When it comes to equity investing there are generally two camps. One is the completely pro camp who strongly believes in the wealth creation potential of equities. From this camp, you will hear stories about people who made a killing in the equity market and retired at the age of 30 or of someone who bought a villa in Dubai with his equity market earnings. The other is the absolutely anti-equity camp that won’t touch equities with even a barge pole. From this camp, you will hear about the dangers of equity investments and how a single mistake can take the shirt off your back. While both camps are correct in their own way, they are largely outliers.
The answer to this one is quite simple. Invest in equities because they have the highest return potential over the long-term when compared to most other asset classes. Basically, if you are invested for the long-term, then equities can potentially generate the highest return and accordingly grow your wealth.
The answer to this one is not quite as simple. Equity stocks basically represent fractional ownership of the holder in a particular company. The price of the stock is influenced by a host of company-specific and macro-environment related factors. In the short-term, due to intermittent changes in these factors and the response of traders, stock prices can tend to be highly volatile. It is this volatility that most investors are afraid of.
When it comes to investing in equity, there are four main things that investors need to pay attention to:
These are long-term wealth creators – in the short-term, they are subject to a great deal of external noise due to which they tend to be fairly volatile. However, in the long-term, volatility gets smoothened and the true fundamental value of the stock emerges.
You must do your research – since equity investing essentially entails buying a piece of a company, it is imperative that you do some basic research to understand what the company does and identify factors that will contribute to its future profitability and growth.
Diversification can help you mitigate risk – within the equity asset class, there are some stocks that will be more volatile than others. One must understand the source of volatility and accordingly spread their equity investments such that the overall risk is mitigated.
Be disciplined and stick to your portfolio strategy – this is true for investing in general but becomes more important when you are investing in relatively riskier assets. Refrain from having a knee-jerk reaction to market developments and take investment decisions only after careful analysis.