Equity investing - it’s all about hiring the right advisor

Each company listed on our stock exchanges has a large number of proud owners – its equity investors. Investing in the equity shares of a company implies that you own the business to the extent of your shareholding. Hence, if the company makes profits, your investment will rise in value, and vice versa. But you may believe that equity investing is ‘risky’. ‘Risk’ in equity investing is usually the result of insufficient knowledge and experience of investing in this asset class. If you want to build your personal wealth to achieve financial security, equity investing cannot be ignored; it’s the most rewarding investment option among the universe of investment options available.

Equity investing requires deep knowledge, experience and time to keep abreast of one’s investments; it’s a full time engagement. Naturally, one cannot be expected to quit one’s job or business in order to become an equity investor. Often, there are people who attempt to engage in equity investing despite lack of time and knowledge. Here is what happened to Rakesh.

The pitfalls of investing on your own – Rakesh’s story

Rakesh, 32, a cloth trader, was aware about equity investing and the potential of building serious wealth from this investment avenue. Rakesh had been watching the stock markets move up and heard from friends about the profits they were making on the markets. Not be to left out, he decided to start investing in equity from the surplus he earned from his business. He called Suresh, his friend, who was a stock broker. He informed Suresh that he could invest a minimum of Rs. 250,000 each month. He wanted Suresh to give him good stock tips and make his investment for him. In the first month, Suresh recommended a number of mid-cap stocks which carried a high level of risk. Rakesh enthusiastically started his venture into equity investing only to see the prices of his investments fall by large amounts each day. After 3 months of investing in various stocks recommended by Suresh (Rs. 750,000 invested over this period), Rakesh’s investment value was down to Rs. 630,350. Rakesh was disillusioned and disappointed. Not only did he exit from the equity markets by booking losses in his equity investments, he also lost a friend; he never spoke to Suresh again. Rakesh vowed never to invest in equity again.

Here are 5 key reasons why Rakesh (and most investors like Rakesh) fail to benefit from equity investing:

1. Insufficient time: Investing in equities is a full-time profession pursued by persons with a finance degree and extensive knowledge and experience of the stock markets. Fund managers, equity investment advisors, etc. are such professionals. They are completely abreast with the developments in our stock markets and have the ability to analyse each development in terms of various stocks, sectors and investment themes. Let’s say you were unwell; would you consult with your chartered accountant or would you go to a doctor? Similarly, if you need to make investments, you must consult with an investment professional.
2. Rumours and tips: Most of us would have received advice on what to eat and not to eat when we are feeling unwell. Perhaps your grandmother would have advised you to have fresh lime water if you have an upset stomach or your mother would have recommended eating a banana if you are feeling tired. However, if none of these recommendations work, you eventually visit a doctor. In case of equity investing, most of us would have started off by seeking tips from friends and associates. When we make losses on these tips (because they are not validated by research and analysis), we realise our mistake and then consult with an investment professional. The most sensible approach would be to avoid seeking tips; use the services of a professional right away. Don’t lose your hard-earned money on tips!
3. Picking the wrong stocks: Some people have an affinity for certain brands/companies which they are comfortable with. For instance, if you use a certain brand of toothpaste, you believe the company manufacturing and marketing the toothpaste must do well and hence, it would make sense to invest in the company. That may not be true. While the company may have a good product (you would not use a bad product!), it may be experiencing internal upheavals, a fall in market share of its product due to new brands introduced by competitors, etc. As a result, you would have invested in the wrong stock! You cannot bypass research, study and analysis to make the right equity investment decisions.
4. Emotions in investment decisions: Dhiraj’s father left him a portfolio of equity investments. Dhiraj, a doctor, was clueless on whether the companies whose stock Dhiraj’s father had invested in, were good or not. However, out of sheer respect and emotions towards his father, he simply retained the portfolio. Years later, when he took a look at the portfolio, most of the companies his father had invested in, no longer existed! Don’t let emotions enter your investment decisions. The most effective way to avoid this is to seek the services of a professional who brings objectivity into your investment decisions.
5. Getting disillusioned: Just like Rakesh, experiencing losses at the initial stage of investing in equity, usually deters a person from this attractive investment option. Often, such people tend to equate equity investing to gambling, which is far from the truth. While speculation (investing without any research) for quick gains is more casino-oriented, investing implies study and analysis, and holding the stock for a sufficient time period in order to let the company’s business generate the revenues expected, which will drive up its share price.

How to select a suitable equity investment advisor

Here are 4 key factors to look for while selecting a suitable investment advisor:

1. Reputation: The reputation and credibility of the investment advisor is a critical factor in your selection. Always select an advisor registered with the Securities and Exchange Board of India (SEBI), the regulator of the capital markets. This will give you the assurance and comfort that the advisor’s business and activities are being monitored by a responsible authority. You must be able to trust the advisor to keep your best interests in mind while making investment recommendations.
2. Investment philosophy: Each investment advisor will have a specific investment philosophy; while some advisors make recommendations purely on technicals, others use only fundamentals. The advisor should consider all factors of each stock including promoters, performance, valuation, outlook, etc. before making a recommendation. His interest must be aligned with your interest. He should not be providing Intra-day tips or tips in F&O.
3. Support: Your advisor must be available to you for any queries that you may have. Unlike in case of mutual funds where you don’t have access to the fund manager, an investor advisor should give you access to speak to the advisor’s equity analysts to find out why a particular stock has been recommended and any other queries that you may have. Communicating with your advisor not only helps you understand the reasons for each recommendation, but also helps you learn more about equity investing; you get a sense of being in control of your investments.
4. Fees: Find out how much your advisor charges for equity advisory services; assess the fees with the services being offered and with fees of competing advisors. However, keep in mind that fees charged by an advisor form a negligible portion of your investments and it’s important not to focus too much on fees. Instead, keep your focus on your advisor’s equity recommendations, services and trustworthiness.

Want to play Futures and Options? You might as well gamble!

Yes, it’s true… futures and options are as risky as gambling. Let me tell you what happened with Rohit. Rohit’s broker told him to trade in ‘Stock futures’. When Rohit asked his broker to help him understand what ‘stock futures’ were, the broker simply said that if the market went up after Rohit had bought stock futures, he would make a lot of money! Rohit was enticed! He bought stock futures worth Rs. 5.40 lakh by simply paying a margin of Rs.96,000 (in derivatives, you can leverage, which means that by paying a small amount (called margin), you can purchase 5 times the margin (transaction value). Rohit enthusiastically bought the stock futures and started planning a holiday, which he believed would be funded by his ‘wonderful’ investment. Over the next few days, the stock market tumbled; the stock fell to Rs. 30 over 4 days. Rohit panicked. He called his broker who asked him to ‘cut his losses’. When Rohit asked him what that meant, the broker told him to sell his stock futures right away. Rohit bore a loss of Rs. 81,000 per lot. His investment amount eroded by 85%. Not only did Rohit throw his holiday plans out the window, he even decided to delay the purchase of a new car in order to recuperate from the losses. Now Rohit equates ‘futures’ and ‘options’ to curse words!

Intra-day Trading is Treacherous!

In the year 2016, Shrikant, a chartered accountant with good knowledge of the stock markets, had studied the annual reports and performance of M&M Financial Services Ltd closely; he had also read about the finance industry (Non-Banking Finance Companies, or NBFCs) and the expected growth of this sector. He was convinced that M&M Finance was well-positioned to take advantage of the expected growth in this sector. He invested Rs. 5,00,000 when the market price of M&M Finance was Rs. 185 per share. He received 2,700 shares (Rs.500,000/Rs.185). He felt optimistic about his investment. Once he had made his investment, Shrikant tracked the company closely; he studied the company’s quarterly results, annual performance and read about this sector periodically to make sure that his investment still made sense.

In the same year, Kartik, a stock trader, was tipped about M&M Finance by a friend. The friend said, ‘It’s a good stock!’ Kartik immediately placed his order for 2,500 shares of M&M Finance which he purchased at a market price of Rs. 185 (Kartik and Shrikant had coincidentally purchased M&M Finance on the same day). Kartik started checking the price of M&M Finance every day. He was excited about the stock. He believed he had a winner because it was recommended by a trusted friend. The stock rose marginally over the next 5 days. Kartik calculated his profits each day. On the fifth day when the market price of the stock rose to Rs. 200 per share, Kartik sold his holding, happy with a profit of Rs. 37,500 over 5 days. He promptly called his friend for more such tips.

A year later…

Shrikant looked at his investments with satisfaction. His eyes lingered for a longer time on M&M Finance. Since his investment in M&M Finance in the year 2016, his original investment of Rs. 5,00,000 had grown to Rs. 11,50,000. A simple calculation told him his investment was a 2-bagger. His decision to stay invested in a good stock had made him a wealthy man!

Kartik was busy staring at his trading terminal. He had bought some stocks for intra-day trading (buying and selling on the same day). He was thinking about the loan he had taken to make this investment and started praying that he would make enough money at the end of the day to justify his borrowing. Suddenly Kartik saw M&M Finance flash on the stock ticker; it had hit an all-time high. He was taken aback at the price. He remembered his M&M Finance investment and his small profit that he had been so elated about. He stared at the screen with regret in his eyes. If only he had stayed invested in M&M Finance… he would have been wealthy.

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Key Points to Remember:

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