“What is stock market and how to invest in stock markets in India?” This is a very common question I come across in yahoo answers forum. Obviously newbies who are getting exposed to the stock market are asking these questions, so I thought an article explaining how to invest in stock market would help.
Understanding the stock market
First of all a stock or share is just a fractional ownership in a company. Assuming you hold 100 Infosys Technologies stock your ownership is to the extent of 100 shares, while the total shareholding in the company may consist of several millions of shares.
You can buy and sell a stock from an authorized stock exchange through a broker. (Example of brokers include Indiainfoline, Kotak Securities, Angel Broking, etc.)
How stock market works in India?
Companies issue “shares” to raise capital for funding their business operations while investors invest in the share in order to share the risks or rewards of the business of the company. The reward or benefit for investors could be in the form of
- Dividends declared by company when the firm makes profits or
- Appreciation in share prices
A stock market is a common platform (just like a local mandi where vegetables are traded), where buyers and sellers quote and perform transactions. The National Stock Exchange (NSE) and Bombay Stock Exchange (BSE) are the leading stock exchanges where stocks in India are traded.
How to invest in stock markets in India? – Different ways
There are two ways to invest in stock markets depending on your familiarity, risk appetite and other factors.
- Investment in Stocks
- Investment via mutual funds
For beginners and those who are not familiar with stocks investing via mutual funds is generally recommended. Mutual funds are investment vehicles (regulated by Securities and Exchange Board of India) who collect savings/investments from various investors and invest the same in stocks, bonds, commodities, etc.
Mutual funds are safe for starters because it provides diversification and lower risk, compared to investing in individual stocks. Once you get familiar with the overall stock market, then you can start investing in reputed companies by buying their stocks directly as well. There is no harm if you invest in stocks as well as mutual funds but some duplication may occur.
To know more about mutual funds please read our blog – Basics of Mutual Funds
Basic Requirements for Investment in Stocks in India
1. To start investing in stocks directly you need a trading cum demat account which will be linked to your bank account. Just like opening a bank account there are some documentation formalities, which are mandatory to be completed.
2. A deposit or margin money may be required to start investing
3. Annual Charges: You will have to pay yearly maintenance charges that can range from Rs.300 and upwards depending on the plan chosen
4. Brokerage Charges: 0.20%-0.60% or higher – this can vary from company to company as well as depend on transaction value and frequency.
For more on how stock trading works and to know all the pre-requisites and formalities for opening a trading account, read our blog – How online trading works
In case of mutual funds you need to fill the required forms and cheques for investment. The fund will give you a folio or account number for all future transactions or reference purposes.
Now that we are done with the basics we will discuss about selection of stocks (if you invest directly) or selection of mutual funds (where you want to invest in funds).
How to invest in Stocks (Stock Selection & Portfolio Management)
Once you get comfortable understanding stocks and the risk in equities, you have to gradually start investing some of your savings. The first step is choosing or selecting stocks. To give you a broad idea you need to understand three important areas:-
- The Economy (E)
- Industry (I) and
- The Companies (C) or stocks you are looking at.
In short this is about understanding the current economic condition in the country, how it affects different industries and companies. Secondly you also look at and shortlist those industries or businesses which you understand.
For instance do you understand the business of the company “Mindtree Technologies” or what it does? If your answer is “No” then you should either avoid such stocks or industries and try to learn about it before committing your investments.
There are two broad areas that you need to focus on to understand a company.
Understand the company, its business, revenue model, management capabilities, its projects, future plans, etc.
This requires you to know and interpret the Income Statement, Balance Sheet and Cash Flow Statement. In addition you may have to know certain metrics and ratios to evaluate the company’s performance against its peers/competitors.
If this all sounds too elaborate and time consuming, I would see this is just the beginning and there is more to it. However, even if you start learning some of the above basics, you can pick up as you move along, since investing is a long learning process which gurus like Warren Buffet have perfected with decades of hard work and real life experiences.
Choice of Stocks:
For starters I would recommend reputed large stocks from the index (NSE), which have strong reputation and market leadership in certain industries. But choose only those businesses, which you know or understand so that the risks are evident and manageable.
Pick stocks from different industries or sectors in order to build a diversified portfolio, which is not biased towards few industries.
Have a medium to long term view in order to reap rewards – but remember that you cannot make easy money or regular income from stocks. We will have a more detailed article on stock selection or Qualitative Analysis.
How to invest in Mutual Funds (Mutual Fund Selection & Portfolio Management)
If you decided to invest in Mutual Fund it does not mean you are 100% safe. So all the points mentioned above are valid even for mutual fund investors although the way these impact them might differ. Why so? Because the funds are managed by Fund Manager who ultimately invest in stocks using the same framework we discussed above. The only difference is in this case we have
- Industry &
- Funds (instead of stocks or companies)
But remember that these funds ultimately invest in stocks or companies and are impacted by corporate performance. The only twist here is the fact that you are investing in funds, which are baskets of stocks.
Learn how to pick the best mutual funds yourself at our blog – which is the best mutual fund in India
Choice of Funds:
Going by the same lines as in stocks, go for large cap funds, which invest in blue chip companies. The second choice could be diversified funds, which invest in large as well as medium sized companies. The third choice would be a Gold ETF/Fund, which invests in gold.
For more information on Gold funds or ETFs you can read our blogs
Why mention Gold in stock market article? Lets be practical that investment is not just about investing in stocks, but diversifying across asset classes including gold, fixed deposits, real estate, etc.
An investor need not have more than 4-5 funds of which a large cap, diversified and gold fund are a must, while others are nice to have. Adding more and more funds will not make any positive difference but can increase your cost, time and can be complex to manage.
There are various stories and rumors of people who made thousands in a matter of minutes or millions in a month as a stock trader. Will this work for you? Never try to do this. Becoming a professional trader requires a different training, experience and qualities.
All you have to do is allocate some savings in a systematic investment plan (SIP) every month or in different amounts as per your convenience, and let the investment grow over a period of time. Its just similar to how spiritual gurus say “Do your duties or actions in the right way, and the results will follow”.
Hope you have a firm understanding on how to invest in stock markets in India now. I welcome you feedback on this Wisdom Times Exclusive article as well as any questions or comments you have.