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10 Investment Basics

Start early
Investing is easy once you know how. That’s why starting early gives you an extra
edge, to learn from mistakes and experiment with various investment techniques and
asset classes. As you grow older, you can take limited risks with equities and would
prefer to invest in debt too.

Also, every year that you postpone investing towards retirement, the annual savings
you need to make to reach your financial goal will keep on rising. For instance, to get
Rs 10 lakh at the end of 20 years, if you start now you will need to invest Rs 13,879
annually but if you start 10 years later, the annual investment will shoot up to Rs
56,984.

Know yourself
Invest in shares or mutual funds based on your needs and after doing proper
homework. Don't buy something because your neighbour believes he has a winner on
hand, or your broker is issuing a big buy report on a stock.

Carefully choose securities that fit your profile. It is important to relate the risk
perceived in a given security not only to returns, but also to your attitude towards risk.
It is important to understand your emotions towards money and comfort levels with
risk. For instance, what would be your reaction if your stock investments plummet by
35 per cent in a month? How would that affect your medium term or long term plans?

The risk/return trade-off


There is no harm in assuming a big risk in the quest for higher long term returns, and
your profile does not preclude taking of such risks. Equities promise higher long term
returns but the period taken to realize these returns too can be uncertain. As far as debt
mutual funds are concerned, they are more stable tenure but returns are much lower. As
an investor, you should be able to judge whether the perceived risk is worth taking in
order to get the expected return and whether a higher return is possible for the same
level of risk (or a lower risk is possible for the same level of return). Smart investing
will involve choices, compromises and trade-offs. And you have to decide the
combination of factors that suit you best. ISMAIL

Don't overpay for growth


Seek out shares that are capable of delivering sustainable earnings growth but don’t fall
into the trap of overpaying for growth. Even the best growth stock may not deliver
dream returns if your purchase price was too high to begin with. Warren Buffet, one of
the most successful investors in the world, said back in 1983: "For the investor, a too
high purchase price for the stock of an excellent company can undo the effects of a
subsequent decade of favourable business developments." So growth riding on the
back of a reasonable purchase price may be a good motto to stick with.

The reinvestment risk


If it suits your plan, choose a fund that reinvests your dividends or interest. That won't
leave you exposed to the risk of reinvesting the amount at equivalent or higher returns
for the same level of risk. Such alternatives are more than often not easily available.
The reinvestment risk is implicitly defined for a debt instrument. Yield-to-maturity,
which is the actual yield on a bond if held to maturity, may be a familiar term to those
who invest in fixed income. But few know that this YTM assumes that each interest
cheque received by the investor is reinvested at the coupon rate. In reality, however,
most investors are probably spending this interest on fullfiling current needs. So even if
investors are getting a coupon of 18 per cent on a semi-annual debt instrument, their
YTM is much lower.

Beware of the law of averages


The average, or mean, acts like a powerful magnet that pulls stock prices down
sharply, often causing returns to deterioriate after they exceed historical norms by
substantial margins. Stocks display runaway tendencies by appreciating sharply.
Subsequently, prices may plateau causing disappointment. In such a situation, investors
may profit from selling out earlier than originally planned. And if the fundamental
story is still intact, you could even buy back your shares at a lower price. So stay tuned
to any short-term movements in the stock market that affect your stocks. However, if
your goals are long term, don't get into the trading mode, where you compromise on
the big picture for short-term gains. It is important that you still think long term. As
Benjamin Graham, author of the investment classic The Intelligent Investor wrote: "In
the short term, the stock market is a voting machine-reflecting a voter registration test
that requires only money, not intelligence or emotional stability-but in the long run the
market is a weighing machine.

A trend may not be your best friend


The psychology of the stock market is not only based on how investors judge future
events, but also on how they react to the immediate past. There is a tendency among
common investors to buy shares of those companies or sectors that have performed
well very recently. It is critical that you assess where you are in the cycle during any
bull run. That's because what may seem to be an everlasting phenomenon eventually
turns out to be illusory. It will be replaced by another, equally compelling one. And as
an investor, you are left with shares bought at the peak of a cycle.
Like Burton Malkiel, the author of A Random Walk Down Wall Street has to say: "It is
not hard, really, to make money in the market… What is hard to avoid is the alluring
temptation to throw your money away on short, get-rich-quick speculative binges."

Time marches on
Time can dramatically enhance the value of your starting capital through the magic of
compounding. At 10 per cent annually, the annual incremental capital accumulation on
a Rs 10,000 investment is Rs 1,000 in the first year, is over Rs 2,300 by the 10th year,
and just under Rs 10,000 by the 25th year. After 25 years, the total value of the initial
Rs 10,000 is Rs 108,000, a ten-fold increase in value. Give your investment all the
benefit of time that you can afford. Choosing an investment plan that automatically
reinvests your dividends and interest is also a way to benefit from the power of
compounding.

Evaluate your future


A lot of investing is about how you see your future, financially speaking. We all make
certain assumptions while estimating our future needs, and how we intend to meet
those needs. But circumstances can change. Hence it is important that you review your
portfolio at least once a year. Also try to evaluate the performance of your investments
against the level of risk you are assuming for achieving the returns you want. And
when necessary re-balance your portfolio to stay on track with your long term financial
goals.

Food is tasteless without spices. While one may manage a few meals without them, it is
difficult to continue doing it day after day.

Something similar applies to our investing too. If we invest for long-term whether in debt
or equity; if we have to keep patience and see our investments grow with time; if we don't
do something actively; we tend to get bored. In fact we may even end up doing
something foolish, if the wait becomes frustrating.

So we need to add a bit of spice to keep our interest going in building a long-term
portfolio and wealth. Therefore, for that enjoyment and kick, one can look to doing some
day trading.

But remember - just a little bit. Too much of spice makes the food unpalatable. Moreover,
you cannot survive only on spices. But before, we jump into day trading here are a few
guidelines, which may prove useful.

Allocate not more than 3-5% of your corpus:

Make sure that you do not allocate more than 3-5 per cent of your equity corpus for day
trading. This is a high risk strategy and so even if one were to lose all money it will not
hurt the overall financial situation. Yes the loss will pinch for some time, but you will get
over the pain shortly. Moreover, it will enable you to come back and try again.

It doesn't become any easy with all the technological support:


People are attracted to day trading by watching the stock market tickers 24 hours on news
channels. Fundamental information/technical charts are available on a number of
websites and most of all there is the ease of online trading.

But these are mere technological tools which only facilitate easier availability of data and
execution of trades. We have to learn to interpret that data correctly and convert it into
meaningful information. Easy availability of data does not make everyone a genius. And
those tickers can be very tempting like chocolates. Have self-control to a them.

Educate yourself:

It is a must that you understand all lingo of day trading, futures, call option, put option,
delta, stop loss trigger among others. You need to be familiar with all such terms as you
will come across these in your day trading. This will help to understand what experts are
saying.

You must also be aware of the economic situation to take a proper view on the market
and stocks. How will oil prices impact the market? What effect interest rates will have on
the stocks you want to trade in? For example, rise in interest rates may have negative
impact on capital intensive companies, which depend on a lot of debt. But may be good
for cash-surplus IT companies.

Choose large cap stocks which have high trading volumes. You don't want to get stuck
with an illiquid stock. Moreover, such stocks will have good amount of technical
information. Try to predict the general direction instead of trying to hit tops and bottoms.
Keep a track of all your trades and analyse them. Over a period time you will be able to
pick up useful trends.

Learn to book your losses and gains:

The main reason why people lose money in day trading is because they are averse to
making losses. If you have taken a wrong call or the market is not going as per your
expectation, be very sure to book losses. Do not live on the hope that the market will turn
around.

In fact, even before you make an investment, first decide at what loss you will exit. Stop
loss pricing is the key to becoming a successful day trader. Always focus on limiting your
losses, not maximizing your profits. Never add to a losing position. It is a prescription for
disaster.

Similarly, don't be greedy. Book profits at regular intervals. A number of small gains is a
more realistic strategy than going in for one to two big kills. Markets, in the short-term,
are never logical, so don't try to assume anything. Flow with the market. Stick to the
objective rules of profit/loss booking.
Discipline and emotional balance is critical to success. Profits should not make you over-
confident nor should the losses intimidate you. No two people with same set of stocks
and information will make same amount of money. It is their mental framework, which
determines success or failure.

Do not overtrade:

One of the common mistakes people make in futures and options is overtrading because
these markets work on margins, rather than paying the full trade value. Therefore, don't
be lulled into complacency by the low margins. Make sure that your total trade value is
within your financial means.

Also, day trading doesn't mean you have to trade every day. Even two to three trades in a
month may be more than sufficient. Trading opportunities don't happen everyday, so bide
your time. Even if you miss some of them, don't rue. Markets are not going anywhere.
You will get your chance sooner or later.

Further, concentrate on just two or three scrips at the most to make trading more
manageable. Moreover, over time you will get a feel of these scrips, which will help you
to trade better.

A word of caution:

Day trading can be injurious to your financial health. Therefore, it is strongly


recommended that you keep away from it. But if you find it irresistible, follow the above
rules to minimize any damage.

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