Thursday 22 May 2008

Beginner's primer on Entry into the Share Market

Beginner's primer on Entry into the Share Market
Part I

Dear friends,

Lots of us who are not already invested in the share market are completely scared about the whole issue. An aunt of mine has been after me to guide her (or better still, invest on her behalf) for quite some time.

Here are some basic fundas for you:

  1. What is a Share (and what do I get by buying shares)?
    • When you put Rs. 1000/= in a bank as a deposit, you only get some interest on the same. However, if you invest Rs. 1000/= to buy a few shares of the same bank, you become an owner of the bank (though you end up owning a very small proportion of the bank). As an owner, you are not entitled to get any interest on the money invested. Instead, you get a proportionate share of the profits and losses of the bank. Part of the profits of the bank is given to you by way of dividends as and when they are declared. Also, depending on how well the bank is performing (from the time you bought its shares) both in absolute terms and vis-a-vis its peers, the share price of the bank keeps going up and down. Whenever you wish, you can sell your shares. The difference between the sale proceeds and the initial Rs. 1000/= that you had originally invested is your profit or loss.
  2. What do I need to buy & sell shares?
    • A bank account
    • An account with a share broker to buy and sell shares
    • A demat account (to hold your shares)
    • A PAN Card (without which you can't open a demat account nor can you buy and sell shares
  3. Is it not too risky to invest in shares?
    • Yes - Indeed shares are risky than most other assets / investments that we are familiar with
      • They are especially if we are buying shares of companies that we don't understand at prices which are too high
    • No - Shares (and equity mutual funds) are often the only option for lower middle class & upper middle class people to beat inflation. Stuff like bank deposits, postal savings, etc. fetch returns that are much lower than the real rate of inflation. (To get an idea of the real rate of inflation, just look at your monthly expenses on a select basket of items (say, groceries, vegetables, dining out, movies, etc.) that you are incurring now, vis-a-vis the corresponding figure a year back.
      • In fact, shares are almost completely low-risk investments if you are buying the shares of the right company (well run, profitable, consistently dividend-paying companies in industries which are growing fast along with the Indian economy) at the right price, with a time horizon of at least a couple of years.
  4. Are mutual funds better than shares?
    • If you don't have the time (or inclination) to study, understand and invest in shares, it is certainly better to invest in mutual funds (look for those funds which are highly rated by folks like CRISIL, Valueresearch Online, Economic Times, etc.)
    • However, if you understand and analyse shares before investing in the same, it is much better to invest in shares
  5. That's theory - What should I do right now - I'm completely new to the share market?
    • Simple - since you are new to the share market, start with mutual funds.
    • However, simultaneously, open your demat account, etc. and start investing a notional sum of money (an amount that you'll consider as a throw-away sum) directly in shares. This will (most likely) result in losses - but will also enable you to learn about the kind of mistakes that one can do while investing in shares. With time and patience, you'll become more confident. After 6-18 months, you're likely to be ready to invest larger amounts of money in shares directly.

Good luck & happy investing!

Watch out for Part II of this series ... ... ... ... ... ...

Regards,

N


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