So you have finally decided that you need to invest in stocks. You have defined an amount you can spend, have got a Demat and a Trading account in place and may even have signed up with a broker or some financial adviser to help you select stocks. However, before you take the plunge ans start investing, there are a few critical ground rules that you must keep in mind. This post ia about such rules to be remembered.
- You will always look to build a portfolio pf stocks and be concerned about performance of portfolio. The portfolio approach is the most important aspect of equity investing. The basic idea is this – as you spread your investment over multiple stocks in multiple sectors, the scale of the risk in each of these is contained. So at an overall portfolio level you have a lower risk of losses. We will discuss on how to build a portfolio at a later date.
- Ideally no stock should be more than 10 % or less than 2 % of your portfolio value in the long run. All of us will have our own favorite companies whose shares we want to buy. However, if we cap the investment at not more than 5 % of the portfolio value then we are once again containing the risk. Similarly, by investing at least 1 % of the portfolio value in a stock, you are ensuring that the investment is at a meaningful level.
- You do not need to analyse companies yourself but must have access to the right information. Many people may have told you that you must read tons of financial information and understand every word of the Balance sheet before you can invest in a company. That is completely unnecessary and frankly it is an utter waste of time. Do not reinvent the wheel – there are far better qualified people than you who can do this well. All you need is to have access to such data and an ability to understand simple stuff well.
- Always buy in small lots and with price triggers for both buying and selling. In stocks it is very important to understand that pricing is dynamic and is impossible to predict in the short run. It therefore does not make any sense to invest a large amount at one go. You can decide on what is a large amount based on the portfolio value that you want to create. We will be discussing this in much greater detail at a later point in time. Also, you must set price triggers for both buying and selling – this will take away the emotion from the decision and enable you to carry out trade calmly.
- All profits and losses are notional till you make a sale. The value of your portfolio will be changing everyday and it can be like a roller coaster ride emotionally. While we will get elated when it rises by 3 % on a single day, it will be emotionally gut wrenching to see it nose dive by the same amount on other days. Remember that you do not make or lose money till you actually sell. On many days doing nothing can be the best solution.
- Never bring yourself to a situation so that you have to sell stocks at the wrong time. The most serious risk in stock markets is that we may sometimes be forced to redeem part of our portfolio at the wrong time, as we need the money for some emergency. Your financial plan must address this issue squarely and make sure that you will have other sources of obtaining this money even if there is an emergency.
- You will make both right and wrong calls on individual stocks do not worry about it. You must always evaluate your portfolio performance, it is impossible for most people to get even 70 % of their stock picks correct. Even if you get half of your stock picks correct for your portfolio, you will make a great deal of money from it.
- Review your stocks in the portfolio every month / quarter but do not be obsessed with it.
- You need to try and buy stocks at the right price and also hold these for as long as practical.
- Do not be sentimental about any stock, if the review shows it has to be got rid of, do so immediately.
We will get into more specific aspects of building a high performing stock portfolio, the next post onward.
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