Equity funds, if selected in the right manner and in the right proportion, have the ability to play an important role in achieving most long-term objectives of investors in different segments. While the selection process becomes much easier if you get advice from professionals, it is equally important to know certain aspects of equity investing yourself to do justice to your hard earned money.
If you are looking to invest directly in the equity market there are some basic areas to take into consideration. Investment expert are presenting a one-stop guide to increase your returns.
Knowing them and by using them in the selection process can make a big difference to the end result. Here are some important investment guidelines:
1. Know your risk profile
Before you take a decision to invest in equity funds, it is important to assess your risk tolerance. Risk tolerance depends on certain factors like emotional temperament, attitude and investment experience. Remember, while ascertaining the risk tolerance, it is crucial to consider one's desire to assume risk as the capacity to assume the risk.
It helps to understand different categories of overall risk tolerance, i.e. conservative, moderate or aggressive. While a conservative investor will accept lower returns to minimize price volatility, a moderate investor would be all right with greater price volatility than conservative risk tolerances to pursue higher returns.
An aggressive investor wouldn't mind large swings in the NAVs to seek the highest returns.
Though identifying the desire for risk is a tough job, it can be made easy by defining one's comfort zone.
2. Price of a stock is not very important it is the "valuation" that is important
Typically in bull markets investors get attracted to low priced stocks. However, such stocks might be the most dangerous to invest into. First of all, if a stock is low priced despite the markets having moved up substantially then there has to be a reason behind it. That reason might be that the company is not doing well financially. Also it is important for investors to see the paid up value of the share of a company, where these days the face value of the shares of a company typically vary from Rs 1 to Rs 10. Most of the people think that all stocks are with a Rs 10 face value and as such a stock priced at Rs 10 with a Rs 1 face value would in the traditional sense be actually trading at a price of Rs 100. Moreover shares should be analyzed in terms of its price earning ratio (the most simple valuation tool for non-professionals) rather than the price of the stock. As a simple example if one share is trading at Rs 1000 and another is trading at Rs 10, but the per share earning of the first company is Rs 200 then its P/E is 5 (i.e. the stock is trading at 5 times its current earnings). However if the per share earning of the second company is Rs 1, then its P/E is 10, which essentially means that it is more expensive than the company whose stock price is Rs 1000.
3. Try to see the free cash flow
This is also something that is very important but may be difficult for most people to understand. I will try to be as simple as possible. This is an analysis where an investor can come to know that whether the profits that are getting reported are actually flowing as cash into the company or is just getting to the profit and loss account through an increase in the debtors of the company. This also helps to analyze whether the business of the company is improving or deteriorating in terms of efficiency. These days' cash flow statements are a part of the annual reports of companies, which investors can go through.
4. Understand that stock prices move on future prospects rather than the past
Although the past history of a company is very important for a proper analysis of the prospect of the company, investors should realize (which most people don't) that the stock prices move up and down based on future prospects of earnings growth rather than what has happened in the past. As such most of the results, which relate to a past date are already factored into the stock prices. As such a proper view formation on the future prospects is essential for successful investing.
5. Do not buy every thing in one lot
As we advise investors in our equity schemes to go for systematic investing, while investing directly into equities a systematic investment route should be the preferred route. Here the investor spreads out investments over different times and market levels so as to get good returns over the long run.
I have tried to cover a few points that can help investors invest better. I will try to add more such points in future articles. However the most important thing while investing in equities is that equity investing is for the long term. After doing proper due diligence and investing, investors should try to give at least 3-5 years for their investments to bear fruit.
6. Don't have too many schemes in your portfolio
While it is true that diversification helps in earning better returns with a lower level of fluctuations, it becomes counter productive when one has too many funds in the portfolio.
For example, if you have 15 funds in your portfolio, it does not necessarily mean that your portfolio is adequately diversified. To determine the right level of diversification, one has to consider factors like size of the portfolio, type of funds and allocation to different asset classes. Therefore, it is possible that a portfolio having 5 schemes may be adequately diversified whereas another one with 10 schemes may have very little diversification.
Remember, to have a well-balanced equity portfolio, it is important to have the right level of exposure to different segments of the equity market like large cap, mid-cap and small cap. In addition, for a decent portfolio size, it is all right to have some exposure in the sector and specialty funds.
7. Longer time horizon provides protection from volatility
As an equity fund investor, you need to understand that volatility is an integral part of the stock market. However, if you remain focused on the long-term objectives and follow a disciplined approach to investing, you can not only handle volatility properly but also turn it to your advantage.
8. Understand and analyze 'Good Performance'
'Good performance' is a subjective thing. Ideally, to analyze performance, one should consider returns as well as the risk taken to achieve those returns. Besides, consistency in terms of performance as well as portfolio selection is another factor that should play an important part while analyzing the performance.
Therefore, if an investment in a mutual fund scheme takes you past your risk tolerance while providing you decent returns, it cannot always be termed as good performance. In fact, at times to ensure that your investment remains within the parameters defined in the investment plan, you may to be forced to exit from that scheme.
In other words, you need to assess as to how much risk did the fund manger subject you to, and did he give you an adequate reward for taking that risk. Besides, you also need to consider whether own risk profile allows you to accept the revised level of risk.
9. Sell your fund, if you need to
There is no standard formula to determine the right time to sell an investment in mutual fund or for that matter any investment. However, you can definitely benefit by following certain guidelines while deciding to sell an investment in a mutual fund scheme. Here are some of them:
* You may consider selling a fund when your investment plan calls for a sale rather than doing so for emotional reasons.
* You need to hold a fund long enough to evaluate its performance over a complete market cycle, i.e. around three years or so. Many of us make the mistake of either holding on to funds for too long or exit in a hurry. It is important to do a thorough analysis before taking a decision to sell. In other words, if you take a wrong decision, there is always a risk of missing out on good rallies in the market or getting out too early thus missing out on potential gains.
* You should consider coming out of a fund if its performance has consistently lagged its peers for a period of one year or so.
* It doesn't make sense to hold a fund when it no longer meets your needs. If you have made a proper selection, you would generally be required to make changes only if the fund changes its objective or investment style, or if your needs change.
10. Prefer tax-paying companies
When bull markets start a large number of companies, which were not doing well earlier and had hardly any profits to talk about start showing good profits growth. Investors should be vary of such companies and should try to see the earnings of the company before tax and after tax. If a company is paying high taxes on its earnings then its profits are likely to be more genuine than companies that pay very low taxes.
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