Initial wealth building strategies – 3

Hi there,

Let’s talk one more way to accumulate money.

Let’s assume that we are in a bull market. Stock prices are on the rise but you expect a correction sooner or later. You, as an investor, can take advantage of such situations in the market to build wealth.

HERE’S AN EXAMPLE

Let’s assume that you own 500 shares that you bought at Rs 250 per share. The bull market, and nothing else, has pushed the price up to Rs 400 per share. You want to hold the stock, but are concerned that a market correction might drop the price below Rs 250 per share.

You sell 250 shares at Rs 400 for a gross of Rs 100,000 which can be put in a short term fixed deposit. When the market correction comes, you buy back shares at a lower price. For example, say the stock fell to Rs 200 per share. Your Rs 100,000 profit will buy you 500 shares.

You now own 750 shares of the stock and have reduced your average cost from Rs 250 per share to  Rs 216 per share and you didn’t take a penny out of your pocket.

250 shares @ Rs 250/share = Rs   62,500
500 shares @ Rs 200/share = Rs 100,000

Earlier you had 500 shares by investing Rs 125000. Now you hold 750 shares @ Rs 216.66 /share without taking a penny from your pocket.  Of course in this example, for ease of explanation,  I have not considered two things. One is the tax on income when you sell shares at a high price and the second is the brokerage for buying and selling shares.

ALRIGHT..WHAT IF IT’s A BEAR MARKET?

If you have done your research properly, you will be able to judge whether the stock’s price decline is simply a reflection of the market’s general pessimism or a signal that something is fundamentally wrong with the company. If the price decline is due to general pessimism in the market, any smart investor would utilize that opportunity to grab more shares of that company at drop price, thus significantly bringing down the average cost per share invested.

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