(A slightly touched up version appears in the Deccan Chronicle)
So we want to invest in stocks and make money. Do we just want the thrill and the experience one time or is it an important avenue for you to put your money to work for you? There are some mental processes you must go through, before you invest in stocks. Whether you are investing in direct equity or following the mutual fund route is not relevant.
One of the first things is to know what you are doing. In other words, do you understand where you are putting your money to work? One good test would be for you to be able to explain your action to your school going kid. That is the best way to be sure whether you know what you do. Do you buy any physical object simply because others are buying? Surely not. Similarly, understand what you are buying with your money.
The second thing to understand is your attitude to money (or in technical jargon- “Risk tolerance”).The whole point in investing is that you should be happy with what you have done with your money. There is no point in doing something because some wise man or a financial expert told you to. This comfort can only come if you understand where you are putting your money to work. Clearly, if you are the type that will sit down with an excel sheet and compute the live total for your stock or mutual fund portfolio, you have a serious problem. You are more likely to lose your health while trying to build your wealth. Once you understand different financial instruments in the markets and make an informed choice, you are better prepared to overcome anxious moments. Of course, the first time a panic in the markets happen, you will tend to have knee jerk reactions, but if you have thought over this possibility, you can take advantage. If there is a crash and you have invested without any knowledge, obviously you will panic and sell out. Hence, you can build attitude with knowledge.
The third and, perhaps (to me for sure) the most important thing whilst investing in equities, is “Time Horizon”. Warren Buffett is often quoted as saying that his preferred holding period of a stock is ‘forever’. If you want to be in equities, think long term. I am talking about ‘investing’ and not about ‘savings’ or ‘day trading’. You cannot have a ‘fixed’ time horizon in equities for the simple reason that the markets may not be nice to you on the day you have decided in advance to sell. Selling is a patient art. You wait for a good bull run, see what your compound returns are and then decide to get out if there is too much heat. The question is to put your money back to work, if you do not have a pressing need for it.
If you need your money in one, two or three years, do not park that money in equities. The minimum time window I would like to give to equity investing is ten years. Why ten? Simply because it is reasonably long enough for us to pass through at least one business cycle.
I come across people who want tips on stocks that will double in anything from a few days to a few hours. These people approach equities like one approaches gambling. In one year, what does one expect from a company that will change its fundamentals so much? The only exceptions will be some corporate action that changes the price or a sudden extreme unanticipated change in the fortune. Yes, sometimes we see exponential moves when the stock market cycles change in the small cap or mid cap stocks due to reasons of focused buying and the generally illiquid market for their stocks.
However, if you are hunting for short term gains, you must be equally prepared to lose most of it. If losing money bothers you, clearly, stocks are NOT for you.
Stock market investing is a way to build wealth. It is not a savings avenue. Start here only after you have saved enough to meet your known needs. You cannot bank on market uncertainties to provide for your known and quantified needs. Make your investments when you have the money and the price is right. Same should apply when you want to liquidate them. Wait for your price.
I know that most people are mentally not tuned to investing for ten years. Many think that one year is a long term. They do not have the attitude and should not be investing. They give stock markets a bad name.