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Thursday, April 22, 2010

Which stock (or mutual fund) to buy?

"I have 2 lakhs to spare - which stock should I buy? Or, should I invest in a mutual fund?" These are typical questions I face from investors who enter the stock or fund investment arena for the first time.

May be it is not the first time. Investors may have burned their fingers in their initial attempts, and are now being cautious by seeking guidance. Either way, my answer is usually the same: If you have less than 5 lakhs and/or are not sure how to go about selecting stocks to buy, invest in mutual funds.

Should I be more 'helpful'? Should I just provide a list of fundamentally strong stocks and be done with it? Here are three reasons why I don't go down that path.

1. There are plenty of web sites, blogs and investment groups spewing out free stock 'buy' advice by the truckload every single day. Why add to the noise?

2.  The stocks I recommend to buy are the ones that are likely to make you rich slowly. They are stocks that have low debt, pay decent dividends and appear to be 'expensive'. Most new investors are interested in 'cheap' stocks that will make them rich quick.

3. This is a corollary to 2. If there isn't a substantial investible surplus, new investors usually buy a large quantity of a 'cheap' stock instead of a small quantity of a 'good' share. This quest for hitting it big usually leads to a big loss. (The fact that the Cals Refineries stock trades in such high volumes is an example.)  

With the Sensex hovering near its 52 week high for a few months and defying all attempts by the bears to engineer a correction, more and more new investors are flocking to the market with full pockets. Unfortunately, most of the low-hanging fruits have already been eaten.

So new entrants will either end up buying good stocks at inflated prices, or junk stocks that appear 'cheap'. Both are harmful to building your long-term wealth.

If you have money to spare and are not sure which stock to buy, look at an index fund or index ETF. You get to 'own' all the stocks in the index by just buying the fund units.

Better still, look at good balanced funds which can better protect the downside due to their debt component. Say an HDFC Prudence fund or a DSPBR Balanced fund that have proven performance records over the years.

Related Post

Should you invest in Balanced Funds?

6 comments:

Titu said...

Hello Sir,

Excellent article sir,

I like the way you guide us to take the investment decision.

thanking you,

titu

Subhankar said...

Thanks for your comments, Titu.

Salil Dhawan said...

I think people who don't have time to follow stock market every other day can invest in Mutual Funds through SIP route if they have long term investment horizon.

Some Diversified funds such as

Birla Sun Life Frontline Equity.
Reliance RSF
IDFC Premium Equity
HDFC Top 200
UTI Opportunities
Reliance Growth

are good bets in long term and magic of compounding and systematic and regular investment can reap rich dividends in future.

Happy investing!!!!
Salil
http://views-point.blogspot.com/

Subhankar said...

Yes, Salil. Long-term SIP in funds may be a good idea for those who can't or don't want to pick their own stocks.

Since bull cycles tend to be longer than bear cycles, the average holding cost keeps going up. That affects long-term returns. Investors should be aware of that.

Fund houses project SIP as the next best invention after sliced bread. The fact is, SIPs provide fund managers with steady income. Lump sum investments on market dips give much better returns to investors.

A value averaging plan works better than a cost averaging plan (like SIP).

Jasi said...

Sir,

Very nice primer like post! Ideal for people wanting to take the plunge now.

Regards!

Subhankar said...

Thanks, Jasi.

You'll be amazed at how many people are jumping into the market trying to buy 'cheap' stocks after a bull run of more than a year's duration!