Equity Investments: Promises & Lies
During the COVID-19 pandemic, a lot of individuals lost their jobs and this massively affected lower income households. Needing a way to support their day-to-day livelihood, a lot of these young individuals resorted to the stock market, hoping to make profits and cash out in order to pay their bills. This drove a lot of retail investors to begin investing in equity markets. However, the main issue with these retail investors is that they lack the necessary and required skill to invest and earn money in the market.
Equity investments provide several benefits but are risky and hence, investors need to understand the potential risk-return tradeoff of any investment. Though the benefits outweigh the risks, it is lack of skill and knowledge that is the biggest mistake made by naïve investors, resulting in loss of wealth. Just by looking at a few ratios, financial statements, and numbers, one might think investing is easy, but the truth is a lot of individuals who follow this strategy might do well during a bull market, but do terribly during a bear market and would have no idea why their portfolio completely reversed trajectory and ended up making losses. Not to mention, a lot of new investors are overwhelmed with the plethora of information available in today’s day and age and have no clue where to start and what to look at.
There are a few important points that new investors should consider that will help them minimize risk and losses whilst at the same time, improve returns. The first is that always remember the fundamentals. One needs to understand how the business generates cash flows, revenues and earns profits. If you understand how a business does this and feel that what the company does makes sense to you, it sounds a lot safer as an investment than just looking at a few ratios and numbers and then investing. The important point here is that fundamentals do not always work in the practical world but by knowing them, you tend to make safe and sound investments.
Another very essential point that many investors do not realize is that as an investor, you need to know yourself. This means that you need to know what kind of strategy works best for you, depending on the risk you intend to take, your time horizon, and investment amount. This does not mean that you cannot make investments that do not follow a similar theme (growth vs value, high risk vs low risk, momentum vs contrarian), but investors tend to incline toward a particular style or two, so knowing that along with your appetite for risk is very essential for your success in equity markets. The important point here is that investors do not need to realize this as soon as they enter the market but rather develop this skill over time, depending on what works best for them according to their nature.
By following a few of these points, investors can definitely make safe and sound investment decisions. It does not mean that they will be guaranteed positive returns, but they will have a better idea as to why they did make a particular investment and learn more about themselves as investors.
by Arhan Parikh (arhan.parikh@xumitcapital.com)
