From Risk to Reward: The do’s and don’ts of investing in stock markets

The Indian stock market has witnessed a retail investor boom in recent years. As financial awareness grows, the stock market is becoming an attractive investment option, with an increasing number of people willing to take the risk and reap the potential rewards.

The Covid-19 pandemic and subsequent fall in the stock market in March 2020, along with job losses and work-from-home initiatives by many companies, drew a flood of first-time investors into the stock market, who participated actively through mutual funds and direct investments in primary and secondary markets.

Despite the ongoing global economic uncertainties, newbie retail investors have retained their interest in the stock market, holding onto their faith in the India growth story.

The steadily rising number of Demat accounts across both depositories aptly indicates this trend. The number of active Demat accounts reached a record high of 11 core in January this year. Multiple factors have contributed to this surge, including the ease of access to market information, availability of online brokerages, increase in financial savings and the potential for good returns.

Also, a slew of measures by the Securities and Exchange Board of India (SEBI), the capital market regulator, in the interest of retail investors with a special emphasis on awareness, risk assessment and so on, have motivated retail investors to trust the market more than ever before.

Retail investors, accounting for over 50% of daily transactions, have helped the Indian stock market remain resilient amid turbulent times. An intriguing part of this influx of new investors was that they were not only from the usual major cities, but also from Tier 2, Tier 3, Tier 4, and other towns and cities, broadening the pool of Demat account holders and thus the investing public. In fact, both depositories now boast of reaching more than 99% of India's pin codes.

However, with great potential comes greater responsibility. The stock markets turned volatile recently due to several economic, geopolitical and global events. Hence, it has become increasingly important for retail investors to make sure they are making astute decisions while making their investments.

Here are a few dos and don’ts that can help investors make informed decisions:
Do your own research: When it comes to choosing stocks, it is tempting to follow others’ recommendations, but relying on it solely can be risky. As business magnate Warren Buffet famously said, “Risk comes from not knowing what you are doing.” Another valuable advice from him is, “Don’t buy stocks but buy into companies.”

It is important to do your research by conducting a thorough analysis of the company, including its financial statements, earnings reports, and industry trends. You should also keep up with updates about the economy and events that may impact the company or sector you are interested in.

Don’t fall for get-quick-rich ideas: Many new investors are enticed by online trainers and influencers who claim to have inside knowledge of the market and promise quick gains. Unfortunately, many of these programs may be ill-intentioned and fraudulent, leading investors to incur huge losses.

Always seek professional advice from brokers and investment managers registered with regulatory bodies and can offer quality guidance. It further helps to avail the benefits of investor awareness campaigns and workshops conducted by the SEBI, the stock exchanges (NSE, BSE and MSEIL) and the depositories (CDSL and NSDL) regularly. The websites of these organizations provide access to past videos of such awareness programs, allowing investors to revisit earlier sessions and stay informed.

Assess and manage your risks: There are many risks associated with investing, such as market volatility, company-specific risk, liquidity risk, and currency risk. You need to determine your personal risk tolerance depending on your age, financial situation, investment goals, and personal preferences. Investing more money than you can afford to lose can ruin your finances if the assets do not perform as expected.

Don’t put all your eggs in one basket: This commonly used adage emphasizes the significance of diversifying one’s funds by avoiding excessive concentration in particular companies or sectors. As an investor, your strategy should be to build a balanced and robust portfolio. One approach is to invest in a variety of stocks, bonds, and mutual funds to leverage different rates of return. Another technique is to spread your funds across companies and sectors to reduce the impact of risks associated with a certain industry or market segment.

Start early, stay long-term: Investors can profit from a longer investment horizon by beginning to invest from a young age, giving their investments more time to grow and recover from market corrections and recession periods. Investing in mutual funds and systematic investment plans (SIPs) can be a good approach for long-term investors, as these funds come with built-in diversity and potential for growth.

Don’t be guided by emotions: When it comes to investing, it is easy to let your emotions get the best of you, especially during market turbulence. However, making investment decisions based on emotions can lead to irrational decisions. Having patience and investing a fixed amount of money on a regular basis every month can help avoid the temptation to time the market and build a diversified portfolio at a lower average cost. Developing an exit strategy prior to making an investment can help you avoid losses.

Tread with caution while trading F&Os: Trading in financial derivatives such as futures and options (F&O) requires a good understanding of the underlying markets and financial instruments. They can be used for hedging but involve a high degree of risk and complexity. Traders who are new to F&Os should seek guidance from experienced professionals.

Don’t ignore taxes and trading charges: Every purchase and sale of securities listed on the exchanges attracts securities transaction tax and commission or fee by brokers. By paying close attention to these costs, you can make more informed investment decisions and potentially save money in the long run.

While the stock market provides excellent rewards, it is fraught with volatility, which may catch even seasoned investors off guard. It takes caution, time, wisdom and patience to create wealth through investments. Having unrealistic market expectations and pursuing hot shares based only on their short-term popularity may result in disappointment.

Remember that knowledge is your ally, and ignorance is your adversary. With the right approach, you can confidently navigate the uncertain and ever-changing terrain of the stock market and make your money work for you.

(Ramkumar K is Chief of Business Development and New Projects at CDSL)