the inherent characteristics of the stock market or the two sides of the same coin. You do not require any rocket science knowledge to become a rich investor. You too can reap good returns from the market and sail successfully by implementing right strategy, following the simple rules and by matching your expectations with the stock performance. Let us discuss and learn those principles helping you becoming a rich investor.
(1) Evaluate your investment horizon, expected return & the risk aptitude
I feel that the performance of any stock should match the investment horizon, the risk & return profile. For example you prefer remain invested in a stock for next 5 years and expect an annual return of 15% from your investment with annual fluctuations in the stock price of +- 10% on the either side. The invested stock although good is giving you the different results may not match your expectations. So it is not always about selecting a good stock rather a stock matching your requirements.
The above question is the starting point of your successful investing journey. Always keep that question in mind and step ahead. So, you need to match your investment horizon, return and the risk profile with the performance of the stock.
(2) A Well researched stock
The first step for the successful investing is to short list and select the fundamentally strong stock. Although it is not difficult to select the one but it research requires your time and energy, so be ready for this for gaining the monetary benefit in the future. Don’t go by the tv news or people saying about the performance of any stock. Rather do your research by analysing the following parameters like:
(3) Predicting the growth rate of the stock
The next step is to calculate the realistic growth rate of the stock. If it matches your return expectation then you should go ahead else search for the next one. There are various step involved in calculating this metrics which I have highlighted in my article “How to calculate the realistic growth rate of the company?”
Doing this exercise will help you in assessing the growth rate of the company and you can decide whether it matches your investment horizon and the expected return or not for example you want to invest for 7 years and you expect an annual return of 15% from your investment. This can be shown as follows:
You can say that your amount is trebled in 8 years when the expected return is 15% per year.
The invested stock giving you the following performance:
Here in this case your amount is also get trebled but in 12 years exceeding your investment horizon. Hence it’s performance does not matches with your expectations.
Yes, minor deviations like +_ 10% is expected from the performance of the stock as you cannot always predict the things with great accuracy.
(4) Evaluating the risk in the stock
Let us say that you can bear the monthly fluctuations in the price of the stock by 10% in the negative direction. If the stock fluctuates more than this limit than it crosses your risk profile despite its good performance. I have highlighted the steps in calculating the daily, monthly and the annual fluctuations in the stock price in my post “How to measure the risk of your portfolio.
(5) Diversify your portfolio over a period of time
The things may not go always in your direction even you made right efforts because the stock market may fluctuate due to many parameters which you can neither include in your calculations nor predict. I think there is no need to predict and include all the parameters otherwise your investment process will become very cumbersome and you prefer avoiding this rather than investing. The one effective method of letting your money boat sailing on the crust and the trough of this financial ocean is to diversify your portfolio. This is a process of mitigating your risk by investing in the different stocks of the different sectors. Let us consider the following example:
You can see from the above table that when you remain invested in the stock A your monthly return with respect to the previous one varies from -15.8% to the +15.8%
And when you remain invested in the stock B, your monthly return varies from -10% to the +17.6%
When you invest the equal amounts in both the stocks, your monthly risk and return reduces to -3.3% and +8.3% respectively.
Here you diversified your portfolio and mitigate your risk.
(6) Calm down under downturn and do not sell
We all know that volatility is the inherent characteristics of the stock market. Your portfolio will go up and down and there will be the times of economic downturns also where your return will be negative. In this situation do not sell your portfolio under pressure rather do the opposites invest your money in the fundamentally strong companies.
Do not invest others money or invest your own money which you do not need in the long term or you feel that you can work without it
(7) Be consistent and make regular investment over a period of time
There is a misconception that you need huge amount to invest in the stock market. It is not true; you can start investing with small amounts also and can reap good returns over a period of time. The key is to keep investing a fixed amount regularly over a period of time. Let us understand with the help of an example:
The more consistent you are the better return you can expect from the stock market.
It is found that people who invest in the stocks matching their investment horizon, risk appetite and with due diligence are expected to enjoy higher and the consistent returns over a period of time. The above parameters shows that investing in the stock market is like any other business of doing due diligence and remain invested in the stock over a period of time. The effect of the compounding favors you more when your investment period gets longer.