Planning to invest in stocks? Here are five things to keep in mind

Here are five things to remember before buying stocks and investing your hard-earned cash.

One must have a long-term horizon while investing. The foremost is that only those funds that one does not require for at least the next five years should be deployed in equities. In the near term, the returns would depend on the vagaries of short-term events. Eventually, in the long term, valuations catch up with a company’s growth. Hence one’s long-term goals must be aligned accordingly.

Stocks are volatile. An investor must inculcate the discipline and patience to bear stock volatility. As stocks go down in value after being bought, some investors cannot bear the downside pain. Similarly, a gain is not incurred on the upside unless the stock is sold. Developing the right temperament ensures one is not taken out of the trade at the wrong time. An investor must also treat volatility as his friend and take advantage of wild swings in stock prices.

Before one invests, the investor must ensure he/she understands the business behind the stock. Its economics, the company’s competitive position, growth factors etc. Investing without a detailed understanding of the company’s fundamentals borders on the investment, becoming a highly speculative bet. If one is inept at doing such a detailed study, one must have a trusted SEBI registered advisor to help with such a task. However, without a proper and detailed understating of the economics of a business, the investor is merely shooting in the dark.

This aspect is paramount while investing. A cheap or at least a reasonable valuation is a must while picking a stock. But how does an investor know if the stock is cheap enough? For that, one must be able to value a business. Through this valuation, one needs to determine the price at which the business is worth. This value is also referred to as the intrinsic value.

An investor must buy a stock at a significant discount to that value. The reason for adding this discount, also called the margin of safety, is to protect the investment from any errors of judgement and changes in business fundamentals post-investment. Adding a layer of discount/safety ensures a reasonable level of protection.

While investing in stocks, one must remain nimble-footed and be ready to change one’s thoughts if the premise of initial investment changes. Suppose you bought the stock on a particular thesis. If the situation changes and the original thesis is no longer valid, one must act accordingly. This means selling the stock or reducing its weightage and vice versa, adding to a stock based on new information. The investor must not cling to the past and ensure that his/her ego does not come between rational judgement.