Nifty is up about 20% so far this year, and that means people are slowly getting back to talking about stocks. I see it on my Twitter, Facebook, personal circle and then of course the blog.
I saw an interesting comment from Mr. Ramamurthy the other day, and I thought I’d do a small post on the topic.
First, the comment.
As I’ve written before, I am a retail investor who invests in stocks directly too, so I obviously don’t buy into the argument that small investors shouldn’t invest in stocks directly.
But I do believe that you run considerable risk when you buy individual stocks. If you buy a few mutual funds then probably the maximum exposure to any single stock is 6 or 7 percent, but if you own individual stocks then you may just own 10 or 15 and within those, you may be concentrated in a few companies. If that’s the case and something happens to one of your companies then your portfolio can take a big hit.
You can reduce this risk to some extent by investing in big companies with long histories but then we all know of big companies that have failed too. And even otherwise, often stocks fall 10 – 20 percent in day like IFCI fell yesterday so that will have a big effect on your portfolio if you owned such a stock.
If you’re at a stage in your life that you already have a huge corpus invested and you take a huge hit like the one I spoke of earlier then that can be devastating to your portfolio.
There are a few ways to get away from this risk (albeit not completely).
You can diversify this risk by owning a number of stocks and limiting your exposure to any single one by less than 5%.
Holding cash so you can invest in times of crisis like last year also helps alleviate this risk because you will be able to buy stocks at a low price. This also helps when there is an eventual rebound in the market because at that time you are inevitably sitting on gains.
Another way to alleviate the risk is to be invested in fundamentally strong companies which have little debt, no promoter pledges and a good track record with disclosure and governance. This also means you stay away from penny stocks and other shady companies.
However, at the end of the day there are risks that come from investing in equities directly, and you can only diversify them so much. If you are going to invest in stocks then know that things can always go wrong, and when they do, it’s your responsibility and no one else’s.