There are lots of options available for investors these days like fixed deposits, NCD, bonds real estate, equities, commodities, currencies etc. which they can use to grow their money. Some of these investment options are assured return options. Equities are the most attractive investment options because of their unlimited profit potential. But there is risk associated with them and it can also erode your capital.
Investment in stock is subject to market risk. If done without proper research can result in loss of capital and if done smartly can multiply your capital. People make lots of mistakes in their investment in stocks. In this post we will discuss how those mistakes can be avoided to make profitable investments in the stock market.
How much money should be invested in Stocks ?
As the investment in the stock market is subject to risk one must calculate the risk potential. When we are young we can take more risk comparable to that at the old age. Even if our investment fails to give return, we have the capacity and energy to turn that loss into profit later. So how much percent of your income should go to equities ? It should be as per your age. Here is the simple formula that you can follow.
Percent of saving in the debt = Age
Let us elaborate this formula with examples. If your age is 25 years, then 25% of your savings should be invested in safe fixed income options like debts and 75% can go in the equities. If your age is 40 years then 40% should go into debts and 60 % in equities and likewise.
When to start investing in equities ?
Warren Buffet started investing in share market at the age of eleven and he became the world’s second richest person. All the big names in the investment world have started early. So start as quickly as possible.
Prerequisite for investment in equities
Warren Buffet says one should buy a house before stocks. So that if you lose, you have a roof on your head. By this he doesn’t actually means that you must buy a house first, he means one should ensure that he/she has proper safety measures for smooth life in case of failure. You should have sufficient money to face the emergencies of life.
The right sectors and stocks for investment
There are some sectors and their stocks which have good weight in the index. Investing in those sectors and stocks is comparatively safer. One should prefer such sectors and find the best stocks with best fundamentals to invest in that sector. Below is the list of sectors and their weight in the Nifty index.
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Risk Mitigation of Investment
Because of political and economical problems many times even the best sectors and stocks fails to give returns. And many times we fail to choose the right sector and stocks for investment. Risk mitigation here deals with reducing the effect of failure. For minimizing the effect of loss you can follow the below time tested recommendations
- Do not invest more than 30% of your capital in the first time.
- Do not invest more than 33% in any sector
- Do not invest more than 10% in any single stock
- Do not invest more than 20% even if the stock gains in value
- Invest 50-70% in index stocks only
- Exit from all stocks whose weightage is less than 1% of your entire portfolio
Selling or exit strategy
When the stock or the sector is not performing as per expectation it is better to exit than reducing the capital. Generally there are no stop losses in stock investments , they are in trading only. The biggest mistake that people make is that they continue to hold bad performing stock that erodes their capital. It is always better to book some lose than vanishing whole capital. Now the questions arise when to exit? Below are certain situations when you should think about exiting from a particular stock which you are holding.
- Bad results for continuous 2-3 quarters
- The share price goes down 33% from its peak when the overall market is at same level or doing well
- Continuous raising of debt levels
- Company promoters pledges holding
- Exodus of top management
- Frequent equity dilution
- Major accidents that can affect company profitability
Systematic selling and profit booking strategy
With long term investments its never recommended to exit from good stock unless you are in urgent need of money. But systematic selling or profit booking is always a good strategy. The 10% formula works great for profit booking, where you book 10% profit on each 10% rise and then revise the target by 20%.
Let us understand it with an example. Lets say you invest 10 lakh, then you should book 10% profit, that is up to 1 lakh. After you have booked 10% profit revised your target by 20% and make it 12 lakh and then you can book profit up to 1.20 lakh , after which you can revise target to 15 lakh.
Since we invest and book profit at random intervals calculating exact returns is also not easy. You can use XIRR return calculation formula to know how much you have earned from your investments.