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Thursday, May 27, 2010

The 7 Steps to Success in Stock Market Investments

Before readers get all excited, I have a disclaimer. The 7 Steps to Success is a sure-fire, fail-safe method for making money in the stock market over the long-term. What it isn't is a short-cut to success. There aren't any short-cuts to success.

To achieve success in any endeavour - be it in the field of education, or sports, or any profession - requires discipline, an ability to concentrate on the important issues, diligence, hard work, persistence and patience.

The stock market is no exception - contrary to what most investors may think before they jump in feet first and lose their shirts. I have been there and done that, and learned the hard way.

Without much further ado, here are the 7 Steps to Success in Stock Market investments:-

Step 1: Develop a reading habit. Business magazines, pink papers and books on investments. Not every one likes to read - particularly if the language is other than one's mother tongue. For success in the stock market, you don't need to know everything. But you need to know where to go to find the answers. Before investing a single Rupee, read 'One Up on Wall Street' by Peter Lynch.

Step 2: Learn how to read an Annual Report. The most important starting point should be the Cash Flow Statement, followed by the Balance Sheet and the Notes on Accounts. The real information is usually hidden there. Most investors take a cursory glance at the Director's Report, may be the Management Discussion and Analysis, and the Profit and Loss statement to check the dividend amount.

Step 3: Refresh your knowledge about grade school arithmetic. If percentages, ratios, graphs, the concept of compound interest and pages full of numbers scare you witless, you won't be much good at stock investing. Since you learned most of the stuff in school, you can and should be able to re-learn the stuff.

Step 4: Make an honest assessment of your financial situation and risk tolerance. Every investor has different requirements. If you are already bent over with the weight of EMIs and credit card debt, the worst thing you can do is try to make some quick money in the stock market. You will get into a deeper hole. Put the 'can't afford to lose' portion of your savings in fixed deposits, PPF, NSC, Post Office MIS schemes.

Step 5: Prepare an asset allocation plan, and stick to it. Within the equity portion of the allocation, maintain 75-90% in a core portfolio of fundamentally strong large-cap stocks/funds. The balance 10-25% can be in a satellite portfolio of mid and small-cap stocks/funds. (If you don't know how to allocate your assets, you probably haven't read my eBook. It is FREE and you can get it by sending me an email request.)

Step 6: Once you have built a good portfolio, monitor it once a week at most. Just as a sapling won't grow faster into a tree if you stare at it every day, neither will your portfolio. Enterprise and activity may be a requirement in other fields, but they are a detriment to investment success. Learn how to be actively passive - if you can pardon the oxymoron.

Step 7: Warren Buffett revealed an investment success secret - 'Be greedy when others are fearful, and fearful when others are greedy'. He is an acknowledged master, and I am his unknown follower. But here is another investment success secret - 'Cut your losses quickly and let your profits grow slowly'. You can do that by learning to set a stop-loss and a trailing stop-loss respectively. (The concepts are explained in my FREE eBook.)

3 comments:

Sanjeev Bhatia said...

Dear Subhankar Da,

A very nice and relevant post. I have a few suggestions for blog topics relevant to this discussion.

Most of us can compare some of the fundamental parameters like profit margin, RoE, RoCE, Debt/equity, dividend payout ratio etc. but proper analysis is still missing. Thanks to you, I have now begin to look after cash flow also after reading abt it and its importance in one of your posts. Why don't you select a company (or two companies) for comparison why one would make a better investment pick relative to other based on BALANCE SHEET analysis? This will enable us to atleast start on the path of properly looking at a balance sheet and how to read the fine print.

Risk assessment is another factor that needs explaining for common investors. There are different theories floating about but the foreost problem I have found is that most of the people don't specify their financial goals. In absence of puting up a quantitative number to the needs, you can't have proper asset allocation plan. Consequently, eithe you take no risk at all (bulk of India's savings lie in debt products, earning -ve rate of interest wrt inflation..so much so for INVESTING); or you take too much risk whether you really need it or not(Futures, commodities et al). In stock market too, What I have found is that people who are short term traders in the morning become long term investors in the evening due to a trade gone bad. The reverse is also true when somebody gets minor profit in a span of few minutes.

Finally the best line of the post: "LEARN HOW TO BE ACTIVELY PASSIVE". Brings another quote to my mind: "Not making any choice is also a choice."

A wonderful post, as always.

Sanjeev Bhatia CFP

samrat said...

Dear Subhankar-da,

I am a regular reader of your blog and I have been reading your blogs for the past 5 months.
It was early 2008 when I started investing but my portfolio is still not very good though some stocks are doing decent while others not so.
While I too believed in long term investing which you ask to do, I learned many things(one of the most important learning was stop loss which I didn't quite understand then) from your blog and I am still learning.

Thanks,
Samrat

Subhankar said...

@Sanjeev: Thanks for your comments and suggestion. Why don't you attempt an answer to the exercise given in Tuesday's (Jun 1, '10) post?

@samrat: Appreciate your comments and kind words. One of the best learning in the stock market is not to repeat the mistakes that caused losses earlier.