Understanding basics of Stock market
Understanding Stocks investment basics for beginners (I am not an expert, so this analysis is not for experts 😉 )
*What is Share and share market?
-Suppose you want to open a shop and you are lacking 5000 rs to open it. So you ask two friends of yours to give you some money. The first friend gave you 3000 rs and the second friend gave you 2000 rs. You successfully started your shop. Now they both ask you:
“We helped you in starting the shop, but what do we get in return?”
You say- “I will give you both partnership in this shop. The profit that I earn, I will share with you both too, and in case I suffer loss in business, your 5000 rs money will be also in danger. So do you want to take the risk?
Both friends know that you are a very good businessman, so they know that you will run the business properly. And there will be profit in future. So they agree to this. They tell you that whatever profit or loss happens, we will share it because we trust your business.
So you give them a paper with your signature saying the first friend gave 3000 rs and the second friend gave 2000 rs. Then, in the future, maybe after 10 years, when they both come, they will show this paper and at that time, whatever profit the shop has made, they will get profit in the same percentage. So the first friend has ‘shares’ worth 3000 rs and the second friend has ‘shares’ worth 2000 rs in this shop.
This is what a share is. We also call it stocks or equity.
Similarly, all big companies give their shares to people who want to invest in their companies. The place where this buying of stocks happens, we call the Share market/Stock exchange. The companies sell their shares to people who want to buy the shares.
Now let us understand the STRATEGY:
The stock exchange (share market) is a body where all companies who want to sell their stocks are listed. First, the company lists itself on the stock exchange, and then, the selling or buying of stocks happens. There are 2 stock exchanges in India:
National Stock Exchange and Bombay stock exchange.
In the stock market, there are 3 types of companies:
Large-cap companies: the big giant companies with a huge market and turnover like tata, reliance, HDFC. etc. are called large-cap companies.
Mid-cap companies: the medium size companies that are smaller than large-cap companies but growing nicely.
Small cap companies: the new companies in the market with a smaller market and smaller turnover etc.
Now, if you invest in large-cap companies, your money is SAFE. Your money will grow at an annual rate of 10-12% which is almost double than fixed deposit. The return percentage is not very high, but the risk is also less. As these are established companies, it is very unlikely that they will go bankrupt in the coming years. They are likely to grow for many years, though, as they have already achieved huge status, they might not grow a lot in the future but they will certainly not suffer big losses. They will continue to grow at 10-12% and if you invest your money in these companies, you will not suffer loss and your invested money will grow at a 10-12% rate per year. Chances of average growth and very less chances of loss are there.
If you invest in mid-cap companies, they have the potential to achieve good growth as they are still on their way to becoming large cap companies but they are not yet as big. So they are likely to grow faster and might give you 15-25% returns per year on your invested amount. But since they are not as established as large-cap companies, they also come with a bit of risk. They are still in the growing phase and they might grow or they might fail. So, if you invest in these companies, they might give you good returns or they might incur loss and might even fail. Chances of good growth and chances of a big loss, both are there.
If you invest in small-cap companies, they are still in their initial phase. So, they might grow very fast as Amazon grew from a small cap company in 1997 to a large cap company within 20-25 years. So, suppose someone invested 1000 rs in Amazon in 1997, today, within 25 years, that 1000 rs would have become 10 crore rs. But, as with the majority of startups, the small-cap companies are just in their initial days, so they might grow rapidly and they might fail. They might give you 25-30% annual returns or they might fail. Changes of huge growth and changes of complete loss, both are there.
What are monopoly stocks?
Monopoly stocks are companies that are leaders in their respective fields and do not face much competition in their respective fields. Like Nestle (Maggi) is a monopoly stock in the field of noodles. Pidilite (Fevicol) is a monopoly stock in the field of glue. These are generally large-cap companies and enjoy very good status.
What are sin stocks?
Sin stocks are industries considered immoral by some groups of people. Industries like cigarettes, alcohol, etc. come under this category. These stocks earn good returns every year but some people feel that investing in these stocks means promoting alcohol or cigarettes and thus, despite good returns, they do not buy them. These industries give good returns always.
Now, you have 2 options for growing your money in the stock market.
- Low risk, low gain - Investing in large-cap companies generally gives 10-12% returns every year which is a good return but not very high. The good point in investing in large-cap companies is that they have very low chances of loss in the future. Your money might not grow at high speed but it will not go into loss. And 10-12% return is any way you will be getting.
- High risk, high gain - Investing in mid and small-cap companies generally gives 15-25% returns every year which is a very good percentage. The bad point with mid and small-cap companies is that these are not very well established in the market and might incur a loss. They might even go bankrupt. They might grow tremendously like Amazon grew in 25 years or they may end like a lot of small companies end up.
If you want to make average money returns with very less risk, you can invest in large-cap companies. You can directly buy stocks of big companies, leave them for 10-15 years and the value of stocks will grow every year at 10-12% compound interest. So if you invest 10,000 rs in a large company for 10 years, and the interest is generally 12% every year, after 10 years, you will have 31,000 rs. There is no risk and this is good growth. If you increase the invested money, the returns will also be higher.
If you want to make more money at a better rate of interest, you will have to take the risk of investing in small and mid-cap companies. So if you invest 10,000 rs in a small cap company for 10 years, and the interest is generally 20% every year, after 10 years, you will have 61,000 rs. But these high returns come with a high risk of loss too, as these are not well-established companies.
Now you have to make a decision based on your risk-taking appetite. Are you ready to take more risks or are you happy with playing safe?
If playing safe is your choice, just buy stocks of big companies regularly and hold them for 15-20 years.
If you are ready to take the risk, you will have to buy small and mid-cap stocks.
The problem lies in identifying the small-cap companies which have growth potential. It is easy to identify large-cap companies with growth potential. Almost all large-cap companies will give you 10-12% growth. But to choose small cap stocks which should perform well in the future, we need to do research. We need to read the balance sheets and finances of hundreds of companies to identify them. Or we can rely on tips from other people who are good in this field. We can also view Youtube and google answers to get the answer of which stocks should we buy that might give us a good return. But these all options are not very trustworthy. Or maybe 1 or 2 companies can be found by this method, but can we rely on these methods for long-term and big amount investments?
I do not think so.
Here comes the option of mutual funds.
A mutual fund is a wonderful thing.
Suppose you and your 4 friends want to invest 1000 rs each in the stock market, but you all are not sure which share to buy for profit. So you all go to a person in your city who is an expert in the stock market. He tells give me your money and I will invest your money in stocks as per my expertise and all profits will go to you 5 people. He will just be investing on your behalf. So he takes your money and invests in the stock market on your behalf. This is what a mutual fund is.
A mutual fund is basically when a lot of people give their money to an expert who invests that money in stocks as per his expertise. This expert is called a mutual fund manager.
Now 2 questions will arise:
- Can that person be trusted? Can he do fraud or run away with our money?
-Mutual funds are run by big financial institutions like HDFC, ICICI, SBI, etc. Fund managers are like employees of these banks who are experts in the finance and stocks market with years of experience.. Just like you keep your money in the bank with the trust, similarly, you give your money in mutual funds to these banks who then assign that money to fund managers who will manage the investments of that money as per their own expertise. These managers work under these banks, not independently. So, if you trust these institutions, you can trust their fund managers too.
2. What if the fund managers make wrong investments and our money is lost? He can also make wrong decisions or lose our money in the wrong stocks.
-Suppose you invested 1000 rs in a mutual fund. The fund manager then divided 1000 rs into 200 rs and purchased shares in 5 different small companies. Now suppose 2 of those companies start making a loss. The fund manager will immediately take out your money from those 2 bad companies and invest in some other company that is performing well. Fund managers are experts in finances and they work on the stock market 24*7. Their duty is to manage the investments. So, it is possible that he might invest in the wrong stocks, but he is constantly managing the money and keeping eye on the stock market. He will take your money out in case something bad happens.
The investments in mutual funds are not by 8-10 people but thousands of people and the money runs into thousands of crores in all mutual funds. These are trustworthy.
I guess the concept of a mutual fund is clear now.
Main types of mutual funds:
*Large cap mutual funds- mutual funds where the money will be invested in large-cap companies only.
*Small and mid-cap mutual funds- mutual funds where the money will be invested in small or medium cap companies.
*Index mutual fund- It is a type of mutual fund in which the investment is done only in the top companies of India, all of them large-cap companies. Out of all large-cap companies, only top companies are used for this investment. If you are investing in an index fund, you are investing in the future of the Indian economy and your money is bound to grow at a minimum 10-12% rate. Nifty 50 and Sensex are examples of an Index. Nifty is a group of top 50 companies listed on the National Stock Exchange of India. Sensex is the group of top 30 companies listed on the Bombay stock exchange.
Now, if you want to grow your money nicely, as discussed earlier, we need to invest some amount in small and mid-cap companies too, for potential growth. So, the best way to invest in these small and mid-cap companies is through small and mid-cap mutual funds where your money is invested in these high-potential companies for growth. And if the companies start falling, the fund manager as per his expertise takes your money out and invests in some other company. You get the expert help of a fund manager and all his management and handling of the investments at a very nominal price of less than 1%. So suppose you invest ten thousand rs every month in a mutual fund, so the fund manager’s fees will be maybe 50 rs only or even less.
This is the reason most people opt for mutual funds.
In my opinion, the best strategy for someone who does not have expertise in the stock market should follow the below strategy for the first 3-5 years:
1) 50% amount in index mutual fund through monthly SIP.
2) 25% amount in small and mid-cap mutual funds through monthly SIP.
3) 25% amount in direct buying of top/blue chip companies' stocks just to learn the process if desired, but only from top 10-15 companies.
SIP means Systematic Investment Plan. You pay every month on a fixed date for the mutual funds instead of buying at one time. This gives much better returns than one-time buys in long term. In a mutual fund, always prefer monthly SIP and hold your mutual funds for the long term.
2nd of June, 2021.
-Subhav Samarth
+91-9015661671.
-----------------------------------------------------------------------------------------------------------
Comments
Post a Comment