Like, we have been listening to our parents since childhood that FD is the best to invest in. A friend of yours may say that you should invest in mutual funds, or lots of relatives may keep informing you about LIC or NPS too. But it rarely happens that someone understands the problems you are facing in detail and tells you which plan is perfect for you and why. So that's what we will talk about in this blog how and where to invest money and how we can solve the problems generally faced by beginners (first-time investors) and start their investing journey with a small case.
Basics of Stock Market for Beginner
Here we are going to focus on the basics of investing in the stock market for beginners (first-time investors). What are the basics of the stock market? So let's start with the biggest and main problem, i.e., where to invest. As we know there are many options available. You can invest in FD, PF, stock market, gold, or real estate. So how to determine where your money should be invested. The first thing is, it is very important to compare all of them.
Let's see a chart for that.
So, as you can see in this chart, you can analyze different asset classes for the period of the last two decades, i.e., 20 years and you can see how they have performed, and how they have generated wealth or money for the investors. From this, you can clearly establish that if you are investing for the long-term, like, 10 or 20 years, then the stock market or equities, as we call it, have significantly outperformed all the other asset classes. So, after this, it is very easy to establish that if you always invest for 5, 10, or 15 years, then your money should be invested in the stock market.
What are the factors you should consider before investing your money?
Here, it is very important to understand that before starting the investing journey, what should you do as a beginner investor? The first and most important thing is to determine when you will need the money back. You may need the money back in 6 months or 1 year. And this need can be for anything. You may want to buy a car after 1 year, go on a holiday after 6 months, buy a house after 5 years, or plan for retirement after 15 years. So your goal for the end of the time can be anything. But it is very important to determine the duration of your investment. If you want the money back in 6 months or a year, it is always safest to deposit it in FD in a bank because it carries zero risk to your money. You always get the money back with a fixed return on your investment.
But if you have a long-term horizon where you are investing for 5 years, or 10 years, or more, then you should always invest in equities or the stock market because, as you saw in the above chart, you can earn good returns in that period compared to other asset classes. Now, given that we have established that long-term investments should go into the stock market.
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Problems faced by first-time investors in the stock market
1. Finding difficulties in understanding financial terms
If you are a first-time investor what are the problems that you can face. The most common problem is that you don't understand lots of difficult financial terms. Like, some will come and talk to you about CAGR, some will advise you to invest in arbitrage schemes, and some will ask about returns or risk-reward ratios. Understanding all this becomes a very difficult task for beginners (first-time investors). So this is a very common problem that we have always observed in the case of first-time investors.
2. Giving too much importance to returns
The second problem is that, generally, first-time investors give too much importance to returns, although you can always see a regulator or disclaimer in a document that past returns never guarantee future returns. It means that if anything has performed well before, there is no guarantee that it will perform well in the future too. If there is such a disclaimer, is it right to give too much importance to past returns or not? Because if anyone is trying to sell any investment product to you, they will always talk about past returns first of all.
3. How much risk is involved in the investment
The third important thing to understand is that how much risk is involved in the investment. And if you want to avoid that risk, protect yourself from it, what is diversification. Why do people say that instead of a single stock, you should invest in a portfolio of stocks? Right?
4. How do fees affect your investments?
And the fourth thing, which is very important, a common mistake beginner investors make and most people avoid it, is how much fee is involved in a product. Because you may think that the fees are just 1% or 0.5%, but whenever you invest, compounding is always at work. You think it is 1%, but if it is 1% for 10 years it won't total to 10%. It compounds to a much higher percentage. It can total 15% 20% or even higher because compounding is always at work. So these are the four general problems for first-time investors who have decided to invest in the stock market.
Firstly, there is a lot of jargon. Secondly, the risk or returns. Talking of returns, how important historical returns are, and how to see them. Thirdly, how to know, understand, and avoid risk, and how important fees are.
What are the different methods of investment?
1. Mutual Fund
When you invest in the stock market, your money is actually invested in a stock that can be of Reliance or HDFC, or it goes into an ETF. Now, there are different methods to invest in those stocks or ETFs. You can invest through mutual funds. When you invest in mutual funds, you actually give your money to a mutual fund company that invests your money in different stocks on your behalf and transfers the returns and losses that you earn to you. It is one of the ways to invest in the stock market.
2. Investment through the broker
A second way is to invest directly through a broker. Through a stock market broker like HDFC Securities, or Axis Direct, or Zerodha, you can directly buy the stocks. You can buy stocks of any company through these brokers, like, HDFC, Reliance, Kotak Mahindra Bank, or any company. These are two general ways. You can invest in stocks either through mutual funds, or directly invest in stocks.
3. Small Case
A third way to invest in stocks is in small cases. What is a small case and how does it work? Small cases are actually a group of stocks, or you can say it's a basket of stocks that are related to each other through a theme or an idea. It represents those companies that have quite strong brands. These can be the brands that you are observing or using in your daily life, or you have seen someone else using them. Essentially, these are the brands that people have either seen or experienced in their day-to-day lives.
So it helps you to invest in all those companies. So it is a readymade basket of stocks that is related to a theme or an idea which can either be of investing in brands, or you may want to invest in the companies related to the rural economy, or you may want to invest in the companies working on the Smart City projects, or you may want to invest in the companies which are benefited from the implementation of GST. So there can be different types of ideas and themes. A readymade portfolio of stocks made for all those ideas and themes is called a small case.
Just like you buy stocks directly through a broker, you can buy small cases directly through a broker. Just like mutual funds and direct stock investing are ways to invest in the stock market, a small case is a new-age modern instrument that you can use to invest in the stock market.
How Small case can solve all the problems for first-time investors?
Now that we have understood what small cases broadly are, let's see how a small case can solve all the problems that we discussed earlier for first-time investors.
1. Finding difficulties in understanding Investment Product
So the first problem faced by first-time investors that we discussed was the use of too much jargon or financial terms which make it very difficult to understand a product. For example, we were talking about arbitrage. I've mentioned a few times that if someone advises you to invest in an arbitrage scheme, it becomes a bit difficult to understand. On the other hand, when you invest in small cases, you are always investing in a theme. So you can easily understand in what type of companies your money is being invested.
But if you are investing through mutual funds, if you are investing in mid-cap mutual funds, large-cap mutual funds, or any other type of mutual funds, then you will never be able to understand in what type of stocks your money has been invested. But when you invest in a small case, you can clearly understand where your money is being invested without decoding any financial terms or jargon.
Example of Small Case
a. Let's take the example of the two small cases. The first is Brand Value. So you can easily understand from the name of the small case that your money is being invested in the companies having a strong brand. People have been using those brands in their daily life, and these companies are encashing this brand value.
b. The second example that we took was a small case called Rising Rural Demand. It has the companies having big exposure in the rural economy or rural areas in India. So whenever the rural economy or the people living in rural areas have a rise in the income level, it leads to an increase in their expenditure, and the companies catering to them are benefited. So this small case is a group or basket of such companies. Thus it becomes easy to understand without knowing the returns and risks.
The first and most important thing that gets clear instantly while investing in a small case is where your money has been actually invested. Has it been invested in the companies with a strong brand, or in the companies serving the rural economy, or in the companies that benefited from the GST? That's how small cases tackle or solve the first problem for you.
2. Risk and Return in Financial Management
The second problem that we talked about was that often too much emphasis is laid on the returns. And there is always a regulator or a disclaimer in the note. It says that past returns are never a guarantee of future returns. It means that if a particular thing has performed well historically, it doesn't guarantee that it will keep performing well in the future. So, will it be the right decision to invest in anything based on returns only? Obviously not.
Because there are changes in time, things, government policies, and regulations. And different countries support different sectors at different times. With all these things changing, there is no guarantee that the sectors or companies that benefited from those policies, those companies, or ideas, or philosophies will keep working well in the future. So first-time investors need to understand that returns are not to be given too much importance.
The thing that is important for you is that you understand the thing in which you invest, and you can relate to it so that when that thing performs well or badly for you, you can understand why your money increased or reduced. For example, if you invest in a Rising Rural Demand small case and that small case is performing well, and you are also reading in the newspaper that the government has allocated a huge amount of the budget to the rural economy, or the government has brought a special scheme for the rural economy, or a simple thing that we observe in India every year is that the monsoon was good, a good monsoon always benefits people in rural areas because, generally, these people are connected to the agricultural economy, so you understand very quickly that how this case or the thing you read or observed can affect your investment.
So if you think that all the current programs or schemes of the government of India will benefit the rural economy in the next 2-3 years, in that case, you should invest in this small case. So, the first crucial thing to note for first-time investors is that never make an investment decision based on historical returns. Instead, understand where your money is being invested. Do you understand the philosophy or the sector in which you are investing and can relate to it? If you can, do you think it has a bright future? If you know, understand, and relate to the answers to all these three questions, you can invest in that particular small case or sector.
3. Factor affecting risk in investments
Now, the third problem we talked about was the risk. Generally, first-time investors fail to understand the risk involved in a security or a stock, and how important is diversification. We can understand that with a small example. Let's say, you have noticed that petrol prices are dropping. The government may also have announced it or you may have to pin it. But if you know it and you think that if this is happening, people will buy more cars. If people will buy more cars, it is obvious that the automobile manufacturers, e.g, Maruti and Mahindra and Mahindra, will see an increase in sales. So you decided that I should invest in these companies because petrol prices are dropping.
But what you do is, let's say, you invest in Maruti. Till now, your hypothesis is absolutely correct. But suppose Maruti's plant catches fire, or someone in Maruti's management resigns. There can be any problems specifically affecting Maruti. Suppose, due to this, Maruti's production stops for the next 2-3 months, or any problems arise. And the stock you invested in, i.e, Maruti falls heavily. Now you will incur a loss. But it was very important to understand that your hypothesis was right. You even executed it well, but still, you incurred a loss. Right? Why did you incur a loss? Because your exposure in the stock market was very company-specific. If anything happens to that company, you will face a problem. Now, it is very important to understand and tackle it while investing in the stock market. And the method to tackle it is called diversification.
Diversification means that while investing, don't invest in just one company. Instead, invest in a portfolio or basket of 5 or 10 companies. Its advantage is that when one company faces any problems, it doesn't affect your investment in the other 9 companies. If I have to quantify it for you, let's say, we are investing 100 rupees in Maruti. And if Maruti faces any of the problems we discussed earlier, your investment of 100 rupees is reduced to 50 rupees. The stock price drops by 50%. So you have incurred a loss of 50%.
But, let's say, to execute it if you had invested in 10 automobile manufacturers, and you had invested 10 rupees in each company with a total of 100 rupees. Now, if Maruti had faced the same problem, you would have incurred a loss of just 5 rupees. And you can actually execute your hypothesis in both ways. So that was the third point, i.e, risk. It is very important to understand how much risk is involved in a stock market investment. And why is it always beneficial to have more exposure in your portfolio? Because it adds diversification and you can protect yourself to a great extent from the problems that a company may face in the future.
4. Mutual Fund Fees and Brokerage
Now the fourth and last problem we discussed was fees. It is always very important to know and understand how much fees are you paying to invest in the stock market. If you are investing in mutual funds, they generally have an expense ratio associated with them. That expense ratio can be 1% or 2%. It doesn't mean that if you have invested 100 or 1000 rupees, you are paying 2 or 20 rupees to the mutual fund at a 2% rate. The expense ratio means that you'll pay 2 rupees or whatever is the amount every year for the whole period of your investment of 100 rupees. So every year, if the expense ratio is 2%, you will be paying 2% of the current value of your investment. These are the fees that you pay when you are investing in mutual funds.
Similarly, you pay brokerage when you invest in the stocks. So when you invest for the long term... as I said earlier, you must invest for the long term if you are investing in the stock market. So when you invest for the long term, the expense ratio becomes very problematic because you have promised to pay a fixed amount or a fixed percent of the money to someone every year without any promise or guarantee from the mutual fund company that they will be generating specified returns for you.
But when you invest in small cases, you don't need to pay a fixed percentage of money every day or every year. When you invest in a small case, you only pay when you are transacting in a small case, buying it, or selling it. Thus you are not being charged any constant fees. And if you invest today and keep it with yourself for 10 years, you are not paying any fees.
Conclusion
The biggest problem for first-time investors is to determine the asset class in which they should invest. FD, real estate, or equities, or any other class. So we have determined that if you want to invest for the long term, like, 5 or 10 years, you should invest only in inequities. After determining that, you first understand the four major problems in it. The first problem was financial jargon.
The second problem was that your decisions were always returns-based. Then how a small case solves both of your problems because when you invest in a small case, you invest in an idea or a theme after understanding it and after knowing that it will perform well in the future in your opinion. There were two more factors.
The third factor was a risk. So we learned how you should never invest in only one stock because it increases your risk. And when you invest in small cases, you invest in a portfolio or a basket of stocks which provides the advantages of diversification, and your risk is quite limited.
And the fourth and very important thing. When you invest in small cases, you only pay when you transact. You never have to pay any constant fees. Thus you can easily establish that if you want to invest in the stock market for the long term, small cases are the best option for long-term stock market investing. So now let's quickly learn which small cases are best for first-time investors. Because we have a list curated for you with which you can start your investing journey.
