Equity Markets: Is it the Place to be in ?

Posted on June 3, 2010

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“Hey, did you see the markets ? The Nifty was up 20 points today”, “Sensex is down by 100 points” are not something you might be hearing for the first time. People around us generally keep talking about the equity markets these days. We have one breed of “market experts” around us who are extremely confident of what is going to happen to the markets (or their favourite stocks) in a couple of hours. We also have other breed of “Burnt Fingers” who never want to talk about the equity markets, forget about investing in it. So, who is right ? Is the equity market the place to be in or not ? Lets discuss.

Both the examples quoted above are examples of two extremes. There is a third breed of “undecideds” who want to bask in the glory of equity markets but also don’t want to play “risky stunts” with their hard earned money. They keep seeking opinions from people and when they come across these “market experts” and “Burnt fingers”, they get more confused. All these mindsets are a result of some myths about the equity markets and once you hit the reality, you will have some clear picture of whether or not you should be a part of this market.

Myth 1: Equity Markets is a Gamble. Go only for fixed income products

Reality: This is the doubt in the mind of maximum people. Reason for their doubt is, there are no assured returns. Agreed, but that also gives you some headroom for growth. To make you understand this better, lets take a beautiful case study as below:

Mr. Dev (Name Changed) was in government service and retired in 1996. He received a sum of Rs. 30 lakhs (as the maturity amount of various deductions in his service). He put this entire amount in bank FD for 5 years with a nationalised bank who was offering a rate of 14% p.a. at that time. He received an interest of Rs. 4.2 lakh p.a. or Rs. 35,000 per month and was enjoying his retired life. But things became difficult at the time of maturity of the FD. Mr. Dev went to the bank and asked the banker to renew it at the same rate. The banker smiled and replied that he can renew it but only at the prevailing rate, which happened to be 6.5% p.a. Mr. Dev’s cash inflows suddenly collapsed to Rs. 1.95 lakh p.a. or Rs. 16,250 p.m. To make things worse, inflation during that period had made Mr. Dev’s requirement to around Rs. 42,000 p.m. Now, Mr. Dev was in a total fix. To plug this shortfall of Rs.25,270, he had to now start withdrawing money from his lumpsum capital of Rs. 30 lakhs (which put further pressure on his interest income and further widened the shortfall). As a result, he had used up all his capital within a span of 7 years and had almost no money left thereafter, still having a life expectancy of 5-7 years for himself and 7-10 years for spouse.

The problem with fixed income products in todays market is, they can-not protect you against inflation. I am not suggesting that Mr. Dev should have invested his retirement corpus in the equity market. All I am suggesting is, you will be needing a much higher corpus at your retirement to beat the inflationary effects. If you are young, this is the right time to enter the markets and create wealth for yourself in the long term.

Myth 2: I never land up buying the right stocks

Reality: Quite true in many cases. But then, should that keep you away from the markets? If you do not have the time and expertise to research the right stocks for yourself, take the route of collective investments i.e. mutual funds. The fund managers have the resources and expertise to pick up the right stocks and also what and when to buy and sell. Thus, you can ride the bandwagon and earn returns on your money much higher than your traditional bank FDs.

Myth 3: I should keep buying and selling as and when my stock broker tells me to do so.

Reality: In my opinion, keep away from short term trading and even worse intra-day trading. In short term, the only person making money is your stock broker, while all the risk of losing money lies with you. Equity is an asset class which will create wealth for you in the long run. Never ever try to do a “Hit and Run” business in the stock market. It might work once or twice, but overall you will stand to lose.

Myth 4: The Sensex is at too high levels currently. I will wait till it falls below 10,000 levels and then I will invest.

Reality: As an investor, never try to time the market. It is regular investment at all levels that will help you to create wealth in the long run. I am not saying that you will not create wealth if you invest below 10,000 levels. But then, what if the markets do not fall to those levels? You will be sitting on idle cash being eaten away every day by inflation. Also, if the markets fall below 10,000, someone might “tip” you that it will fall below 7,000 and you again keep waiting, only to realise that the markets bounced back from 9,500 levels and you are again left punching your palms.

The best strategy is to fix up a small amount from your monthly income and invest regularly. Over a period of time, you will reap advantage of both, rupee-cost averaging and power of compounding.

Myth 5: Equity markets are good. So I will buy a ULIP rather than an endowment plan.

Reality: This would be like saying, “The frying pan is too hot, I will rather jump into the oven”. You will be exposed to more heat there. The basic idea is, never try to mix investment and insurance with each other (I might be stating this for the Nth time now). When you need insurance, go for a pure term plan, which gives you highest risk cover at the lowest premium. Investing in ULIPs, because equity markets create wealth in the long term, could have been a great idea, if ULIP was the only product available to invest in the market. In my opinion, ULIP can never be a good investment option, whichever criteria you put it in. (For details on ULIPs, please refer to my blog “Look before ULIP”)

Myth 6: All my friends are making money in F&O. If I don’t do it, they will find me dumb.

Reality: Don’t give in to the peer pressure. Futures & Options are “Financial Weapons of Mass Destruction” as per Warren Buffet, the greatest investor in the world. (http://www.fintools.com/docs/Warren%20Buffet%20on%20Derivatives.pdf)

Your basic idea is to create wealth for yourself. Do it steadily through systematic investments. There are no magical investment avenues which will create wealth for you overnight. If your friends want to think of you as dumb, let them. Time will prove who is dumb, when they start losing money in F&O.

Myth 7: I will choose 5 Stocks for myself and trade only in them

Reality: Though this might appear to be giving you some ease of operation (research, tracking, monitoring etc) it will expose you to the concentration risk. Thus, instead of choosing 5 stocks for investing, choose 5 mutual funds for yourself, which will also give you similar ease of operation but will protect you from concentration by giving diversification benefits.

In a nutshell, be an informed investor. Don’t be lured away by greed and repelled away by fear. Equity markets can act as a double edged sword. If handled properly, might win you wars; If not, might hurt yourself as well.

We look forward to your feedback and comments on the above article. Please feel free to contact us on saurabh.nidhiinvestments@gmail.com if you have any questions.

(The views mentioned in the article are personal opinion of the author. The readers are advised to use their own judgement and consult their investment advisor before making any investment decisions.)

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