New to investing? Bet only a small part of your surplus directly in stocks

The bulk of your money should be invested via mutual funds and low-cost passive funds

Neha Gupta, 29, a resident of Udhampur, has been active in the stock markets for the past six months. “The lockdown has given me time to read up on companies, do proper evaluation, and then invest,” she says. Gupta goes through the annual reports of companies, reads highlights of their annual general meetings, and assesses their valuations before investing. Being risk averse, she has stuck to large-cap names and mostly put her money on market leaders in various sectors in these volatile times. She has also diversified into sovereign gold bonds to hedge her portfolio.

Influx of new customers

The lockdown and the extra hours of free time have prompted a large number of new investors to enter the markets. Stockbrokers we spoke said there has been a spike in account opening over the past quarter. “We saw a 300 per cent increase in monthly account opening numbers from March to June. The account opening numbers for the first six months of 2020 have already surpassed the total number for 2019,” says Nithin Kamath, founder and chief executive officer (CEO), Zerodha, the country's largest stockbroker. Central Depository Services (India) Ltd (CDSL), one of the country's two depositories, has also witnessed a rise in new demat accounts. In January and February, the number of new demat accounts rose by 900,000, while in March and April it rose by 1.2 million.

Cashing in on the correction

Besides having more time, several other factors have led to people entering the stock markets. "The FOMO (fear of missing out) is playing out in the markets. A number of people had missed out on the chance to invest in stocks and benefit from the post-demonetisation rally. They are keen not to miss out on the opportunities thrown up by the recent correction,” says Jimeet Modi, founder and CEO, Samco Securities. He further adds that the low interest rates being offered by bank fixed deposits has also led many people to allocate more to equities.

While the shift to equities should be regarded as a positive development, since equities have the power to deliver higher returns over the long term, experts say that investing directly in stocks is not for everyone. "Direct equity research and investing by oneself is not for everyone. I would say that 99 per cent of the people who wish to invest in equities should take the diversified mutual fund and exchange traded fund route, and only one per cent should invest directly," says Jatin Khemani, founder and CEO, Stalwart Advisors, a Sebi-registered independent equity research firm. While this may sound rather discouraging, a number of experts we spoke to held similar views. “You should not go to learn swimming when there is a tsunami,” says S G Raja Sekharan, lecturer on wealth management at Bengaluru's Christ University and an avid investor in the equity markets, referring to the global economic slowdown. According to Khemani, to be a successful, fundamentals-based stock investor, you need to have an understanding of subjects like accounts, economics, portfolio management and risk management. You should also have the time and the inclination to do the due diligence. Then you must have the psychological resilience to tolerate volatility, and finally, have a portfolio size that justifies the time and effort.

Most investors who enter the markets without adequate knowledge inevitably get their fingers burned. Once they sustain losses, they swear off equities and invest in fixed-income products only for the rest of their lives. They thus lose out entirely on the wealth-generation potential of equities and end up with a much smaller retirement kitty.

But it does not necessarily have to be so. We shall first examine some of the common mistakes that stock investors make and then offer a roadmap so that you are able to take your first tentative steps in the equity markets without a mishap.  

Since I am rather risk-averse, I have stuck to large-caps and to market leaders in various sectors. I have also bought gold to hedge my equity bets -- Neha Gupta, 29, Udhampur-based new investor  

Mistakes newcomers make

Investing in leveraged instruments: Right at the start of their investment career, sometimes encouraged by unscrupulous relationship managers, many investors start dabbling in futures and options (F&O) segment of the market, instead of sticking to the delivery-based equity segment. “Stick to the cash segment of the equity market. That way you will only lose money that you have. If you make leveraged bets, your losses can get magnified,” says Raja Sekharan. He adds that F&O trading is dangerous even in normal circumstances, but it can be outright catastrophic in these times when the outlook is so murky. In recent times, there has been a case of a youngster in the US committing suicide after he racked up massive losses in the F&O segment using the popular Robinhood stock investment platform (his losses were actually not that high, he had mis-read his statement, which makes it all the more tragic).

Betting on penny stocks: According to market experts, one mistake that new investors have been prone to in recent times is investing in penny stocks. “Many investors have been investing in stocks priced at Rs. 5-8. Some have even made money in them because the gush of liquidity that has come into the markets has driven their prices up,” says Modi. Many of these stocks are heavily burdened with both long-term and short-term debt and have poor business prospects. After some time, prices of such stocks tend to collapse and fall all the way to zero. Retail investors are usually unable to exit these highly risky bets in time and end up losing their entire investment.

Short-term orientation and overconfidence bias: The markets had collapsed in March and have rallied since. Many of the new investors who have entered the markets in the past few months have made money in this rally. The risk is that they may end up attributing their success to skill rather than to luck. Many may even feel that having an investment horizon of two-four weeks is the right way invest in stocks. Such investors will continue to ride the market volatility. Experts say that they will inevitably run out of luck after some time, because no one can predict the short-term random movements of the market with accuracy for a sustained period. “There are opportunities available in this market. For instance, you could invest in stocks of top-notch multiplex owners or hotel companies that have taken a severe beating because of the pandemic. Once the pandemic ends, you could well make a gain of 30-40 per cent in them. But you need an investment horizon of 12-18 months for this kind of an investment thesis to play out," says Rajasekharan.

Not paying heed to valuations: Not only do you need to invest in companies that have strong prospects, you also need to get the entry price right. Take one example. Most investors are aware that people are spending only on essentials at present. Therefore, fast moving consumer goods companies, telecom companies (because of the rising demand for data), etc are expected to do well. However, only having this knowledge is not sufficient. Smarter investors would have already figured this out and entered those stocks, driving their prices up. An investor who enters such stocks at a late stage could earn lower returns, or even sustain losses.

Bengaluru-based Naufal Iqab, 29, who entered the markets two years ago, believes that engaging in intraday trading is the commonest mistake that novice investors make. "I started investing in 2018 when a bull market was still on. I made the mistake of investing heavily into equities and not diversifying into fixed income and gold," he says.   

What should new entrants do?

By taking a few precautionary measures, you can ensure that your initial foray into the equity markets does not end in a fiasco. The bulk of your monthly investments should go into actively managed mutual funds, where there is a team of knowledgeable experts to look after your money. You may also invest in low-cost index funds. Khemani suggests that you invest only a small portion of your surplus in direct equities initially. This should be money you can afford to lose. “Even if you lose this money, treat it as tuition fee paid to learn how to invest," he says. He suggests building a diversified portfolio consisting of about 20-25 stocks, belonging to different sectors, with exposure to each stock limited to 5 per cent of the portfolio. Finally, he emphasises the importance of patience and continuous learning. “It takes about 5-10 years, over which you would witness one or two complete market cycles, to get a proper understanding of the markets and of your of own psychology. Only if you are prepared to devote this kind of timeframe will you get trained adequately and be able to benefit from subsequent market cycles,” he says. 

Ashish Gandotra, 29, Jammu-based investor

“Equities are not for those who want to make a quick buck”

Jammu-based Ashish Gandotra, 29, started investing in the equity markets two years ago. He mentors many other young investors. He recounts his key learnings from his journey so far.

Getting introduced to equities: My parents invested in traditional plans offered by insurance companies and in Public Provident Fund (PPF). While doing my MBA, I was introduced to equity investing during a course on financial planning and wealth management. That is where I learnt that one can make much higher returns over the long term by investing in the capital markets.

Major mistake so far: I invested in the stock of a non-banking financial company (NBFC). This investment was done based on what I heard in the media. I did not do adequate research on my own. My purchase price was Rs. 130 and the stock is now at about Rs. 65. Even when it was falling, I could not muster the courage to cut my losses and exit. Instead, I bought more of its shares to average down my purchase price.

Lessons learnt from others’ mistakes: A friend started investing with me in 2018, when the markets were at peak valuations. Value investing says that you should buy more when the markets correct. Instead, my friend panicked and exited at a loss when they fell. The major lesson for me from that episode was that this is a long-term game. Things can end badly for those who want quick gains.

Precautions he has taken: I have tried to build my portfolio using stocks that have low or negative correlation with each other. I have also invested in sovereign gold bonds to hedge my bests on equities. I have also invested in PPF.

Advice for other newcomers: The markets have corrected. This is a good time to enter the markets. But you must be prepared for high volatility. If a second wave of infections hits, we could see another correction. However, if you have invested in companies with strong fundamentals, you don’t need to worry.

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