiting your loss when you made a wrong choice of stock. As selling of stocks involves fees, changing your portfolio rapidly could cost you a part of your profits. So, to avoid this, it is always better to invest part by part.
4. Use tactical asset allocation based on rules
When the markets are too volatile, then rule-based allocation works best for you. What does that mean? Firstly, set a rule for you to shift out of asset classes. For example, if the P/E of the Nifty crosses 23X, then you can set a rule to automatically reduce your exposure to equity and transfer to debt. Similarly, if the interest rates have touched a 10-year low, then your focus should be to tactically shift out of bond funds (specifically long duration bond funds) and either shift to variable rate funds or into equities. Here you do not have to take a view on the market and worry about whether you will be right or wrong. If you set broad rules in your asset allocation based on past experience, you are good to handle volatility in the markets.
5. Prefer companies with low debt and low equity base
This should be a guiding principle for your equity investing. Over the long term, the companies that create value are the ones with low debt and low capital base. That explains why IT companies like Infosys and TCS created tremendous wealth. A low equity base means that your profits are going to be distributed across less number of shares. That enhances valuations. Don’t give too much credence to prices. Some stocks might be trading in single digits and some might be in 5 digits, but the inference because a stock is trading in single digits and the notion surrounding perceived value towards such stocks might be illusionary. There are obvious inherent reasons why the stocks are trading at such low value and valuations. Don’t be obsessed with low P/E stocks; probably that is what they are worth.
(By Jaikishan Parmar, Senior Equity and Research Analyst, Angel Broking)