Part 3: How should beginners approach investing in the stock market?

by Manshu on April 9, 2012

in Investments

In part 1 of this series I wrote about the evolution of an investor to either a trader or a long term investor, and said that I favor long term investing to short term trading.

Then in the second part I wrote about the implicit assumption that a long term investor makes which is over a very long period of time the market will move upwards, and then also spoke about the nature of a share or stock. That nature I said was that a stock is a representation of the earnings of a company, and looking at it that way helps you stomach the volatility that exists in the market and deal with the daily ups and downs.

In this part I’m going to build on the two concepts I spoke about earlier and share a few thoughts on execution.

I invest regularly in the market throughout the year but I don’t have a SIP set up and I do this on my own. I invest very aggressively in the market when there is doom and gloom and put in as much as I can like I was doing last December, and during the Lehman crisis, and I slow down (but still keep investing) when there isn’t much doom and gloom but people are not over the top as well. The market right now resembles that situation and while I’m investing in the market the sums that go in the market aren’t as much as they were last December.

There are three big ideas behind this type of thinking – one is that in the long term I expect markets to edge upwards so even if they are down today I feel that they will be up 3, 4 or 5 years down the line and as long as no one forces me to sell the position – I can wait for the tide to turn and sell at that time.

The second big idea is that markets don’t move in a linear fashion, and no one knows when, why or by how much they will go up or down. You can’t simply stop investing with the fear that the market will go down more because there is no way to know when the tide will turn and by how much the market will rise then. If you sit on the sidelines when the market is down, then I’m pretty sure you’re sitting on the sidelines through most of the earnings that come about when the tide turns.

The past decade has shown us that up moves have been as violent as down – moves and that too at very unexpected times, so that’s why I like to stay invested in the market as much as I can. I hear a lot of people say that I’m going to start investing when the market turns and perhaps Santa whispers when the market is about to turn in their ears, but I am not one of those people.

Here is a chart that illustrates what I’m talking about.

 

Nifty Annual Returns

Nifty Annual Returns

The third big idea is that while you can’t time your in and out, you can try to calibrate how much you put in the market, and while that exposes you to additional risk – if you don’t have any loans and can stomach risk and volatility then it is possible to make this volatility work in your favor rather than give you jitters.

The big difficulty in doing this is it’s very hard to buy when everyone else is paring down and the general atmosphere is of doom and gloom. However, if you view a stock as ownership in a company (like I wrote in the earlier post) and if you believe that the company will survive the downturn – that gives you confidence to hold on and continue buying. Then when the tide turns you will be sitting on some good profits, and you won’t be rushed into investing in the market like the people who feel left behind by sudden market jumps, and the jumps are always sudden, so at that time you can moderate your investments.

I think people who are starting out can leave calibrating out of the equation and start with investing small sums monthly which they continue with even when the market is down. I say small sums because it doesn’t hurt as much when you see them in the red (which you inevitably will) and it makes it easier to continue investing small sums even when the market is falling. Within a three to five year period you will get a sense of where you stand as far as shares are concerned and whether you want to stay away completely from them (understandable) or want to go in very aggressively (also understandable) but whichever way you eventually turn to I’d recommend you follow this approach initially rather than buying and selling daily or weekly in an ad-hoc manner.

In the next part of this series I will write about some type of mutual funds that can be used to invest in equities regularly and execute this strategy.

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