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Photo: Hemant Mishra/Mint
Photo: Hemant Mishra/Mint

Four questions you should ask before buying stocks

  • Before giving in to the excitement of stock trading, consider all the risks involved
  • If you don’t have enough knowledge about market movements, leave stock investing to professionals

As India went into lockdown in late March and markets nosedived, a lot of millennials took to online stock trading, suggests their social media footprint. The average daily turnover in the cash segment (which retail investors largely resort to) of the National Stock Exchange surged to 58,000 crore in March, nearly 50% above the level in January and February 2020. In April and May, it remained around the 50,000 crore mark.

Sagar Chauhan, 28, an IT professional based in Ghaziabad, started investing after the lockdown, when the prices of bluechip companies fell. “I wanted to hold them for two-three years but I had to sell one of my stocks (of a major commercial bank) because it’s volatile," he said, betraying low tolerance for sharp stock moves. Chauhan relies on technical analysis, company results and news to make his decisions.

Aditya Swarup, 35, a New Delhi-based consultant, began investing in stocks to benefit from the market correction. “Anyone remotely aware of the bull markets after the bears of the 2008 financial crisis knows that millionaires are made during such times," he said.

Stock trading could appear more exciting than investing in mutual funds or FDs but it is a lot more risky. Lack of experience with previous corrections make Chauhan, Swarup and other first-time investors vulnerable.

Mint’s Personal Finance team does not endorse direct stock investing by retail investors. However, if you are determined to enter this field, here are four questions you should ask yourself before investing in stocks.

Do I have an emergency corpus in place?

Consider stock investing only after your basic financial needs are met. Foremost among these is an emergency corpus to tide over loss of income temporarily due to job or salary cuts or to meet medical emergencies. According to financial planners, this should amount to six to 12 months of expenses. “My suggestion to a stock investor would be to first secure an emergency corpus and long-term goals through lower-risk options like bank FDs and mutual funds. After that, if they want, they can deploy 5% of their corpus in direct stocks," said Nishith Baldevdas, a Sebi-registered investment adviser (RIA).

Some experts don’t recommend even limited push into direct stocks without the required expertise. “No part of your portfolio should be into direct stocks unless you have the expertise of an analyst and a full-time commitment to investing," said Mrin Agarwal, founder of Finsafe India Pvt. Ltd and co-founder of Womantra.

Do I understand the stock market well?

Many would argue that picking the right stocks can help you achieve long-term goals. But to be able to do so, you need sound knowledge of not just the market but even the sectors and stocks that you pick.

In the absence of this, it’s an extremely high-risk approach. “Most people, without a high level of financial training don’t understand stocks and don’t have the technical expertise for direct stock investing. They also lose interest in it after a while and leave the portfolio unattended," said Agarwal.

Typically, retail investors rely on stock tips and recommendations offered by brokers and other platforms. But understand the conflict of interest here: brokers make money through commissions and the more frequently you trade, the higher will be their commission.

“Ideally, beginners should seek professional advice from Sebi-RIAs," said Amol Joshi, founder, Plan Rupee Investment Services, a financial planning firm. While advice from RIAs is not foolproof, there is a chain of accountability and regulation in place. Supplement this safeguard by asking the RIA for advice in writing. Also, provide the RIA with enough information to get the best advice. If you can’t afford an RIA, mutual funds are a good route as there is a professional fund manager involved.

Is my overall portfolio well-diversified?

Diversification is a strong antidote to the risk of stock investing.

A portfolio with 20 companies has a much lower chance of dropping to zero than one having just two companies. However, such a portfolio also begins to behave like a mutual fund, draining the adrenaline rush big daily jumps in the value of demat account may create.

You also need to be diversified across asset classes like FDs, mutual funds and gold. When the stock market crashed in March 2020, gold rose sharply, protecting those who owned both assets.

Do i need to borrow in order to invest?

Borrowing money to invest is an absolute no-no, said Baldevdas. Many stock market products like futures and options (F&O) are based on putting up only a fraction of the money and you may not even realize you are borrowing the rest. This borrowing is not free because the interest rate is in-built in the prices of futures contracts. Borrowing or leverage can both magnify your gains as well as losses.

Beginners should stick to the cash market (delivery-based trading) and avoid keeping any margins with brokers for leveraged trading.

Equity trading can be exciting and the atmosphere is amplified by feverish commentary on the media. But think hard about what you are doing and why. If you have a career to focus on, stock investing is a job best left to professionals.

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