Investing refers to the process of allocating money in financial instruments like equity, derivatives, fixed income instruments, mutual funds, precious metals, real estate, small businesses, etc with an expectation of a profit or benefit in the future. The main motive of investing is to fulfill the financial goals which vary upon the factors like income, age, risk tolerance, and many other factors like how many people are supported by that income, etc. Investing helps to beat inflation that is it helps to maintain the purchasing parity and helps to create wealth for retirement.
How can you get started with investing?
How can you get started with Investing?
It is said that one should start investing as early as possible because it allows a person to make mistakes and strategize better to gain money effectively in the future. To get started, it is imperative to decide on how much one can invest and how much one can afford to lose. A fixed deposit in a bank is considered a comparatively safer option as compared to investment in equity- the risk tolerance should be an important consideration for an investor.
An investor should thoroughly understand the domain they wish to put their money in. For example, if investing in the stock market, one should do thorough research on the background of the company and should consider the factors related to the company like revenue model, management stability, competitors, etc. Along with researching the current affairs of the company, an investor must consider the future outlook as well. After getting acquainted with the process, investors should work on diversifying their portfolios to manage the risk more effectively and to avoid any kind of leverage. These are the major pointers that one has to thoroughly research to gain a good understanding of the process of wealth creation. The key is to start and it is never too late to start!
Introduction to Asset Classes
What is an asset class?
An Asset Class can be referred to as a collection of various securities with comparable traits that undergo somewhat similar market fluctuations. Therefore, components of a similar asset class show similar traits subjecting to similar regulations in the marketplace. There are numerous criteria, regulations, methods, etc that can be used to classify asset classes. We will be discussing important asset classes with examples.
Consider your average Indian middle-class family consisting of 5 members- parents, their two school-going children, and one retired grandmother. Uncle works as an accountant with an okayish firm and his wife is a teacher at a primary school. The combined salary of both of them and the only source of income is around Rs 50,000- 55,000 per month. However, with the ever-increasing ration costs, school fees, coaching institute fees, and other miscellaneous expenses the savings land to not more than Rs 5,000 a month.
Well, this family does not want to lose their hard-earned money due to gambling in the stock market which is very uncertain. They want to invest their money somewhere secure and with no risks attached. With this, comes the most preferred asset class by the Indians- Fixed Income Deposits.
Fixed income is an investment option providing a steady stream of cash flows where investors do not lose the money they invest. Investment can be made either for the long term ( with a higher rate of returns but the money is generally invested for a few years) or short term ( with comparatively lesser returns but money can be retracted within a shorter span). It is a great way to grow savings with utmost safety. Once a fixed investment gets locked on a decided interest and a decided tenure, it remains unaffected by further changes in financial policies and fluctuations. Thus, the returns are guaranteed!
Adrian is a 22-year-old girl working at one of the top consulting firms since she graduated college. Even though it is her second year at the firm, she has been promoted to a higher position with her monthly income around Rs 1,20,000 leaving her with plenty of cash as she lives with her parents and multiple expenses are borne by her company. Adrian does not believe in keeping all the cash idle or invest it in a bank for multiple years. She wants to put her money to use and wants good returns. She researches and finds out that she can be a partial owner of any major company by investing in the stock market- as that company gains, Adrian gains as well.
Investing in the stock market comes with its own set of risks and uncertainties, however, if an investor plays their cards right, it can lead to augmented gains.
When an investor buys a part/share in any company through the stock market, it is known as equity. On the investment, the investor receives profits or losses as the company’s share price appreciates or depreciates due to governmental financial policies, news, capital gain/losses by the company, or anything important to the dynamic of the company. Investing in equities provides a cushion against the increasing inflation rate as the rate of returns is higher than the wearing down of the purchasing power of the investor.
As the name implies, this asset class focuses on apartments, plots, commercial buildings, industrial areas, etc. Real estate is a profitable way of increasing wealth because people always require shelter for their families, malls, and entertainment places to enjoy their time and stay in hotels while staying in different parts of the world. Therefore, real estate is an investment option that has increasing demand wrt to the increasing world population making it a preferred option for investors.
Investment in commodities refers to buying raw materials or primary products where prices of the commodities rise and fall as per the demand and supply. Commodities markets provide a centralized and liquid marketplace for producers and consumers of commodity products. Commodity derivatives can also be used by market participants to hedge future consumption or output. In these markets, speculators, investors, and arbitrageurs all play a part.
A derivative is a financial contract whose value is determined by the performance of another asset. A security whose value is determined by, or derived from, the value of another asset is referred to as a financial derivative. An underlying asset, or simply underlying, is the asset or security from which a derivative derives its value. Let us understand this with an example-
A farmer produces cocoa and has been one of the cocoa suppliers to XYZ, one of the biggest chocolate manufacturing companies. Let’s assume that the farmer provides cocoa per quintal at the rate of Rs 5000 to the company. However, with the chances of rain in the upcoming months, there is a high possibility that the plant might get destroyed which means the company will have to pay more than the usual price owing to the fall in supply. Therefore, to prevent losses at its end, the company gets into a contract with the farmer that the company will pay Rs 5000 at the end of two months in any case scenario. If there are no excessive rains and the overall production increases causing a fall in the market price, even then the company will have to pay Rs 5000 only with the farmer gaining profit!
Introduction to the Stock Market
The Stock Market offers a platform to facilitate the exchange of shares of publicly listed companies. If you want to buy 10 shares of Reliance, the stock market connects you with a buyer who wishes to sell 10 shares of Reliance. Two of the major stock exchanges in India are-
The responsibility of overall regulation and supervision resides with the Securities and Exchange Board of India. SEBI ensures that the stock exchanges and brokers conduct their businesses fairly and no organization uses Stock Markets to benefit themselves. SEBI also ensures that the interest of small retailers who invest and trade in the market is protected.
A Stock Market Index is an indicator of the performance of the respective stock exchanges. Sensex is associated with BSE which includes shares of 30 firms listed on BSE and Nifty includes 50 shares that are listed on NSE. Stocks are chosen based on market capitalization.
Introduction to Mutual Funds
The word ‘Mutual’ suggests that a group of people is involved in an activity related to investing as the word ‘Funds’ comes along with it. Let us assume that you wanted to invest in a Stock X which is trading at Rs 1000, however, you only have Rs 100. So, what can one do in such a situation? You can pool your money with like-minded people- in this case, you will be teaming up with 9 other people who wish to invest in Stock X where the gains and losses will be shared by everyone. The value of your units changes in direct proportion to the value of investments made with that money.
What are Mutual Funds?
A mutual fund is a financial instrument that pools money from a variety of investors with like-minded investing interests. The money is subsequently pooled and invested in securities such as public listed companies’ stocks, government bonds, corporate bonds, and money market instruments. A mutual fund is a type of investment instrument that is created when an asset management company (AMC) or fund house gathers assets from several individuals and institutional investors that have similar financial goals. The pooled investment is managed by a fund manager, who is a financial professional. The fund manager makes stock and bond transactions that comply with the investing mandate. SEBI has a database of all mutual funds. They operate under the confines of rigorous regulations designed to safeguard the investor’s interests.
How can one invest in Mutual Funds?
Investing in mutual funds is easy. You put money into a fund with a variety of assets. As a result, you don’t have to risk placing all your eggs in one basket. The asset management firm is in charge of a mutual fund. The money is pooled and invested in a carefully constructed portfolio of several asset types such as stock, debt, money market instruments, and other funds. As a result, you enjoy the benefit of diversity, a tested market mantra.
Advantages of Investing in Mutual Funds
- Experts manage your money
The money pooled by the investors is managed by a group of experts who do meticulous research in determining the asset allocation and the market trends.
The money is invested into diversified options to reduce the risk of the overall portfolio- the money is spread across various companies from different industries and different financial instruments.
- Tax Benefits
Tax benefits associated with various mutual funds draw multiple investors towards the same. To encourage investments in Mutual Funds, the Government of India offers tax benefits.
- High Liquidity
Exit options in Mutual Funds are comparatively easier as compared to other financial instruments where investors can easily sell when the market is high. Upon the liquidation of funds, the money gets transferred in a few days. However, some mutual funds can be liquified within a certain timeline only.
How to Start Investing?
Investing in the stock market is a long-term approach that can help you manage your finances. To get started with Investing and Trading, you require three accounts-
- DEMAT Account
- Trading Account
- Linked Bank Account
Let us understand the link between the three of them. Let us say that Walmart is about to invest $124 Million in Company X. You believe that this can be important for Company X and its stock prices will rise. You wish to buy the stock of Company X. How will the transaction be carried out?
You will be placing your order via your Trading Account and the money will be debited from your linked bank account. The shares will be credited into your DEMAT account in 2-3 days.
Investing in the stock market can be intimidating, especially if you’re just getting started because it appears to be excessively complicated or risky. A full understanding will assist you in getting started. The first step is opening a DEMAT Account.
What is a DEMAT Account and Why is it required?
When you invest in a company, you get allotted the shares. However, one cannot hold physical shares because it involves risk and it is difficult to manage. DEMAT account allows you to store your shares in an electronic format where different financial instruments can be managed and transferred easily.
Your name on a canceled cheque from your active bank account
Proof of residence
Selecting a Depository Participant
The first step in opening a Demat account is to select a depository participant (DP). DP services are available in India through banks, stockbrokers, and internet investment platforms. When selecting a DP, look for a service provider whose services and features match your demands and expectations. Fill out the DEMAT form at your chosen platform’s website.
After you’ve completed the Demat account application, you’ll be requested to complete the Know Your Customer (KYC) requirements. This will necessitate the submission of scanned copies of KYC documents such as proof of identification, proof of address, bank account statement, and proof of income. It’s a good idea to have all of the necessary paperwork on hand before applying since this will help you get through the process more quickly. For some platforms, personal verification might take place as well. After the fulfillment of the verifications, an agreement is signed stating all the rules and regulations and a unique Beneficial Owner Identification number is generated which is used to access the DEMAT account. This is the procedure for opening a DEMAT account.
The second requirement is a Trading Account. As explained in the example above, a trading account acts as a link between your bank account and your DEMAT Account. A trading account is used to buy and sell shares in the market. A trading account can be opened via any broker or firm of your choice. The documentation requirements are similar to those required in the opening of your DEMAT Account.
After all the requisite requirements are completed, you’re all set to trade!