Shares & Stock Markets

Invest for a long term or short term?

Imagine the thrill when the stock you just invested in, zooms! What an easy way to make money! Are not good returns over a short period very tempting? Your next move: Identify other stocks that have this potential. From now on, all your energy will be directed towards making that quick buck, daily.

You will find yourself taking tips from every trader, reading every available material on the subject, spending hours studying charts and sighing at every small fall in the indices. Yet, with all the time and energy spent on it, you may end up burning your fingers. This is a reality that every newbie has faced, I am sure.Not only newbies- I have seen most of the investors trying the same. If you have decided to invest money in stock markets, it’s always better to remain invested for a long term. Here’s why:

BENEFITS OF LONG TERM INVESTING

Short term investments may have the potential to give you quick bucks, but long term investment has several significant advantages.

Advantage #1:Compounding: Time can be investor’s best friend because it gives compounding time to work its magic. Compounding is the mathematical process where interest on your money in turn earns interest and is added to your principal.

Advantage #2: Dividends: Holding a stock to take advantage of payouts from dividends is another way to increase the value of an investment. Some companies offer the ability to reinvest dividends with additional share purchases thereby increasing the overall value of your investment. Consistent dividend payout is a reflection of a company’s overall business strategy and success.

Advantage #3: Reduction Of The Impact Of Price Fluctuations: When you invest for a long term, your investments are less affected by short term volatility. The market tends to address all factors that keep changing in the short term. So a person involved in long term investment will not be affected as much by short term instability due to factors such as liquidity, fancy of a particular sector or stock which may make the price of a stock over or undervalued. In the long term, good stocks which may have been affected due to some other factors (in the short term) will give better than average returns.
Long-term investors can ride out down markets without dramatically affecting his or her ability to reach their goals.

Advantage #4:Making Corrections: It is highly likely that you could achieve a constant return over a long period. The reality is that there will be times when your investments earn less and other times when you make a lot of money in short term. There may also be times when you lose money in short term but as you are in quality stocks and have long perspective of investment you will earn good returns over a period of time.
There are always times when some stocks do not perform and it is the wise choice to pull out of an investment. With a long term perspective based on quality stocks, it is easier to make decisions to change in a more timely manner without the urgency that accompanies short term and day trading strategies chasing volatile changes.

Advantage #5: Less Time Spent Monitoring Stocks: day trading requires constant monitoring of stocks throughout the day to capitalize on intraday volatility. But, Long term trading can be carried out effectively using a weekly monitoring system. This approach is most often far less stressful than watching prices constantly on a daily basis. Moreover, long term investment strategy helps you to concentrate more on your job/profession.

Advantage #6: Tax Effect: In India, short term capital gains (The profit you make by buying shares and selling it off anytime within a year) is taxable at 15% and there are no exemptions to it. Long term capital gains (The profit you make by buying shares and selling it off after a year) are totally tax free

Advantage #7:Oppurtunity to average down: Suppose you invest in a blue chip like reliance at Rs.1000 and for some reason the stock falls unexpectedly to Rs 850. That gives you an opportunity to buy more shares and bring the average cost down. This can bring dramatic increase in profits in the long term.

Advantage #8: Opportunity to make huge returns: Long term investments, if done after careful study of fundamentals, would give opportunity to create huge wealth over a period of time.Investors like Warren Buffet has followed this strategy to create wealth.

Overall, investors that begin early and stay in the market have a much better chance of riding out the bad times and capitalizing on the periods when the market is rising. When you invest for a short term, you miss out all these advantages.

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What are Blue-chip shares?

BLUE CHIPS

‘Blue-chips’ is one word that you’d be hearing a lot of times once you start following the stock markets. So this post is about blue chips or ‘bellwethers’ as it is sometimes called.

Blue chip stocks are large companies whose shares are considered to be relatively safe than normal shares. It gains that status from its past record of being a high growth, high dividend paying company. These companies would be leaders in its field. For example-Infosys technologies is described by Medias as an ‘IT bellwether’. It reflects the investor’s confidence in that company’s capacity to maintain its status as the leader of the pack and its past record of excellent management and of giving good returns to it’s share holders.

The term ‘blue-chip’ is coined from a game called poker where the chip with the highest value is blue in color. In stock markets, the term is used to describe the stock that has highest quality – in terms of investor confidence.

There is no hard and fast rule to find out which a blue chip company is and which one is not. A blue-chip typically would have stable earnings and dividend history, a strong asset position, high credit rating and an excellent record of being a leader in its field. These are huge companies in terms of market capitalization and revenues.

All the 30 stocks in Sensex index can be considered as blue-chip companies. You can also see the Dow Jones list of Indian blue chips at –

http://www.bluechiplist.com/indices/dow-jones-india-titans-30/

ARE THESE SHARES SAFE FOREVER?

No. These shares may be assumed to be relatively safer than others, provided, the positive factors that drive the company remain intact. Just like any other company, a blue chip company can also run into financial troubles and become dead one day. No one can guarantee you that a blue-chip will remain like that in future also.

May be, some of the future blue chips are hidden in mid caps right now. If you have managed to spot them right now, you have a chance to become a millioner soon.

SHOULD YOU INVEST IN BLUE-CHIPS?

Of course, Yes! You must have some portion of your investments in Blue-chips. They bring the required solidity in your portfolio, since they do not fluctuate heavily like mid caps or small caps.

Investing in blue chip also requires lot money because; typically these shares will cost more. Hence, there is a necessity to valuate it meticulously.

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What drives the stock market ?

WHAT DRIVES THE STOCK MARKETS?

Basically, investors respond positively to good news from the government and corporate world and would stay back from the market when they face negative news. From the government’s side, they would expect relaxed monetary polices and interest rates that would enable companies to expand, grow and do business. They would also expect the laws and regulations to be corporate friendly.  From the corporate’s side, investors expect better results and profitability. Over the long term, the growth of the business and profitability is the concern of all investors. Since the current stock prices are nothing but the present value of expected future earnings, we can say that, in the long term, earnings drive stock prices.

WHY EARNINGS?

Investors buy stocks to get to sell it off at higher prices. Stocks will rise in price only if it is in great demand. Demand for a stock rises only if the investors feel that the company has the potential to grow and would increase earnings every year.

The stock market is a discounting mechanism where it’s not the current earnings but, the ability of a company to generate earnings in the future keeps driving it. The present has already been discounted by the market 6 or 12 months ago. So, if investors expect a good season in the future, the stock prices will respond by an increase in price now. Should they expect the reverse, the stock price would tumble. This is a continuing process in the markets – and will be so in the future.

So if you ask us which is the best time to buy stocks, our answer is – it’s when the earnings are declining and when the economy is in recession.

OTHER FACTORS.

Earnings are not the only factor that drives markets. Other factors that drive stock markets include sentiments, valuation, interest rates, inflation and the economic policies in general.

In this, Sentiments has more to do with investor’s psychology. Sentiments represent a collective view of all the participants at a give point of time. The moment there’s a change in stock prices, common investors would assume that it’s going to continue for a long time and would react accordingly. For example – if the stock market responds with a 50 point slide due to increase in interest rates, investor’s negative sentiments may kick off a series of downfalls since, they would keep selling their positions expecting further damage.

VALUATION

Investors will be attracted to the option which appears cheap in valuation. Valuation can be relative valuation or absolute valuation. By relative valuation we mean comparing the stock market to other form of investments like gold or real estate. By absolute valuation we mean, valuating the stock itself with its past price and present and expected performance.

MONETARY POLICIES AND INTEREST RATES

If the interest rates are increased, it affects the borrowing costs of companies and hence, high borrowing cost would bring the earnings down and it will also prompt the companies to post pone their expansion plans.  Changes in interest rates will also affect the rate at which future earnings are discounted by the market.

Fixed income earning instruments like fixed deposits become more attractive at high interest rates and that would impact the markets negatively. Investors would move their money from the markets and will park it in fixed instruments since the rate is high.

One major cause of high interest rates is inflation. As inflation in a country increases, the government will be forced to keep the interest rates high in order to restrict the money flow into the economy. As we said earlier, higher interest rates are not good for the stock markets. When the interest rates are low, fixed income instruments are no longer attractive and this would induce investors to enter stock markets.

So the interplay of all  these factors keeps driving the stock markets.

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How much money should you invest in stock markets?

People often end up investing majority of their savings into stock markets, especially if they get a handsome profit on their first trade itself.They also commit more money to recoup all the loses they made earlier.

Both these situations are dangerous. More than 80% of the retail investors in India have this problem of committing more. In the first case, they do it because they are excited about making more money quickly and in the second case they do it out of despair – to somehow recoup the losses and get out of the market. Ask any broker whom you know personally – he will have a list of hundreds of clients who came in –opened de-mat accounts and vanished in a year’s time.

HOW MUCH ? IS THERE A FORMULA?

So what we are trying to give you is a set of two tips that would help you have control over your money invested in stock markets:

First of all – never try the ‘daily money making process’ in stock markets. I know quite few of them who has tried ‘playing in stock markets’ to make a daily income-and lost all their money.

Secondly, There is a limit to which you should expose your money in stock markets. There’s no hard and fast rule as to how much should be exposed. However to help you out, here’s a formula which gives you a rough calculation about how much money should go into stocks based on your age.

It is:

90 –(minus) YOUR AGE = % of income to be exposed In stock markets.

So, if you are 35 years old , you can expose a maximum of 50% of your income into stocks. Ok. Fine. so does that mean you can expose 15% of your income at 75? May be not. Investments in stock markets ideally should be stopped at the age of 65 or 70 maximum. Again , as I said earlier , investing is entirely personal. If you have the money, health and will to invest at 70 or even at 90 , Go ahead ! ! Sir Warren Buffet is 81 years old now, and he hasn’t stopped investing !

Clearly, when you are young , you can afford to take more risk and hence, you should be investing in stocks rather than debt funds. when you grow older, the proportion of money invested in stocks should be brought down and the the debt or fixed income potion in your investments should be increased.

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