If you are new to investing and stock markets then, terms
such as stocks, bonds, yield, P/E ratio, mutual funds may overwhelm you in the
beginning. That’s understandable and it’s fine. Some people jump in to stock
markets by listening to some success stories but fail to realize that investing
is an art and it can be mastered with proper understanding and education of the
markets. Usually, with dedication, one can get mastery over the art of
investing in stocks, however for some it may take years to understand, but
you’re not alone.
To start investing you must gather as many facts and details
apart from knowledge of stock markets. One should also learn to deal with the
fact that you may not know everything. As Buffett, rightly said “Risk comes
from not knowing what you are doing.”
Investing is another means to earn money other than doing a
9-5 job. In simple terms, investing is putting your money to use to generate
additional income on the same. Investing is neither gambling nor speculation.
Gambling is the activity of risking money on an uncertain outcome hoping to
make money. Speculation involves trading a financial instrument involving high
risk, in expectation of significant returns. The motive is to take maximum
advantage from fluctuations in the market.
Investing is necessary so that after your retirement, you
can live off funds earned from these investments. It shields you against rising
inflation and provides a sense of financial security to fall back on.
There are various investment vehicles for the investors to
choose from. But for today let’s just stick to mutual funds and stocks and
understand how they differ from each other, even though they both relate to
investing in company stocks.
Mutual Funds:
So where have you heard the word “Mutual Funds” before?
“Mutual Fund investments are subject to market risks, read
all scheme-related documents carefully.”
Still not striking a chord? More often than not this
disclaimer is heard or seen on television, radios, hoardings, billboards, etc.
The advertisements are engaging and eye-catching with their slogans like “Aim
to achieve long term goals”, “Looking for long term investment?”, “Invest and
enjoy the benefits of tax free dividend”.
However the disclaimer is promptly ignored before it is
completely read or heard. As per the Securities and Exchange Board of India
rules, this disclaimer is a must for every mutual fund scheme advertisement and
is basically intended to communicate the risks that mutual fund schemes are
usually exposed to.
Meaning:
A mutual fund is nothing more than a collection of stocks
and/or bonds. It can also be understood as a pool of money from various
investors who wish to save or make money just like you by investing their money
in stocks, bonds, and other securities. Each investor owns shares, which
represent a portion of the holdings of the fund.
Each fund’s investments are chosen and monitored by
qualified professionals who use this money to create a portfolio. That
portfolio could consist of stocks, bonds, money market instruments or a
combination of the above. Investors purchase funds because they do not have the
time or the expertise to manage their own portfolios.
Types of Mutual Funds:
The mutual funds industry of India is continuously evolving.
The mutual funds are categorized in order to enable the investors to choose a
scheme based on the risk they are willing to take, the invest able amount, their
goals, the investment term, etc.
On the basis of maturity period of investment, mutual fund
schemes can be classified into three categories as shown below.
Source: Smart moneygoal
Let us look into some of the pros and cons of investing in
mutual funds :
Pros:
Mutual Funds are
managed by professional fund managers, responsible for making wise investments
according to market movements and trend analysis. The role of the fund manager
and his approach plays a crucial role along with market risks as the key issue
is how a fund manager mitigates these risks without significantly impacting the
performance of the scheme of a fund.
Mutual Funds allow
you to invest your savings across a variety of securities and diversify your
assets according to your objectives and risk tolerance. Buying a widely
diversified basket of stocks can be difficult for all but the wealthiest
investor. Small investors are better off buying a quality stock mutual fund. Diversification
is not putting all the eggs in one basket but spreading them over a number of
baskets thereby reducing the possibility of losing an egg for any reason
possible.
Mutual funds
enable you to make transactions on a much larger scale for comparatively less
money. This can also be called as economies of scale. When you purchase more
than one unit of a product, the manufacturer is able to cover his costs by
producing more goods that too at a lesser rate. For example, when the service
provider for a telephone line has to cater to only one customer, his costs
incurred on setting up the infrastructure will not be covered by the fees paid
by the only customer. Hence he may charge higher than usual. However when the
number of customers increase he is able to cover the same cost by reducing the
fees charged per customer. The fees payable by the consumers gets divided thus
reducing the cost.
Cons:
Over-diversification can also be a danger. It occurs when investors
acquire many funds that are highly related and as a result, end up losing the
benefit of reduction in the risk.
According to Warren Buffett, “Wide diversification is only
required when investors do not understand what they are doing.” Basically, if
you diversify too much, you may not lose much, but neither will you gain much.
Costs are the
major drawback of mutual funds. These costs may eat up your returns and cause
sub-par performance of the funds. Fees can be broken down into two categories :
Ongoing yearly
fees to keep you invested in the fund.
Transaction fees
paid when you buy or sell shares in a fund.
Stocks/Shares:
Apart from mutual funds, there are various other financial
instruments for the investors to choose from like Stocks, Debt Funds, Fixed
Deposits, Exchange Traded Fund.
The stock market in India consists of the NSE and BSE. The
Bombay Stock Exchange (BSE) and the National Stock Exchange of India Ltd (NSE)
are the two primary exchanges in India. In addition, there are 22 Regional
Stock Exchanges.
Stock market is defined as the market in which shares of
publicly held companies are issued and traded either through exchanges or
over-the-counter markets.
In order to begin investing in the stock market, you must
have the following :
Pan Card
Broker
Demat and Trading
Account
Buying and Selling
Types of stocks:
There are two main types of stocks:
Common Stock
Preferred Stock
Source: Investopedia
Let us take a look at some of the merits and the demerits of
investing in the stock market:
Merits:
Returns:
The stock market is a volatile market and a company’s share
price fluctuates very frequently all within a day. The risk factor in investing
in stocks is high as one moment, the prices are high, the other moment they may
fall. However, greater the risk taken, greater are the chances of earning
exceedingly good returns in a short time. Along with the returns that you earn,
some stocks do provide income in the form of dividends.
Stock Market
Knowledge:
Mutual Funds, are professionally managed by fund managers
who are well versed with the market conditions at all times. Hence, the need
for an investor to personally monitor the stocks is almost eliminated and this
is a major drawback as the investor will not be much aware with the terms like
stock analysis, valuation, EPS, intrinsic value calculation.
Legal liabilities
are restricted :
Since you are a passive holder of common stocks, your
liability to a company is limited. Any problems that arise beyond a
stockholder’s financial investment, will not affect you.
Demerits:
Volatile
Investments :
On one hand this may be seen as benefit, as investors do not
mind volatility upside however downward volatility can result in a severe loss.
The market is uncertain and constant monitoring is required in order to minimize the losses.
Bankruptcy:
This is probably the major demerit of investing in stock
market. If a company files for bankruptcy, you will not be paid till those who
rank high on the priority ladder aren’t paid. The company has to cover the
costs that come up as a part of bankruptcy. The law firm, the accountants, the
auction services and other services involved in winding up the company are
payable followed by creditors.
High Brokerage
costs:
Buying and selling stocks costs money in the form of
brokerage commissions and many brokerage firms charge account maintenance fees
as well. This might end up using all your profits earned in the stock market.
Conclusion:
see saw
From the above, we can conclude the following:
No investment is
risk-free. There is not just a single risk involved but various like market
risk, inflation risk, credit risk, interest rate risk, exchange risk, etc.
Where on one hand,
mutual funds have a lower risk, they also have relatively lower returns in
proportion to the stocks which possess high risk.
Investing in stock
market includes both investing in stocks/shares as well as investing in equity
mutual funds. We have always heard that investing in company stocks is risky,
but so is investing in mutual funds as they are just a basket of company
stocks.
However this is where the difference arises because the
characteristics of investing in mutual funds differ widely from the
characteristics of investing in shares.
The investors with
limited time, money or expertise may find mutual funds a suitable investment
vehicle. It provides the benefit of diversification which involves mixing of
investments within a portfolio and is used to manage risk.
Stocks are not the
magic answer to instant wealth with no risk. The key to protecting yourself in
the stock market is to understand where you are putting your money. You can
lose all of your investment with stocks if you don’t do a detailed analysis and
invest blindly on the basis of the rumours or unverified information or tips. #Source Finnovationz.com
