CHAPTER - 10
Is it safe to invest in the stock market?
Stock market investment is an avenue to generate wealth in the long term. But, the stock market world works on the rule- higher risk offers a better possibility of higher returns. The successful investor manages the risk & does not avoid it. The risk involved in share market investment can be managed if you know the risk involved.
Risks involved with share market investments:
1. Market risk:
The price of the share is determined by the demand & supply of that share in the market. Therefore, the share price fluctuates with every buy & sell order placed. The investor earns profit by buying the shares at a lower price & selling at a higher price. But, if you need to sell the shares & the price is below your purchase price, you tend to lose.
2. Company risk:
The share price depends upon the company's business. If the company is facing problems in the business, the share price tends to fall. Let's take a recent example of the automobile industry. There has been a shortage of chips used in the manufacturing of cars. This is affecting the sales of automobile companies. As a result, the share prices of automobile company shares have gone down.
3. Liquidity risk:
If the company is facing liquidity problems, the company cannot pay off its debt & will have to cut down the dividend payouts. So naturally, this can adversely affect the share price of the company.
4. Debt
If the company is in massive debt, it affects the cash generation & profits of the company. This is because the cash generated by the company is utilized to repay the debt, which ultimately affects the company's profitability. Also, due to this cash outflow hampers business expansion.
5. Interest rate risk
RBI changes the interest rate on deposits & loans as per the economic conditions. In case of an interest rate hike, the companies get loans at a higher interest rate, which badly affects the company's profits. Reduction in profits affects the share price adversely.
6. Government policies
The government policies affect the share price. Let's understand this with an example – when the government increased the FDI limit in the insurance sector, it positively impacted the share prices of insurance companies.
7. There are various other risks involved like inflation, political risk, currency risk, etc.
These risks can be managed easily with the following tips & tricks:
1. Diversification of the portfolio
A diversified portfolio is a commonly used term by portfolio managers or money managers. It means allocating your capital to various sectors rather than investing all your money in one company or one industry. If you go all-in for one company or one sector & that sector or company suffers huge losses for any reason, you might lose all your capital.
2. Research-based investment
Do not invest blindly in any stock. Do your research before investing in the stock, do not depend upon any tips from anyone. Even after investing in any stock, you should keep tabs on the financials & business of the company.
3. Avoid taking emotion-based decisions
The investor has many ways to get information & market news like – Newspapers, news channels, online articles & blogs, etc. However, the investor should avoid making decisions based on emotions of greed or fear. In fear or panic, the investor can take decisions that can lead to losses & can put the portfolio at risk.
4. Keep track of all your investments
It is essential to study the company before deciding on investing in the company. Still, it's more important to keep a tab on the company's performance once you are a shareholder. A good company can turn into a risky bet for various reasons like – new loans, issues in business, changes in government policies, etc.
So it's essential to keep track of the company so that you do not suffer loss in the future.
5. Invest as per your risk-taking ability
Before investing in any company, analyze the risk involved in that company & share. After analyzing the risk involved, check if you can afford that degree of risk considering your financial stability, financial goals, etc. If you are not a person who can take risks & want to earn a decent % of the return, then you can select the stocks accordingly (bluechip stocks). On the other hand, if you can take risks, you can invest in risky stocks.
6. Invest in defensive stocks
We have already learned about defensive stocks in chapter 7. It is advisable to include them in the portfolio as they perform well even in unfavorable economic conditions, saving your capital investment when the market falls.
You can manage the risk involved in the stock market by taking the above steps or tips.