Updated on: December 18, 2020 ; Behaviour
Introduction:
Actually, “Why is it so difficult to make money in stock markets?” would have been a more apt title. I just chose this one to keep is short and crisp.
We all know what stock markets are. If not, don’t worry. Please read the primer on stock markets/exchange here. Stock markets offer a great opportunity to everyone, common mortals like us included, to make great investments and build a modest fortune.
But why does this possibility elude most of us? Why does it feel like a distant dream? Why do we find many people more often than not losing money in stock markets? Eventually giving a general impression of stock markets being difficult.
I am sure, all of us have heard and read about many stock market success stories. But when it comes to our personal experiences, why is it different? We will attempt to understand it in this article.
For that, we need to take a look at the qualities and conditions required for making sound and successful investments. These requirements will help you understand why stock markets are difficult or perceived to be difficult.
Requirements:
Basic knowledge of investment opportunities: Investors who wish to invest in stock markets should have the basic knowledge of the investment assets available to them. It is important to know the past returns and the nature of risks associated with them.
You may choose to directly invest in individual stocks or invest indirectly through mutual funds.
You can study the performance of different equity mutual fund classes written in the different articles. Follow this link and the other links within it.
In the case of direct stock investment, you need to know a lot about the company. You need to understand the business, the prospects of the company, and the industry as a whole.
This would require thorough research on the company, its financials, its management, competitors’ landscape, growth opportunities, and potential risks. You will need to heavily invest your time and mind for this. Based on your research, choose the companies that have a solid footing. There is enough literature available on how to analyze companies and value them. Spend time to read them and develop the capability of evaluating and identifying such stocks.
Don’t blindly invest in any company without having done your research. Think about investing only when you have convinced yourself that you know enough about the company. And are reasonably confident about your decision.
If you are not comfortable with direct stock buying, then don’t worry. You have the option of buying equity mutual funds or index funds that are managed by professionals. They then invest your money in buying equity shares of listed companies. Click on this link to understand more about the performance of equity mutual funds.
Right valuation: You as an investor may have spotted the right investment asset, be it equity shares of a company or a mutual fund after doing your research. But it might not be available at the right price. These identified assets might suit your needs and investment style but might be overpriced.
You need to know how to value these assets and buy only when the price justifies its valuation. Please note, the perceived value and the price of the asset might differ significantly and frequently. I suggest you read more about how to value companies.
Liquidity in the asset: The asset you plan to invest in, needs to be freely available for buying and selling. This is called liquidity. If there is no liquidity, then you may not find sellers to buy the asset from when the opportunity is right.
More importantly, you might get stuck with the asset when you want to sell it. This might happens when there are no buyers available at the time of selling. Lower liquidity also makes the price discovery of the asset sub-optimal.
Availability of capital: You will need money to buy stocks or MFs (Mutual Funds) when they are available at your choice of valuations. You can park the funds separately for this purpose or move funds out of any other liquid asset. You should not be looking around for capital when the right opportunity comes knocking at your door.
I highly discourage you from taking debt for investment purposes. There is no certainty in the markets, and you would not want to be in a leveraged position during bad times.
Cushion: Markets are highly unpredictable. So you should never rely on your long term investments for your immediate or near future expenditures. Always have a cushion of cash to fall back on for your normal or emergency expenses. This is to avoid situations where you may require money. And you find all your money locked away in long term investments.
In such scenarios, you will be forced to pull out money from your investments at lower price levels. So, keep your cushion money for rainy days separate from investments.
Being debt-free: Being debt-free provides you peace of mind and the freedom of making constraint-free financial choices. Carrying debt is a constant burden over your head that can be very stressful. So try to be debt-free as early as possible and remain so forever.
Patience: This is the biggest virtue of a worthy investor. You will need a lot of patience to be successful in stock markets. Investors need to wait patiently for the right opportunities to come by. Not knowing if such an opportunity will ever come again.
Your patience will be tested thoroughly, especially during bear markets. You will be tempted to cut your losses and move out every day. The key is to hold on to your sound investments and wait for the bad phase to pass. You might even take this opportunity to buy more during such periods.
Markets go through a series of bull and bear cycles. The patience of a real investor is tried during these times. You have to wait for the right time to enter and exit the markets.
Don’t be greedy: Control your greed by curtailing personal expenses. This will help you save more capital for investments.
More importantly, avoid buying ‘enticing’ opportunities if you don’t understand them. Don’t fall for tips that promise multi-fold returns in short periods. Many times these turn out to be traps, where you have more chances of losing money. Stick to your sound investment strategy.
Discipline: Once you have framed your strategy, stick to it. Don’t try to make too many adjustments to it with changing market conditions. Too many changes will only prove to be detrimental to your portfolio.
In the long term, a sound strategy with a disciplined approach will give superior returns. Investors who don’t stick to a disciplined approach end up buying high and selling low more often than not.
Screen out the noise: There is an overload of information and news these days. There is no scarcity of news, opinions, tips, etc. They are the biggest sources of distraction for an investor. Most of the time they spread misinformation and also eat into your precious time.
Avoid non-trustworthy sources, especially business news channels that have a compulsion to give out ‘breaking news’ every second. Keep in mind, solid businesses don’t change overnight.
You should be able to differentiate fundamental changes from inconsequential changes.
Self-belief: Have belief in yourself. If you have done solid research on your stock picks, and they are fundamentally strong, then you have nothing to worry about as long as those fundamental pillars are intact. Trust your work and decisions. Do not let temporary movements in the markets waver your confidence.
Strength to buck the trend: You will need strong determination to stay on your course. There will be instances when trends and so-called expert opinions will be against you. That is the time when you should show the conviction to go against the popular consensus if that is the right choice.
Humility: Be humble and honest to yourself. Acknowledge and accept your mistakes. If you figure out that some of your investments have gone wrong, then accept it and move out of them. Don’t wait too long to let matters get worse. Instead, pull out that money at the earliest, even if it is at a loss, and invest in better avenues. Don’t let regret of mistakes linger on your mind.
Should be ok doing nothing: What I mean here is, doing nothing in the market. There will be times in the stock markets where you have to wait and let compounding do its magic. You should have the temperament of doing nothing with your investments during such periods.
Long-term commitment: Time plays a very critical role in the success of your investments. Investment is a very long journey, and there are no shortcuts to it. Stock markets reward those who stay committed for the long term. Long-term here means many many years.
You will find people who have had big success stories in a very short time period. But these kinds of success are not consistent. There are many more who have lost more money while trying to make quick gains. So, a solid portfolio held for a long time is the right recipe for success.
Avoid timing the market: Again, similar to the last point. Timing is something not many people are good at, and many have lost money while attempting to do so. Some people do day-trading and are proponents of technical analysis. But that is very different gameplay. The skills and the mindset required for it are very different.
If you can’t dedicate most of your time actively tracking and trading in stocks, you better stay away from day-trading. When you don’t understand the factors that drive prices, there is no point in trying to time the market. You will be at mercy of luck all the time.
Enter, hold or exit based on the right valuations. Never hurry your investment decisions.
Diversify: No matter how sound the fundamentals of your investments might be, you can never be sure of their future performance. To mitigate such risks, you need to diversify your investments.
A good set of 10-20 stocks and 2-3 mutual funds should be enough to build a well-diversified portfolio for any investor. Studies have shown that going beyond a certain number does not give any significantly higher returns. It only adds more chaos.
Read, Read, and Read: Most successful investors are voracious readers. Read as much as possible on investments, history, biographies, human behavior, fiction, research papers, blogs, or any other source of valuable knowledge.
Reading expands your horizon of thinking and the ability to see things from different perspectives. It will help you evolve as a better person and as a mature investor.
Are stock markets really difficult?
You meet these requirements and, you are on your way to being a successful investor in stock markets.
In fact, making money in stock markets is not so difficult or complicated. What is difficult is – to meet these simple requirements.
it is much harder to follow these simple and essential tenets. It is more of a mindset than financial knowledge that is required to be successful in the stock markets. More to do with human behavior than intelligence.
People often get distracted easily and deviate from their original strategy. They finally end up losing money and are left with a below-par portfolio. You need to avoid these scenarios. After all, it is not so difficult.
So, stay focused and enjoy the success!!!