Financial planning is now an important part of life. One should ideally start planning his finances early in life and should start with basic steps such as prioritizing their needs and requirements. He can accordingly allot funds for the same. He can invest the money that remains after expenses and savings.
Whether the stock market is the best place to invest is one question that always arises. A rookie in the field of investing may not know the good investment decisions from the bad ones and hence may not become a good investor. This is because he may have many doubts in his mid which need to be solved and many myths that need to be broken.
Myth #1: Stocks at 52-Week Lows are Inexpensive
If someone is new to the market and is keen to invest, he may get attract to stocks which are at a 52-week, or a year’s, low. However, before purchasing the stock one must understand the cause of it hitting that level. You would never know, but it might just be the start of the downfall of that stock. An investor must understand that the 52-week low does not give any type of assurance.
The best time to purchase a stock for long term investors is when the markets are falling. However, the stock must only be bought if its fundamentals are intact.
If there is some uncertainty surrounding the company’s stock, one should avoid the share of the company until some clarity emerges.
Myth 2: The Best Stock is an Index Stock
It is often observed that people who are new to the world of stock markets invest their money in index stocks anticipating higher profits and ignoring other valuable stocks. Index stocks are a combination of stocks which are highly traded and have a large market capitalization.
Although most index stocks are based on large market cap or may be the free float of the company, it is not always true that these index stocks are highly profitable. However, the risks involved in purchasing index stocks are much lesser than the others since index stocks are well established and researched in their respective fields.
Myth 3: Stocks Giving High Share of Profits are Low on Risk
Those new to the world of stocks have another belief that those stocks which will give them a high share of profits are low on risk.
However, this statement does not always hold true. It may be possible that a company is making suitable payouts to its share holders while there is comparatively low price appreciation of its shares. So, before parking your money into stocks, one must understand whether or not the company is reinvesting the profit to grow its earnings.
Myth 4: Stock Market Situation Can’t Get Worse Than What It Is
Nothing is certain in the world of stock markets. Any political or economic announcement can change the direction of the market. Markets are not just driven by earnings but by sentiments too.
We can take the example of the rise in the level of the BSE Sensex from 10,000 points in Feb 2006 to 21,000 points in Jan 2008 and the crash which followed taking the index to 9,000 in Mar 2009. Investors must understand that when crashes occur and market bubbles burst, they most often happen without a warning.
Myth 5: Small Expenditure Comes with Better Future
There are available some low price stocks in the market which are more prone to speculation and are more risky in nature. Yes, it is true that it is easy to invest in these penny stocks but there is also a high chance of losing money in it. One can also earn with the help of highly denominated stocks; however, denomination does not affect the fundamental reasons and logical basis of choosing a particular stock.
The main aspects that an investor must focus on before making an investment decision includes the profitability of a stock, its past record of profits, the valuation of the stock, and the future prospects and growth of the company.
Myth 6: Stocks Having Lower P/E are Not a Good Option
P/E or price to earnings ratio is one of the most crucial ratios in the stock market. It is the ratio between purchasing price and the earnings. It is true that stocks that have lower P/E ratio are cheap but it should not be the sole criteria of choosing stocks. However, it is true that it is a fast method of valuing a particular stock. While purchasing a stock, one should look at the P/E ratio and its mutual relation with the expected growth in earnings, the performance of the company and its potential growth and risks.
Myth 7: Stocks Having Low Price than Book Value are Cheap
A company’s balance sheet or book contains the actual price of the stock which is known as Book Value or BV. It is the cost which is the difference in the amount of asset and the accumulated depreciation. It is mostly based on historical price and depreciation and is little correlated with the actual stock price.
Generally, it includes companies which have low earnings and industries that are capital intensive. It is a fact that companies or business models that have high human capital investment will earn more profits and earnings and thus will trade at higher price/book ratios while the companies and the business models which have low human capital investment will earn less profit when compared with other companies. Thus, they trade at low price/book ratios or low book value. Stocks which have a book ratio below 1 are considered inexpensive. This is an important factor one must watch out for before purchasing any stocks. However, other factors and aspects such as forecasts in earnings, management and debt on book or balance sheet of the company are also worth considering.
- While investing your capital into the stock market, one must look at all the aspects of investing in the companies such as their earnings and profits, their performance and fundamentals, risks, valuation of stocks and future growth of the company.
- One should choose balanced funds
- One should not invest only in liquid stocks. Equity investments are for the long term and one should opt for day-trading only if they are experienced.
- One can also invest in a Systematic Investment Plan (SIP) where he invests a fixed amount every month in a fund which diversifies his investments.
- One should be patient and tactful, and not listen to everything he hears. He should steer clear from the above mentioned myths. Even when the market crashes, he should maintain his calm and plan his investments in such a way that he is not shattered by the crash.