Stock markets are known to provide higher returns. But one must invest at a young age when the magic of compounding comes into play to provide higher gains

There are many reasons why some investors prefer not to invest in the stock market. Being risk averse, limited or no knowledge and expertise, a bad experience or being just a beginner are some of the reasons to remain out of it. Although markets can be unpredictable, in the long-run, they can provide comparatively higher returns than other low risk assets or securities. This is why it is a necessity in the overall investment portfolio, with the proportion being different for different investors. Here are some tips for first-time stock market investors.

• Know your purpose: The foremost prerequisite for stock market investment is to be aware of the purpose and the timeline of fund requirements. As an investor, one must have an estimate of future requirements. This can be done via an online financial calculator, which can help calculate how much one should invest and what kind of return will be needed to produce the desired result.
• Identify your risk appetite: Risk appetite is the extent to which one is ready to experience a loss in pursuit of profit. Generally, it is seen that risk appetite increases with education, income and wealth but decreases with age. A middle aged investor generally stays away from risky investments as compared to a young investor. All investors have their own risk appetite and one has to identify his/her own zone.
• Give time and be patient: A crucial thumb rule for stock market investment is to invest funds that one does not require for the next five years. As an investor, one needs to be patient and give time for the investments to grow. Investments need time to weather the ups and downs of the market. An early withdrawal or frequent buying or selling can also mean brokerage and taxes eating into the returns.
• Don’t bet on one or a few stocks: The best strategy for a beginner is to focus in a balanced portfolio by investing in mutual funds or index funds and not on one or a few stocks. Investing in mutual funds has its own advantages. One can take the benefit of the expertise and market timings of the fund manager.
• Take advantage of passive strategies: Beginners can use the passive investment strategy, where fund mirrors a particular index instead of an active portfolio management with frequent buying and selling. Inexpensive index funds and ETFs have finally moved ahead of the old-fashioned traditional stock pickers. Passive investing styles have been gaining ground on actively managed funds for decades. But in August this year, the investment industry reached one of the biggest milestones in its modern history as assets in the US index-based equity mutual funds and ETFs topped those in active stock funds for the first time. According to Bloomberg, investors added $88.9 billion to passive US stock funds while pulling $124.1 billion from active funds till August. Hailed all around the world, passive stock market investment is an important strategy for a stock market novice. If one is interested in active trading anyways, he/she must limit the activity to 10 per cent of the portfolio.
• Regularity is the key: One of the advantages of being a passive investor is that one does not have to always be on the toes to predict the highs and lows of market. Investing at regular intervals is a better strategy and also gives the benefit of rupee cost averaging. By regular, small and pre-determined value of investments, one will be in a position to buy more shares when prices fall, thereby bringing down the average cost of purchase. As we all know, stock markets rarely move in a straight line and price fluctuations are common. Therefore, by making regular investments over a period of time, one tends to invest across a range of prices and effectively ends up paying the average price over a fixed period, which can help smooth out market volatility.
• Don’t give in to emotions: It is evident worldwide that investors can be very irrational. They are mostly possessed by feelings of greed and fear and in most cases are subject to herd mentality. As an investor, one should develop the ability to control his/her emotions and make logical decisions. Many emotions bombard the mind both in bull and bear market, which can lead to an incorrect decision to be taken in panic. One should have an exit strategy before buying the security and execute that strategy unemotionally.

In the long run, stock markets have provided higher returns in addition to easy liquidity and a transparent environment due to strong regulations. However, the younger you begin investing, the magic of compounding comes into play to provide higher gains. In the meanwhile, just remember to take one step at a time.

(The writer is an Associate Professor, Amity University)