TRADING & INVESTING STRATEGIES
Online Course
REGISTER NOW
The Truth About Investing
Posted: Oct 22, 2022 15:18
SHARE
Why invest in stocks?
- One problem we all face is where to keep our savings.
- We can keep them in very safe places like government bonds, or as fixed deposits in highly rated banks. However, though these are very safe, the interest you receive will be less than the inflation rate.
- This means that the purchasing power of your savings will decrease all the time.
- Investing in the stock market solves this problem, as the market appreciates at a higher rate than inflation in the long run.
- Other advantages of stocks include liquidity, as you can buy and sell stocks easily, compared to real estate and other assets. You also receive dividends, plus you can invest any amount - however large or small.
How risky are stocks?
- Investing in stocks comes at a cost. There will be years when there will be negative returns. It is only in the long run that stocks are really rewarding.
- Economic threats and crises are quite frequent, and the market can sometimes sell-off very quickly, creating panic. At times like these it is not unusual for many investors to sell off their stocks and find themselves without any when the market bounces back. This gives them negative returns instead of positive ones.
- Also, investors may find themselves having to sell their stocks to raise cash for emergencies. This can be circumvented by keeping a contingency cash reserve at all times.
- Keep in mind that the interest rate for credit card debt is usually higher than market returns. You are therefore better off first getting rid of such debt, and then investing.
How should you invest?
- Many investors spend hours researching stocks to add to their portfolios . Others look for advice from professionals. Quite a few take to buying mutual funds - often as a consequence of good marketing by the companies themselves.
- The number of shares or funds investors hold usually just increases with time, if they simply buy and hold. Otherwise the number keep rising and falling if they keep reacting to events. The first approach works a lot better!
- However, there is a much easier and effective method for investing. Simply buy and hold forever a piece of the market. You do this by buying an Index ETF (Exchange Traded Fund).
- In India a heavily traded nifty ETF is a good choice. Currently, Nippon India ETF Nifty 50 BeES is the most heavily traded one. The favoured one in the US is the Vanguard Total Stock Market Index Fund ETF (VTI).
- You can find all the ETFs traded on the NSE at the link below. Just sort by descending order of value, and look for Nifty 50 ETFs. The most heavily traded ones will be on top.
NSE website : Exchange Traded Funds
What’s so special about an index ETF?
- An Index Exchange Traded Fund (ETF) is basically a fund that has the same stocks as the index it copies, and in the same proportion. It has an extra advantage that it is traded like any stock on the exchange. And most importantly, the charges for an ETF are much lower than those for MFs.
- This means that you get a diversified portfolio of 50 stocks with a nifty ETF, and over 4000 in the case of VTI. There are several alternatives to the VTI in the US, where ETFs have been popular for many years, but no suitable one for a Nifty ETF in India, where the concept is just starting to catch on and most are very thinly traded.
- However, the most compelling reason for investing in an index ETF is that Mutual Funds and individual investors underperform market indices when observed over several years. Several MFs will outperform the index in any given year, but hardly any in the long run. Besides, it is impossible to predict which ones will outperform the index.
Surely, many people beat the market index?
- Almost anyone with a portfolio of stocks will beat the market every now and then. But to do it consistently over several years is extremely difficult. There are legendary investors like Warren Buffett and Peter Lynch who have done so over decades. But obviously they are exceptions, otherwise they would not be legends!
- In fact, there is a market model known as the Efficient Market Hypothesis which actually postulates that the market cannot be beaten. This is not a fringe theory like so many others in the market, but has been the basis for several Nobel Prizes. To date it remains the best available model for describing the market, though it is by no means perfect.
- Since the market is fairly well represented by an Index ETF, this instrument is a good way to invest. The expected returns from investing in the market are the historical returns - about 12.5% annualised in the last ten years in India, and 9.5% in the US.
Are there any strategies proven to beat the market?
- Two well-known strategies have been proven to beat the market : Value Investing and Momentum Investing. There are a few funds dedicated to these strategies, but they have no established index to track.
- There are also a handful of other lesser-known anomalies which appear to consistently provide at least a short-lived advantage over the market. (By market, we always mean a broad index representing the market).
- Even the Efficient Market Hypothesis accepts these anomalies, and variations of the hypothesis either incorporate them, or “explain” them away.
- Insider trading can also beat the market, but is a criminal activity!
- Another way to beat the market is by taking higher risks or using leverage. But doing so also increases the chances of a large loss.
Should an investor use these strategies?
- An investor can certainly use Value and/or Momentum Investing, as also other proven strategies, and perhaps outperform the market with them. However, this requires a good understanding of these methods, and no errors or wrong assumptions while making computations.
- Another approach the investor can try is to keep most of the portfolio in an index fund, and the remainder for strategies such as these.
- For busy investors, an index ETF is a very simple and effective way to invest. For people wanting to regularly invest a part of their earnings, an SIP can be used. Your bank and broker can do it automatically for you, but if there are charges for the service, it is best to do it yourself. The savings in charges accumulate into higher returns over time.
- Also bear in mind that any dividends paid by an ETF should be immediately reinvested for greater returns down the years.
Can I beat the market by trading?
- Trading performance is hard to assess, with much of it based on subjective interpretation of charts or data - unlike investing strategies.
- However, performance of accounts maintained with brokers is loosely available, and these suggest that 85-95% of all traders lose money. Trading is nonetheless encouraged by service providers, of which there are many.
- Technical Analysis provides an array of indicators, but most of these fail to make a profit on past data, let alone beat the market. It is of course possible to combine and tweak these indicators (or invent your own) to get a profit out of past data, but that is not a valid statistical method.
- Some traders sell options to get an apparent regular source of income, but this is likened to Russian Roulette which also has an impressive 83% chance of winning!
- Trading is best done opportunistically, or as a bet when the odds seem good.
Where do I go from here?
- We have seen that an Index ETF is a great investment, especially for those stretched for time. The proportion of your capital in the market is up to you, but some part should be in FDs or government securities for contingencies.
- To learn more about the subject, we have a unique, informative and solid online course that will interest you. The material is taken from the most authoritative sources in the world (think Nobel). It is designed for beginners and experienced investors alike, and is completely self-paced.
- Course details and the registration form can be found here:
TRADING & INVESTING STRATEGIES - For further details about the content, structure, and the instructor:
Additional details about the course
REGISTER NOW!
More stories about:
Investing
Markets
Trading
Blog