Before discussing the process of investing, we need first to understand why we should invest in the first place? What makes investing the most important thing to do in your twenties?
Well, we all know that Compounding is the eighth wonder of the world and that’s precisely what empowers investing in the capital markets. The earlier you start investing, the higher are your chances of creating significant wealth. A unique feature of Compounding is that your existing investment, along with the return on investment and the new investment each month, all contribute towards further gains – Interest on interest.
However, as a newbie, it is essential to understand the nitty-gritty of investing, mode of investing – basically, how can one start?
II. How to Invest?
As we use a bank account to transact in money, a Demat account is used to transact in financial securities like shares, units of mutual funds etc. A Demat account is an online account to hold and transact in financial securities in electronic form. This is the first step towards investing and trading. Once you have opened a Demat account with the broker, you can invest in securities.
III. Where to Invest?
To participate in the financial markets, a newbie investor can either chose to invest in equities of the company or invest in a mutual fund and get indirect exposure to the underlying equity investments.
A. Direct stock purchase
Investing in direct equity means buying shares of a company – becoming a part-owner of that company. Being a shareholder of a company means chipping into the ownership of the company. Therefore, the investor shares the associated business risks as well as shares in the potential value in terms of profits and growth of the company.
Few Benefits of investing directly in equities are Control on stock selection, asset allocation, discretionary concentration in the portfolio, dividends, lower cost, higher liquidity and quicker action and turnaround.
However, with added freedom and decision-making power, comes increased risks as well. Investing directly in equities could be a riskier proposition for a novice investor due to limited knowledge and minimal experience of financial markets.
B. Mutual funds
A mutual fund is an investment product consisting of a portfolio of securities, stocks or other financial securities. Mutual funds give individual retail investors access to professionally managed, diversified portfolios at a low cost. There are many types of plans depending on the risk exposure, industry specification, investment objectives, asset allocation and the type of returns they seek. Mutual funds generally charge professional fees for portfolio management by way of annual fees, called expense ratios, and in some cases, commissions.
Few benefits of investing through a Mutual Fund are access to professional expertise, incorporation of a disciplined investing habit, adequate diversification, transparency of asset allocation (but no discretion of asset allocation), flexibility and liquidity. New investors could begin by investing in mutual funds and then move on to investing directly in equity.
C.Direct plan vs Regular Plan
Digging a little deeper, selection of mutual fund depends on many factors and criteria based on the overall objective of the investor and the policy statement. However, there are mainly further two modes of investing in mutual funds – either through a direct mutual fund or regular mutual funds, i.e. through a stockbroker. A Direct plan is bought from the mutual fund company directly (usually from their website). As against this. A Regular plan is purchased through an advisor, broker, or mutual fund distributor, i.e. an intermediary. In a regular plan, the mutual fund company pays a commission to the intermediary, which is the cost of the investor and could have compounded effects in the long run.
IV.Key things/ principles to keep in mind when direct stock investing.
Buying a stock is very similar to buying any consumer product, let’s say, a cell phone. Just as you would compare, understand and research about the qualities, features, benefits, drawbacks, problems and specifications of a mobile phone with its competitors in the same price band before actually buying it, every investor should always understand the business of the company, its competitors’ scalability before actually investing in it.
Here is one such approach analysis approach – known as the Top-down style of investing. A newbie investor can follow these simple steps to understand the fundamental value of any company.
- Analyze the Industry – it is important to choose the potentially high growth Industry. A company can be a market leader of a particular industry yet give substandard returns if the overall industry has a drowsy growth.
2. Selecting the stock – Choosing the market leaders enables you to immunize the risk in that industry. Market leaders tend to outperform the industry competitors giving a better edge and superior returns than other market participants.
3.Understand the business of the company – It would include understanding the business model, viability and scalability, company’s Unique Selling Proposition (USP), profitability, its competitors etc.
4.Competitors: A simple SWOT analysis can give you preliminary inference of the company’s potential growth as compared to its competitors.
5.Company’s Management: Running a company is all about leadership and their intentions. A company can be big success or an abysmal failure.. it all depends on the promoters and the management.
6. Analyse Financial Statements and Financial ratios: The last but the most important step is to perform some number crunching. This is where your analytical skills may be tested. This helps an investor to understand the company’s financial position and performance for the period and should be reviewed at regular intervals. The important aspects are growth, profitability, liquidity and solvency.
Hope this helps !