Introduction to Investing
Logically speaking, one should invest to protect oneself from the ill effects of rising inflation by utilizing the growth attained from the act. In order to give you a decent chunk of surplus, the rate of return on investments should be greater than the rate of inflation. No matter where your money is invested, be it stocks, bonds, mutual funds or certificates of deposit (CD), the idea is to create wealth for retirement, marriage, college fees, vacations, better standard of living or to just pass on the money as a legacy. Also, it is priceless to watch your investment returns grow at a faster rate than your salary.
- But when is the right time to invest?
By investing into the market right away you give your investments more time to grow. Here comes the concept of compounding interest that inflates your income by accumulating your earnings and dividends. Compounding refers to growth via reinvestment of returns earned on your savings as you earn income not only on the original investment but also on the reinvestment of dividend/interest accumulated over the years. Taking the volatility of the markets into account, research and experience indicates that all investors, should invest early, invest regularly and have a disciplined approach towards investing.
- Do I need a fortune to invest?
The beauty of investing in the financial markets is that it suits everyone's pockets from the obscenely rich to the man next door. There is no fixed amount that investors need to invest so as to generate adequate returns from their savings. The amount that you invest will eventually depend on factors such as your risk profile, time horizon and amount of savings.
There is a plethora of investing options such as:
- Equities (Shares/Stocks)
- Bonds
- Mutual funds
- Fixed deposits and many more.
Investment Avenues
There are a number of investment options available in the advanced financial markets; the idea is to pick the right investment tool based on the risk profile, circumstances and holding capacity. Market volatility has the potential to give you a high rate of return. But if you are risk averse and simply desire some additional source of income, then the fixed income securities should be given a thought. However, it should be noted that risk is directly proportional to return; higher the risk, higher the return.
The following sections will give you a bird's view of various tools of investments:
Equities Investment in the shares of companies is investing in equities. It is rightly said that the shareholders are the owners of the company. Stocks/Shares can be bought/sold from the exchanges (secondary market) or via IPOs - Initial Public Offerings (primary market). Stocks are the best long-term investment options wherein the market volatility and the resultant risk of losses, if given enough time, is mitigated by the general upward momentum of the economy.
There are two branches of revenue generation from this form of investment.
Dividend
Periodic payments made to the shareholders out of the company's profits are termed as dividends.
Growth
The price of a stock appreciates commensurate to the growth posted by the company resulting in capital appreciation.
Bonds
It is a fixed income debt instrument issued for a period of more than one year with the purpose of raising capital. The central or state government, corporations and similar institutions sell bonds. A bond is generally a promise to repay the principal along with fixed rate of interest on a specified date, called as the maturity date. The average rate of return on bonds and securities in India has been around 10 - 12 % p.a.
Certificate of Deposits These are short-to-medium-term interest bearing debt instruments, such as fixed deposits and recurring deposits, offered by banks. They are low-risk, low-return instruments. Furthermore there is usually an early withdrawal penalty associated with them. Average rate of return is usually between 4-12 %, depending on which instrument you park your funds in.
Mutual Fund These are open and close ended funds operated by an investment company which raises money from the public and invests it in a group of assets, in accordance with a stated set of objectives. Its a substitute for those who are unable to invest in equities or debt because of resource, time or knowledge constraints. Benefits include diversification and professional money management. The average rate of return as a combination of all mutual funds put together is not fixed but is generally more than what earned in fixed deposits. In the recent past, MFs have given a return of 18 - 30%.
Cash Equivalents
These are highly liquid and safe instruments which can be easily converted into cash. Treasury bills and money market funds are examples of cash equivalents.
Others
There are also other saving and investment vehicles such as gold, real estate, commodities, art and crafts, antiques, foreign currency. However, holding assets in foreign currency are considered as more of a hedging tool (risk management) rather than an investment.
An Overview of the Stock Market
- How does the stock market work?
To learn how to earn money on the stock market, one has to understand how it works. A person desirous of buying/selling shares in the market has to first place his order with a broker. When the buy order of the shares is communicated to the broker he routes the order through his system to the exchange. The order stays in queue on the exchange system and gets executed when it reaches the buy price that has been specified. The shares purchased will be sent to the purchaser by the broker either in physical or demat format.
Indian Stock Market Overview The Bombay Stock Exchange (BSE) and the National Stock Exchange of India Ltd (NSE) are the two primary exchanges in India. In addition, there are 22 Regional Stock Exchanges. However, the BSE and NSE have established themselves as the two leading exchanges and account for about 80 per cent of the equity volume traded in India. Most key stocks are traded on both the exchanges and hence the investor could buy them on either exchange. Both exchanges have a different settlement cycle, which allows investors to shift their positions on the bourses. The BSE Sensex is the older and more widely followed index. The scrips traded on the BSE have been classified into 'A', 'B1', 'B2', 'C', 'F' and 'Z' groups. The 'A' group shares represent those, which are in the carry forward system (Badla). The 'F' group represents the debt market (fixed income securities) segment. The 'Z' group scrips comprise of blacklisted companies. The 'C' group covers the odd lot securities in 'A', 'B1' & 'B2' groups and Rights renunciations. The key regulator governing Stock Exchanges, Brokers, Depositories, Depository participants, Mutual Funds, FIIs and other participants in Indian secondary and primary market is the Securities and Exchange Board of India (SEBI) Ltd.
Rolling Settlement Cycle In a rolling settlement, each trading day is considered as a trading period and trades executed during the day are settled based on the net obligations for the day. At NSE and BSE, trades in rolling settlement are settled on a T+2 basis i.e. on the 2nd working day. To arrive at the settlement date all intervening holidays, which include bank holidays, NSE/BSE holidays, Saturdays and Sundays are excluded. Typically trades taking place on Monday are settled on Wednesday, Tuesday's trades settled on Thursday and so on.
Types of Orders There are various types of orders, which can be placed on the exchanges:
Limit Order It refers to a buy or sell order with a limit price. Suppose, you check the quote of ABC Ltd. at Rs. 251 (Ask). You place a buy order for ABC with a limit price of Rs 250. This puts a cap on your purchase price. In this case as the current price is greater than your limit price, order will remain pending and will be executed as soon as the price falls to Rs. 250 or below. In case the actual price of ABC on the exchange was Rs 248, your order will be executed at the best price offered on the exchange, say Rs 249. Thus you may get an execution below your limit price but in no case will exceed the limit buy price. Similarly for a limit sell order in no case the execution price will be below the limit sell price.
Market Order Generally a market order is used by investors, who expect the price of a share to move sharply and are yet keen on buying and selling the share regardless of price. Suppose, the last quote of ABC is Rs 251 and you place a market buy order. The execution will be at the best offer price on the exchange, which could be above Rs 251 or below Rs 251. The risk is that the execution price could be substantially different from the last quote you saw.
Stop Loss Order A stop loss order allows the trading member to place an order which gets activated only when the last traded price (LTP) of the share is reached or crosses a threshold price called as the trigger price. The trigger price will be as it is on the price mark that you want it to be. For example, you have a sold on a position in ABC Ltd booked at Rs. 345. Later in case the market goes against you, you would not like to buy the scrip for more than Rs.353. Then you would put a SL Buy order with a Limit Price of Rs.353. You may choose to give a trigger price of Rs.351.50 in which case the order will get triggered into the market when the last traded price hits Rs.351.50 or above. The execution will then be immediate and will be at the best price between 351.50 and 353.
Circuit Filters and Trading Bands In order to check the volatility of shares, SEBI has come with a set of rules to determine the fixed price bands for different securities within which they can move in a day. As per SEBI, all securities traded at or above Rs.10/- and below Rs.20/- have a daily price band of ±25%. All securities traded below Rs. 10/- have a daily price band of ±50%. Price band for all securities traded at or above Rs. 20/- have a daily price band of ±8%. The price bands have been relaxed to ±8% for select 100 scrips after a cooling period of thirty minutes.