I have discussed the basics of stocks as an asset class and also provided a checklist to use before deciding to invest in the stock market. As I mentioned in the header, let’s take a deeper dive into some of the specifics of stock investing.
As I always mention in my posts, all the points discussed here are based on my personal experience and preferences, which may not apply to all. Before making any financial decisions, you should think carefully and critically. Consult with professionals when necessary.
As of now, stocks and stock options are my favourite investments. This is because I’m comfortable with the risks associated with stock investing and I look forward to compounding the money in the long term. By long term, I mean next 5-8 years. As I age, I’m also planning to add some bonds and other lesser riskier assets for diversification. For now, let it grow and become a bigger pot, such that it can grow at a slower pace in the future.
Should You Be All-in On Stocks?
The simple answer to this question is “No”. This is because there are other options too, with different risk levels. Given that stock investment is a high risk, it is always good to consider some bond allocation to your portfolios too. This can also be allocated to your portfolio by adding bond mutual funds as well as by adding any bond ETF.
Make sure you have a good understanding of the risk and potential returns of the other asset classes you are investing in. Do keep in mind that higher risk may not always equal higher returns, meme stocks like AMC or GameStop are some of the examples of speculative stocks. Crypto investing seems to be a speculative investment too.
If you are only interested in stocks, do make sure that you don’t put all your eggs in one basket. Meaning, don’t put your entire money in 1 stock. In the stock market, anything can happen at any time. Thus, it is very important to diversify to make sure you manage your risk exposure.
Why I Choose Stock Investing?
I started by putting some money into a mutual fund to do some testing. This is to understand whether what I have read about these in different books were right or not. Once I got an idea of how it works and experienced it for a few months, I decided not to continue with mutual funds. Because I like to analyze companies and also perform some fundamental analysis on them. One other reason for the consideration was the fact that there are higher fees involved with mutual funds.
By owning shares of a company, you are becoming a part-owner of the company. As the company grow over time, the value of your investments will go up too.
Why Am I Not Into Crypto Yet?
Since the crypto market remains unregulated as well as lacks any underlying fundamentals, I’m not
Planning to get my skin in the game yet. This opinion may change as I gather more information and read more about this stuff. As of now, the prices of cryptocurrencies are volatile and it’s derived from supply and demand.
While stock prices are also determined based on supply and demand, there is still some fundamental value to a stock entitlement. By buying a stock, you become a part-owner.
It seems like crypto is here to stay and sooner or later, governments will embrace them. It is also worth noting that there are corporates that have crypto in their balance sheets. Companies like Tesla, micro strategy and square are some of the examples.
How Is Money Made From Stocks?
Money is made from Buying companies that are traded well below their intrinsic value and selling them when they are overpriced. Much of the money is made by waiting. You will need to wait for the market to value the company stock at an appropriate valuation. This is when the stock price goes up.
Apple stock chart
Microsoft stock chart all time
Dividend
Dividends are an attractive perk of investing in stocks. As I mentioned, buying stocks will entitle you to partial ownership of the company. If the company is doing well and it pays a dividend, you will receive a dividend when the company announces a dividend.
Companies don’t need to pay a dividend. Most of the companies in their aggressive growth stage prefer not to pay dividends. Any profits from the operation will be reinvested back into the company for future growth.
Do note that dividend income is taxable in some countries like the US. You will be charged 30 per cent of the dividend received from a US-listed company as Tax.
Dividend reinvestment
If the company you invest in pays a dividend and you do not need this cash flow for your short term needs, you may reinvest it into the stock and buy more shares.
These extra stocks you purchased will also be entitled to dividends in the next year, and it brings in more money the next year. This is how the money is being compounded.
Before Picking Stocks
You must understand the companies and industry well before you put your hard-earned money into any stocks. This understanding will help you ride through the ups and downs of the stock market and the fluctuations in stock prices. Don’t ever buy and sell stocks purely based on someone else’s opinions or suggestions.
Check Past Performance
With the help of stock screeners like yahoo finance/ Google finance, you will be able to access the historical stock prices. These are charted in graphs and are easy to understand. All healthy stocks go up and down and move pretty much like a wave pattern.
A healthy company’s share price tends to rise over time when you study its history from its beginning to the present day.
Checking past performance itself is not enough as companies that were relevant in the past may not be relevant today. This applies to companies that are relevant today also.
Do also note that past performance of stock prices does not guarantee future returns.
Companies In Your Circle Of Competence
As the greatest investor of all-time – Warren Buffet suggests, look for companies and industries that are in your circle of competence. If you are an expert in an industry, you will know some of the leading companies in that sector.
If you are working in the IT industry, you may have a better idea of the IT industry than the pharmaceutical or other industries. And by that, you can also understand how IT companies make money and how companies differ from their product and service offerings.
Companies of Product You Use Daily
Another way to identify good companies is by looking into your daily life. Checking what company products you are using, and reflecting on what you are using them. Are the products good and durable, is this company’s products the best? Do they have a comparative moat? Are they the market leaders? Do they have pricing power? These are some of the questions you can ask yourself and use for your initial screening. If you identify some companies and you have some favourable answers to the questions. Perform detailed analysis and due diligence on the companies.
Good fundamentals
Good companies always have good fundamentals. By good fundamentals, I mean steady and increasing annual revenue and profits. Reasonable financial ratios like price to earnings, price to book etc… Look for competent management with integrity. Companies with little or manageable debt in their balance sheet and total assets greater than the total debt.
These are some of the important measures I use to understand the fundamentals of a company. As this itself demands a separate post, I will limit it here and write a separate post in the coming weeks.
Conclusion
I hope I was able to provide some deeper insights into stock investing. Also provided my reasoning on choosing stocks as the investment vehicle of my choice. I will be writing more content about stock investing in the weeks and months to come. If you are interested in these topics, do remember to stay subscribed. This is free of charge and you will receive email notifications on new posts published.