It is important to understand that the way you choose to approach equities can impact your investment journey
You may often have heard the story of that friend who invested in equities and made enough money to buy his/her dream home. Such is the lure of equities. It promises untold riches that make you think that it is simple to clock in gains through equity investing. However, have you ever heard of that friend who invested in the equity market and lost the shirt on his back? Perhaps you have.
That brings us to the question - How can you reap the benefits of equity investing?
Stay invested for the long-term: Equities are inherently volatile by nature. In the short-term, they respond to a host of factors including fundamental, economic, geopolitical, and sentiment-based factors that influence stock prices (and as we have seen recently, Pandemics too may have a major impact on markets). However, over the long-term, equities hold the potential to generate wealth and help you achieve your financial goals. In the long run, the growth of a country’s GDP is reflected in higher Corporate Profits and eventually flows into a higher market capitalisation for the companies. Hence to reap the benefit of equities, it is important for you to ignore the short-term price movements and stay focused on the long-term. It is equally important for you to stay invested through the down periods so that you can benefit from the up periods. Unfortunately, this is easier said than done. You might find it challenging to stay invested when markets are in red and your portfolio is in deep losses.
Direct equity could be a risky bet: It is well known that portfolio diversification is one of the best ways through which you can reduce the overall risk of your portfolio. This is true for your equity portfolio as well. However, diversifying your equity portfolio can be tricky. You need to know the sectors, industries, and businesses well. You need to know whether 10 stocks are enough for diversification or you need at least 25 stocks to optimally diversify your equity portfolio. Further, once you have bought these stocks, you need to constantly monitor them and ensure that their true fundamental value is still intact. This can be a tedious and challenging exercise that is often prone to errors.
Need for research: When investing in equities, it is important to invest in stocks that have the potential for good earnings growth or are trading below their asset value. For this, you need to do in-depth research, go through reams of company annual reports and financial statements, attend company conference calls, and estimate the future growth potential. As an investor, you might not have the time, inclination, or even aptitude to do this kind of research. In the absence of research, you might end up investing in poor quality stocks that could bring down your overall portfolio returns.
Avoid behavioural biases: As an investor, you may often hear stories of how investors got influenced by behavioural biases and ended up with sub-optimal investment decisions. For example, you might be biased about the growth potential of stock and refuse to exit it even though it has lost its fundamental value and continues to make losses. On the other hand, you might end up buying a stock just because it is in vogue without understanding the fundamentals of the stock. These kinds of investment decisions can strongly impact your portfolio returns.
The way you invest
Keeping the above risks in mind, it is important to understand that the way you choose to approach equities can impact your investment journey. As an investor, you can either choose to invest directly in equities or you can choose to invest in mutual funds or Exchange Traded funds (ETFs). Many of the above risks become magnified if you choose to invest directly in equities. On the other hand, they can easily be mitigated by investing through an investment vehicle such as the ETFs.
ETFs are a type of investment fund or basket of securities that are traded on the stock exchange. Generally, most ETFs are index funds, that is, they hold the same securities as a stock market or bond market index and that too in the same proportion. Since they replicate the index holdings, ETFs tend to generate returns similar to that of the underlying index. Thus, with an ETF, you get to generate market linked returns, at a low-cost and without taking the risks associated with direct investing. Further, the onus monitoring the portfolio lies with the fund manager managing the ETF, thereby helping you focus on your long-term goals.
The author is Head- Product Development and Strategy, ICICI Prudential AMC
DISCLAIMER: Views expressed are the authors' own, and Outlook Money does not necessarily subscribe to them. Outlook Money shall not be responsible for any damage caused to any person/organisation directly or indirectly.