Stock Investing, like everything else, is difficult until someone explains it to you!
Investing is a lot like driving a car and going on a journey. Building a car is complex, but driving it is easy. However, every beginner goes through the pangs of learning how to drive. Once you have learnt how to drive, usually with someone’s help, you stop thinking about how to drive the car and focus on the road and the traffic. More importantly, you think about where you want to go and the route you need to take. Today, you don’t even have to worry about the route as long as you have GPS and know how to use it. In our series of posts on investing in stocks, you can learn the equivalent of how to drive and how to use GPS to achieve your financial goals. You will learn enough to do it successfully, without losing sleep. And soon, you will love the journey as much as your destination.
Long-term stock investing, like physics, is governed by a few fundamental principles. When you learn how to drive a car, you first learn the basics of how the car works, not the engineering but how it functions. You learn how to start a car, use the different pedals and the steering, change gears, switch on lights, wipers, etc. and read the dashboard to make the car work the way it is designed to. A car works according to certain fundamental principles, and a driver cannot change those. For example, when you press the accelerator, the car will run faster provided you are not pressing the clutch pedal or have not forgotten to release the hand brakes. A good driver knows these fundamentals. Pressing the accelerator and increasing the fuel supply will only rev the engine, make a lot of noise, and spoil your car. Losing your cool and cursing the car will raise your blood pressure and also disturb your passengers’ peace of mind.
Similarly, stock investment is governed by certain fundamental principles; you cannot change them, but you can use them to your advantage. The most important principle is that the Intrinsic or Fair Value of a stock depends on its ability to generate profits consistently. The market prices in the long term always depend on this fair value. In short, if a company generates a growing stream of profits over the years, the market will reward it with a higher and higher price. However, this is not a simple straight-line affair because of what happens every day in the stock market.
In the short term, stock price is driven by demand and supply. However, it is best ignored while taking decisions.
Daily and short-term price movement depends on the number of buyers versus the number of sellers. Many, if not most, are traders and speculators; very few are real investors. Their reasons to buy or sell are completely different from those of investors. However, they are present in large numbers and trade substantially larger volumes than investors do. Even so-called investors have different time horizons for investing, e.g. usually six months to a year, which are mostly driven by target price estimates put out by various brokers-analysts. All of them are strongly influenced by short-term events, and hence prices fluctuate a lot. Long-term investors need not even try to make sense of these fluctuations. However, they need to know the fair price or value of the stock.
But why learn how to invest in stocks when one has other options such as Mutual Funds?
There are about 350 Equity Mutual Funds, while there are about 200 good-quality stocks worth investing in. So, it’s not easy to know which mutual fund to buy. Currently, decisions are taken on the basis of past returns, but this is a very poor criterion. The underlying assets in equity mutual funds are stocks. A Fund Manager decides which stocks to buy, how much to buy, and at what price. Knowing the basics of stock investing will help you better understand what the equity mutual fund is invested in, and why it makes sense to buy or not buy it. Similarly, if you are taking investing advice, you will be able to understand what advice is good and what advice is not well thought out. And finally, you pay quite a lot for these services, and so you need to know whether you are getting your money’s worth. You cannot be ignorant and leave investing to your MF Distributor, Wealth Manager, Relationship Manager, Insurance Advisor or your Broker. Because, simply put — in investing, ignorance is not bliss, kyunki ye paise ka mamla hai.
When learning how to drive a vehicle, most of us experience some tension and anxiety. But, we don’t abandon learning how to drive, because we understand it is a necessary skill. Yes, there are buses, local trains and auto-rickshaws, but our personal mobility is best served by a personal vehicle. Similarly, knowing the basics of investing, especially in stocks, is a necessary prerequisite for successful investing.
Read our next article: ‘How to invest in stocks successfully