Are you ready to invest in stocks after investing in mutual funds? Know how to decide However, very soon many of these investors want to move forward and get the benefit investing directly into stocks which can have significant impact on their wealth creation journey. So here is how you can check if you are ready for it
Equity investment is known to give a higher return in the long term than many other asset classes. However, not every investor is comfortable with this investment class as it comes with a higher degree of risk and is also known to have high volatility over the short term. Nevertheless, mutual funds have emerged as a good vehicle for layman investors to start their investments in equities in a much safer and convenient way. As a natural progression, many of these investors soon want to venture into direct equity investment. However, not many of them get the desired result as they have high expectations. Either they don't spend enough time or put enough effort into understanding the equity market dynamics well.Let us understand what is the ideal time after which these investors should start investing in equity directly and what are the precautions they should take throughout this journey.
Right time for an MF investors to invest in direct equity
So, what is the right way to invest in equities and when is the right time to start direct equity investment?
"It is always better to start investing through MFs and then venture into direct stocks as this helps investors understand how equity behaves over a period. It makes them more aware of both volatility and return potential. Giving a definite period is not easy as it is subjective," says Harshad Chetanwala, Co-founder of MyWealthGrowth.com.
Most experts agree on at least one point: stay with equity MFs for at least one year before venturing into direct equity. "Generally, gaining a solid understanding of investing basics through mutual funds is apt before transitioning to stocks and this could take around one to three years, depending on the investor's first-hand knowledge of the different metrics. The one-to-three-year timeframe allows investors time to learn about market dynamics, risk tolerance and investment strategies," says Raghvendra Nath, MD, Ladderup Wealth Management.
However, it would be better if you devote sufficient time to understand the various phases that an equity market goes through.
Sanjeev Govila, a certified financial planner and CEO of Hum Fauji Initiatives, says 2-4 years in MFs would be required to understand the dynamics of the equity market. "This time frame allows you to grasp market movements, gauge your risk tolerance, and comprehend how your investments react to different market conditions in the short and the long term. A solid foundation always takes time to establish," he says.
Start only when you have developed good understanding of the market
Investing in any avenue requires the person concerned to collect reasonable information about it; so does equity investment. "When one has to manage the investment on their own, like direct stocks, the need to understand it well is important. Investing based on limited or less information may not generate the right results. Hence, one has to gain reasonable information, knowledge and updates about the companies one plans to invest in," says Chetanwala.
The process of learning stock market intricacies should start with your equity MF investment. Nath suggests investors focus on building a diversified mutual fund portfolio as that will help them grasp key concepts like asset allocation and develop a sense of market behaviour before migrating to stocks.
Though gaining an advanced understanding may be difficult, investors should try to learn the basics well. "While not mandatory, having a minimum understanding of stock analysis, evaluation and exit strategies significantly enhances successful stock investing. A basic to robust familiarity with key financial ratios, industry trends and company fundamentals helps in identifying good stocks, while a regular review of financial statements, news and performance indicators aids in taking informed decisions regarding the composition and movement of your portfolio," says Nath.
It is not only stock selection that is important, but the knowledge of how to review the performance and when to exit is also important.
It is vital to know when to exit a stock, says the MD of Ladderup Wealth Management, as having an exit strategy based on a stock's deviation from your investment thesis or changing market conditions prevents you from making emotional decisions. "Without a doubt, knowledge empowers investors to make rational choices, mitigate risks and seize opportunities, leading to a more fruitful stock investment journey," says Nath.
Raise your exposure to direct equity gradually
Rather than going full throttle into direct equity investment right in the beginning, it is better to go slow and steady. "When considering the switch, evaluate your confidence in stock analysis, risk appetite and time commitment, and remember that the transition does not need to be abrupt. A gradual approach involving partial stock investments while holding onto mutual funds can ensure a balanced shift. Each person's learning curve varies, so be patient and ensure you are comfortable before diving into direct stocks," says Nath.
Some factors are different in stock investment
Before entering the stock market, investors must recognise certain factors that make the direct equity landscape distinct from mutual fund investing. Govila points out that stocks are more volatile than MFs. The company's performance, management quality, market sentiment and global events play significant roles here. "Recognise that you're owning a piece of a business, not just a ticker symbol. Benjamin Graham's advice that 'investing is most intelligent when it is most businesslike' always holds true when one is dealing with stocks directly rather than through MFs," he says.
Comparative analysis of stocks helps you zero down on one that suits you the best. There are many parameters that should be closely watched. Chetanwala lists the important ones as the company, its sector, internal and external environment, competition and growth potential, among others. Knowing about these will help investors make more informed decisions while investing in stocks.
One also needs to keep a watch on macroeconomic developments that may affect a stock's performance. Nath says a stock's performance is also tied to macroeconomic trends, interest rates and industry cycles. So it is crucial to understand these as individual stock selection demands a deeper analysis than broad mutual fund investments.
Even if an investor takes all the precautions and the stock's fundamentals are strong, it may still face higher volatility in the short term. "Maintaining a long-term perspective while being prepared for short-term fluctuations is essential in stock investments, as you are the sole decision maker here, and do not have access to the expertise and experience depicted by mutual fund managers who take the decisions on your behalf," says Nath.
What should be your initial investment strategy
You should start your equity investment with relatively stable stocks. "Your initial foray into stock investments should focus on established, well-performing companies with fundamentally strong and sustainable business models, as these have the power to stand the test of time and market volatility. Such companies can be found in the large cap segment of the market, so choose your initial investments from the Nifty 50 or Nifty 100 index, which have companies with a market capitalisation above Rs 20,000 crore," says Nath.
Even here, invest in several stocks so that your risk is lower than investing in a single stock. "Diversify across sectors to reduce risk. Initially aiming for 10 stocks and then slowly building it up to 15-20 stocks is reasonable. Remember Warren Buffett's words 'diversification may preserve wealth, but concentration builds wealth'. Add to it that concentrated portfolios are risky to maintain as small price fluctuations in one or a few stocks will affect the entire portfolio," says Govila.
Stock market investment requires constant look out to identify a good performer. "Look for companies with a competitive edge, solid financials and growth prospects and start with a manageable number of stocks, perhaps around 5-10, to achieve diversification without overwhelming management efforts. As your expertise grows, you can consider branching out to more stocks across various sectors," says Nath.
Should you ditch MF for direct equity investment?
The next question many investors want an answer to is whether they should liquidate their equity MF investment to invest in stocks or should they go in for stock investment with the incremental surplus money. "MF and direct stocks can go along, instead of migrating completely from MF to direct stocks, as MFs are managed by professional fund managers and at the same time this method gives sufficient time to investors to focus on their professional and personal lives. Many investors build their core portfolio through MF and then invest the surplus into stocks from an additional wealth creation perspective as it allows them to take additional risk," says Chetanwala.
Should all MF investors try equity investment?
You should venture into direct equity investment only when you have enough time and skill to do so. In fact, Chetanwala says, not all MF investors should try direct stock investing. The utmost priority of investors should be to build a core portfolio that takes care of their different financial objectives. "In today's time, one should always have an allocation in equities, but this allocation can be easily taken care of with the help of equity diversified MFs. Hence, venturing into direct stocks is not really required," he adds.
Not all MF investors need direct equity exposure. "Conservative or risk-averse investors, as well as those with short-term goals, might find MFs a better fit. Investing in stocks requires time, effort and understanding. Investors lacking these resources or those unable to weather market fluctuations should avoid direct equity investments. As Buffett emphasises, 'risk comes from not knowing what you're doing'. It's crucial to match your investment approach with your risk tolerance and goals," adds Govila.
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This story originally appeared on: India Times - Author:Faqs of Insurances
