Investing: A Beginner’s Guide

Investing: A Beginner's Guide - An Overview

Investing is buying assets to hold for more than one year. The support can be securities, commodities, tangible assets, etc.

In this article, we will focus only on the financial aspect of investing, considering the importance of time and energy, as they help us in decision-making.

Many retail investors have little financial understanding and need to be financially literate.

Financial literacy not only includes:

• Investing also includes better management of money and debt.
• Planning an annual family budget.
• The ability to differentiate and invest in various financial instruments for diversification. 

Financial literacy plays a crucial role in family planning, like making a balanced budget, buying a home, budgeting an emergency fund, funding children's education and marriage, or their retirement plans.

It's a human tendency to question 'why' when we ask someone something to do. By now, you might be wondering why I should even invest. We have tried to answer that. 

Investing: A Beginner’s Guide: Why Should I Invest?

To understand why we should invest, let's take the example of a person 'A' who has never invested and compare this situation with a person 'B' who has been investing for the past 20 years.

For the sake of simplicity, let us consider that the person has invested only in equity. Let's assume that 20 years ago, both of these guys had a monthly income of 5,000$.

If we consider somewhere around, 3,000$ was spent every month on living. Person' A' has not invested, whereas Person' B' has invested his balance of 2,000$ if we assume that his portfolio has given a return of 15% per annum.

Let's make a few simple assumptions.

1. Consider their annual salary increased at a rate of 10% 
2. The Inflation rose 5% yearly, which increased spending by 5%.

Now let's compare their net savings after 20 years:

Now, if we compare the savings of both these persons, we can quickly figure out how investing has enabled Person B' to gain much more than he could have without investing.

It is one of the examples where I have considered equity as the way to invest, but in reality, you have many more options, and we will discuss all possible forms of investing in the next section.

Beginner's Guide To Investing: Where To Invest?

To answer where exactly to invest, we will look at all the various opportunities we have in different asset classes, which include:

• Equity Investing
• Fixed Income
• Commodities 
• Real Estate
• Other Asset Classes

A person has to choose the best asset class that suits the individual's risk and return temperament, considering some diversification.

We will look at these asset classes in detail further, but before diving into understanding these asset classes, let's look at some essential things we need to know before investing.

It might look straightforward to invest, but everything comes with a price. Therefore, we need to look at every aspect before investing. Here are some of the essential considerations for anyone who wants to invest.

• Identify the reason

You need to identify why you want to invest. Your investment decision may be for the following reasons:

1. Grow your money
2. Retirement purpose
3. Child's education
4. Child's marriage

And the list goes on. It may be whatever, but you need to make a goal and take the necessary steps to achieve that.  

• Risk and return

Investing in the equities/stock market is an excellent option if you know its risks. It's a general belief that the higher the risk, the higher the return.

• Bonds and FDs

Fixed Income is a perfect option if your target is not to multiply your savings but to ensure it is protected. Fixed Deposits and Bonds offer a fixed interest rate for your principal amount, but often these rates fail to beat Inflation.

Beginner's Guide To Investing: Various Types Of Investing

Discuss these asset classes in detail, along with their pros and cons. Then, investors usually allocate their money using a technique known as Asset Allocation.

They believe investors should be diversified among various asset classes, and an optimal portfolio should contain a mix of all different asset classes.

Let's understand this with an example; consider that a young professional working in a software company may be able to take a higher risk than an older person who is about to retire.

Generally, aggressive investors allocate 75% of their savings in equity and the remaining 25% to relatively less volatile investments, which include gold, silver, and Fixed Income.

Similarly, a defensive investor like an old-age person may wish to invest 80% of his savings in low-volume instruments such as fixed income and precious metals. On the other hand, he might invest only 20% of his savings in equity.

The ratio in which every person invests in different asset classes may vary depending on their risk appetite.

Equity Investing

Investing through equity is the most widely used form of financing. It involves buying and selling shares of publicly listed companies on the stock exchange.

The New York Stock Exchange(NYSE) and the National Association of Securities Dealers Automated Quotation System (NASDAQ) are two highly traded significant stock exchanges in the US.

Investing in the stock market can be done by directly trading stocks through a stock broker. It acts as an intermediary between investors and the stock exchange. Usually, there are 2 kinds of stock brokers:

1. Full-service brokers: Provide services other than buying and selling shares that help clients make better investment decisions, like research reports and portfolio management advice.  
2. Discount brokers: Services are restricted to buying and selling shares.

Investors usually make their investment decisions regarding any trade through fundamental and technical analysis. These are 2 ways to study the performance of any company and its stock price.

The stock price is determined by the supply and demand in the market; the more the need, the cost of stock increases, and the less demand decreases.

Usually, a company's performance determines the demand and supply, but sometimes the sentiments in the market drive the demand and supply, which causes the price movement.

Some companies pay dividends regularly to share the profits with shareholders.

Pros:

1. It provides an opportunity to create a high Return On Investment(ROI) if invested over the long term.
2. It can serve as an alternate source of Income through dividends.

Cons:

1. Higher returns come with higher risks. Investing in stocks is risky; there is a high possibility of a negative Return On Investment if a company goes bankrupt.

Fixed Income Instruments

These financial instruments offer fixed-rate interest payments at low risk over a certain period as per the contract; the return is usually low as the risk is low. Some of the most popular kinds of fixed-income instruments:

1. Banks offer fixed Deposits.
2. Bonds issued by government/corporate companies.
3. Public Provident Fund or PPF.

The government or corporations issue bonds to raise funds to finance operations or projects of the company.

All bonds have different credit ratings issued by credit rating agencies. Classified mainly as investment-grade bonds and non-investment-grade bonds.

The interest paid for bonds could be quarterly, semi-annual or annual intervals, varying from company to company. Finally, the capital is returned to the investor at the maturity period.

Pros:

1. Investing in fixed instruments helps diversify your portfolio.
2. Steady Income throughout the bond periods acts as a source of Income till its maturity.

Cons:

1. Low rate of return
2. Fluctuations in interest rates make trading bonds before maturity risky.

Real Estate

Real Estate Investment involves transacting (buying and selling) commercial and non-commercial land/Buildings.

It is significantly less volatile compared to equity or fixed-income investments. Typical examples would include transacting in sites, apartments, and commercial buildings.

You can also invest in real estate without purchasing a physical asset by investing in REITs.

Real Estate Investment Trusts(REITs) provide a way to have some real estate presence in your portfolio by allowing retailers to invest in companies that operate income-producing tangible estate-related assets. 

By investing in REITs, you become a property shareholder, and you are entitled to earn regular Income produced through commercial properties, shopping malls, apartments, and hotels.

There are two sources of Income from real estate investments: Rental Income and Capital appreciation of the investment amount.

To invest in rental properties, you have to become a commercial property or a house owner to rent. It would help if you also managed other responsibilities like paying the mortgage, paying taxes, finding tenants, etc.

To invest with the expectation of capital appreciation, one must identify undervalued properties that have the potential to increase their market value with some repair and update or buying in a booming market, holding it for some time, and then selling at a higher price.

The real estate sector is significantly less volatile and can create huge returns if invested long-term. However, it also has high transaction costs, high maintenance costs, and low liquidity.

Commodities

Commodities include metals, crude oil, energy, and food grains. Investors can purchase items directly through the market or indirectly through mutual funds and exchange-traded funds that invest in commodities of your interest.

Investments in gold and silver are considered one of the most popular investment avenues. Gold and silver, over a long-term period, have appreciated and were able to beat Inflation.

Pros:

1. It offers leverage in the futures market which can make much money with significantly less investment if invested smartly. 
2. It protects against Inflation.

Cons:

1. Commodity markets are very volatile.
2. Factors like exchange rates, interest rates, and the global economy affect commodity prices.
3. High leverage can sometimes lead to higher losses.

Principles Of Investing For Beginner's

Understanding certain principles that help you make better investment decisions, provide better returns, and minimize losses is essential.

Discipline is key to learning any skill; following these principles makes you a disciplined investor.

1. Risk and Opportunity
The first principle you must understand is that risk and return are directly proportional. Therefore, investors should realize all the risks involved in the investment.

2. Fundamental Analysis
While investing in equity, investors need to study the company and its sector. Investors should have complete knowledge of the company's business model before investing.

Tools for Fundamental Analysis:

1. Annual Report
2. Investor Presentations
3. News related to the sector

3. Technical Analysis

Technical analysis is a popular technique that helps you make trading decisions. It enables you to develop a point of view on a particular stock or index and define the trade, keeping in mind the entry, exit, and risk perspectives. 

It helps you determine: 

1. When to buy and when to sell
2. Risks involved
3. Expected reward and loss

Technical analysis is the study of charts and identifying patterns in them. It is helpful in short-term trades. 

4. Invest Regularly

It is essential to understand that investing regularly can help you utilize the corrections in the stock market. Most people try to time the market but fail; it's vital to know that the time spent in the market is more important than trying to time it.

It is recommended to invest in equities for the long term. Long-term investing helps your investment compound, and it can create a huge amount of return.

Even after mastering technical analysis and being able to understand the global cues, it's very difficult for you to time the market. 

Dollar-cost averaging (DCA) is one of the best ways to invest in equities, wherein a fixed sum is regularly invested into a security or a basket of securities. DCA eliminates market timing and gives a structure to your investments.

DCA is also beneficial for retail investors who don't have large sums of money; they can accumulate large sums if continue over extended periods of time.

Mutual Funds & Exchange-Traded Funds (ETFs)

These are a few popular ways of investment that allow investors to invest in multiple assets simply by investing in an (MF)Mutual Fund or (ETF)Exchange Traded Fund.

• Mutual Fund: It is a type of investment instrument that invests in a basket of stocks handled by a fund manager who is legally compelled to work in the best interest of mutual fund shareholders.
• ETFs: Exchange Traded Funds are also a basket of stocks, tracking an index or some group of commodities, etc, but unlike mutual funds, we can directly invest in them through the stock exchange.
• Investing for Beginners Conclusion: Investing in an Education in Investing

Investing without having complete knowledge about the investment is risky. It's very important to invest in knowledge that will reap better benefits than any sought investment.

Researched and authored by Pranav Kanjarla | LinkedIn

Reviewed and Edited by Aditya Salunke | LinkedIn

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