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the ABCs of Equity Investing

the ABCs of Equity Investing

stock markets have offered up to 40% returns in the past year. but how does one tread the risks? we have answers.
November 17, 2021
5 min read
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the ABCs of Equity Investing

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investing in the stock market is something like learning to drive. the basics are the same, but the rules change with geographies, terrains, countries. if you don’t tweak your driving pattern regularly to meet the rules of the place you are in, there would be penalties. similarly, to live that dream of becoming a millionaire, retiring quickly with good money, you have to learn the rules of investing in the public market. these rules can be complicated, but that is never a reason to shy away from anything. start small, access the risks, and keep learning.

considering the falling interest rates in the country and a double-digit inflation projection, equities have stood as the best instrument to save and invest. in the past 10 years, BSE Sensex has risen 245 times. in the same period, bank FD rates have slid from around 8.5% in 2011 to roughly 6%. the message, as one can see, is clear. equities are a better instrument to save. 

to help build the investment kitty, a flurry of IPOs will hit the Indian stock markets over the next four months. amidst this, the equity markets have touched their all-time highs. in Samvat 2077, Sensex and Nifty gave close to 40% returns. 

this could be the beginning of your investment journey. but being a first-time stock market investor or even figuring which upcoming IPO is worth investing in can be a tough task. to make things easier for you, we spoke to an expert. popular YouTuber and chartered accountant Rachana Phadke Ranade has been educating the public on financial literacy for the past 10 years through her videos, online lessons, and books. she breaks down the nuances of public investment for you in this exclusive interview:

Q. how do you choose stocks as an investor?

i choose stocks by doing a fundamental analysis of the company, which helps in understanding the intrinsic value of the stock. the first thing would be to analyze what the company does and also its revenue mix, the company’s history, and its reach. next would be to analyze the company’s reports. this could include checking the company’s year-on-year growth, operating profit margin, free cash flow, debt-to-equity ratio. and finally, checking the risks associated with the investment.

Q. should people consider quitting their jobs and taking up trading?

i would not recommend quitting jobs and taking up trading, especially if you’re early in your earning stages. trading comes with several risks associated with it. and it also requires that you have a decent corpus before you trade to get returns. so if you’re early in your career, or have other dependencies on you, it would be good to stay in your current job until you are financially stable. you can explore trading by the side and with small amounts till you learn more.

Q. how many times in a year should I churn my equity portfolio?

it is a good practice to review your portfolio quarterly. as and when the results are out, you could check how your portfolio was impacted. and for rebalancing, it can be done twice a year. so even if during the review you understand that the company is not doing as you expected it to, if the fundamentals are still strong, you can give it another quarter to prove itself. 

you can also try this alternate method. you can set a limit for performance. if that limit is achieved, you book part of the profits, rebalance the portfolio, and set another target. 

so, it can be a mix and match of both these methods.

Q. diversification is key to good returns. is there a magic formula for investments between debt and equity?

there is a standard thumb rule which says that 100 minus your age should be the percentage of your investment in equity. so assuming that my age is 25, in this case, my investment in equity would be 100 minus 25 i.e. 75% of my investments will go in equity and 25% will go in debt.

Q. is there something like ‘bad time’ to enter the stock market?

if you’re entering the stock market with the intention of investing for the long term, then there is no bad time to enter the stock market, provided you aren’t jumping into the market without prior knowledge.

Q. a lot of IPOs in 2021. apart from financials, what are the three basics to look for in a company before investing?

there is a specific methodology that works like a common mould to analyze any IPO. the three basic things you could look for in a company before investing are:

1. understand the business model of a company:

the Draft Red Herring Prospectus/Red Herring Prospectus servers as the most reliable form of document of the company. this contains a lot of information that can help you understand the business model of a company, which is the next step.

to understand the business model of a company, the top-to-bottom approach for analyzing the company is carrying out the analysis as below: 

a. economy analysis

b. industry analysis

c. company analysis

2. understand the company's vision: 

in an IPO, you are not investing in what the company has done. you are investing in what the company is planning to do; you are investing in the dream of the promoter. try to understand and judge that vision. if you think you are willing to be a part of that story, then you are ready for the next step. 

3. valuing the issue:

check out various valuation methods which are given in the prospectus. here, you can assess if the premium is justified for the story the promoters are selling. next, you can check the risk factors & litigations. towards the end, you can check the IPO details of the company.

Q. how much money should I set aside for investments?

before we set aside money for investments, we must analyze our financial position. this includes figuring out how much our monthly expenses are and whether they can be reduced. a good thumb rule that can help us with better allocation of our income is the 50/30/20 rule. it suggests that we allocate 50% of our income to basic “needs”, 30% to our “wants”, and the last 20% to “savings and investments”. the allocations here can be changed based on one's needs and financial position.

Q. how do I plan for retirement? i am 30 years old and I want to retire at 65. what kind of regiment should I follow so I can maintain the same quality of life? Say, I spend Rs 2 lakh a month right now.

when we talk about planning for retirement these days, there is a popular concept around gaining financial independence and retiring early. this approach is called the FIRE approach — Financial Independence, Retire Early. if you want to retire early, you must follow these three major concepts in the FIRE approach: extreme savings, frugality, and generating passive income. 

Step 1: determine your savings percentage

as in the 50/30/20 thumb rule I mentioned above, this savings percentage could be around 20%. however, if you wish to retire early this percentage should be increased to around 50%.

Step 2: calculate your target retirement amount

the general formula used to calculate this according to the FIRE approach is: “Retirement amount = 25 * Annual expenses”. So, as in the example, if you spend Rs 2 lakh a month, i.e., Rs 24 lakh a year, you should save 25*24 lakh that is Rs 6 crore. Out of this, let’s assume that 4% of the corpus will be the withdrawals per year. Again, this percent can vary. 

Step 3: calculate how long it will take you to achieve FIRE

for this step, you can check for a FIRE Age calculator online. this includes parameters based on the person and can help calculate how long it will take to achieve retirement goals.