Investors' Hangout: How to start investing?

Our first question is, we have heard that investing money is one way to build wealth over a long period of time. But when we start, we don't have much salary, we have rents to pay, monthly bills, and there are so many things we want to earn. So how do we take out money when there is so little, and we want to do so much?
I would suggest starting in a very modest way. It's important not to target becoming wealthy right away. Instead, focus on financial security and having some money of your own, so you're not dependent on someone else for your financial needs beyond the essentials. So that's the first step: prioritise financial security over wealth accumulation.

The second step is developing the habit of saving and investing. Saving alone is not enough because you earn, spend, and whatever is left is what you save. But if you don't put that saved money to work, it won't grow. So you need to start the process of investing to make your money work for you. Think of it as forming a habit, like brushing your teeth. Just as you get used to brushing your teeth every day, you need to get used to putting your money to work. Even with just Rs 500, you can start. The goal is to develop the habit, not to immediately build wealth or gain financial security.

As for investing and listening to lectures or advice, it won't have much impact unless you actually make your own 500 rupee investment and see what happens after 12 months. That's when you'll realise the tangible results of your investment. You'll see that your Rs 500 has grown. This practical demonstration is a much more powerful learning experience than just listening to someone talk about it.

But if the amount is so little, will it help if we start investing with Rs 500 and gradually increase the amount?
As I mentioned earlier, it's not about the amount being too little. The main purpose is to develop the habit of investing. Starting with whatever amount you can spare, even if it's just Rs 500, is essential. By doing so, you'll have your own personal demonstration of how your money can grow and how it's done. It's about preparing yourself so that when you have more spare money in the future, you'll be in a better position to invest and understand the importance and value of doing so. So don't worry about the initial amount being small. Focus on forming the habit and building your knowledge and confidence in investing.

So basically, I am a beginner in investing, and I want to know if I should rely solely on mutual fund investments or if I should also learn about equity investments, considering that my return expectations are quite high.
It's perfectly fine to have high return expectations, but it's also important to start your investment journey in a way that allows you to develop confidence in the entire process. Investing in equity can be risky, especially when you're starting out and feeling confident that anything you touch will turn to gold, especially in a rising market. There is a risk of developing false confidence. So my suggestion is not to start with individual stocks until you have formulated a mechanism, gained knowledge from sources like Wealth Insight, and understood how it works. Only then should you consider investing in stocks. It's something you should definitely explore at some point, but not as a beginner.

Secondly, it's important to understand that investing in stocks carries risks, not because stocks are inherently dangerous, but because people often approach them with the wrong expectations. Many individuals want to become rich overnight and invest in a stock without understanding the business behind it. They are investing in a stock, not in a business, and that's where the problem lies. This approach turns stock investment into speculation. The difference between stock investment and speculation is that investment involves planning to hold the stock and let it grow, while speculation involves the intention to sell as soon as it goes up. When most people enter the stock market, they do so with a speculative mindset, planning to sell as soon as they see some growth. They are not investing with the mindset of letting it grow over many years. Therefore, it's crucial to be clear-headed about what stock investing truly means.

So, my recommendation is to start with mutual funds. But before that, make sure you have an emergency fund of Rs 5,000 in your pocket. This will serve as your fallback in case of any unforeseen expenses. Additionally, have a credit card that provides access to Rs 5,000-10,000 for emergencies. Then, begin with a Rs 5,000 systematic investment plan (SIP) in a mutual fund. This will allow you to understand the investment process while you learn about equity. Once you become confident and sure that you can behave like an investor when it comes to investing in equity, then you can consider investing in individual stocks.

Since I'm just starting my investing journey, are there any important factors I should keep in mind before investing in equity? Are there any key points that I should always adhere to?
When investing in equity, it's crucial to start thinking like an investor and an owner. Remember that you are not simply investing in a stock; you are buying a share of a company and becoming a small owner. Even though your ownership might seem insignificant, this mindset shift is essential.

Next, ensure that the money you are investing is not needed for several years. If you invest funds that you might require in the near future, you may be disappointed with the results.

Furthermore, it's important to acknowledge that we cannot accurately predict the state of the market—whether it's high or low, or if it will be disappointing. Therefore, avoid rushing into investments. This applies to both equity funds and individual stocks.

If you decide to invest in a company, and you should think like an owner, make sure you understand what the company does, how it generates revenue, why it will continue to grow, and why it's likely to thrive in the future. Ask yourself these simple questions. If you don't find satisfactory answers about a company, it's best not to invest in it.

I am considering investing in mutual funds, and I've heard a lot about small-cap funds. My question is, what portion of my income should I invest in small-cap funds if I have a sufficient risk appetite and can handle the associated risks?
My suggestion is to first look for the best-performing small-cap fund on Value Research Online. Then examine the best and worst returns of the fund over its history. For instance, the best small-cap fund over the last 20 years experienced a decline of 70 per cent. So, if you invest Rs 1,000 and, unfortunately, over the next two to four months, the value reduces to Rs 300, would you be okay with that? It's important to acknowledge that having a risk appetite is necessary, especially when you are still learning and just beginning to earn. The return on small-cap investments is a result of enduring such declines. Those who invested Rs 1,000 and saw it drop to Rs 300 but stayed invested for the next two to five years eventually saw it grow to Rs 2,000. It's crucial to understand this concept, especially during good times when investments seem to be consistently growing. Risk appetite alone is not sufficient. Time is also a factor. If you need the money in one and a half years, you may not have the risk appetite to tolerate such volatility. Thus, having time on your side and a good risk appetite are both important factors. So, if you have confidence, a long-term orientation, and a strong stomach for volatility, you can consider investing in small-cap funds.

My question is a bit different. How should we plan for our first house and car? What approach should we take?
Firstly, if you have the money, you can proceed with your plans. However, it's important to be cautious about borrowing money, especially with the availability of easy credit. Borrowing money for non-productive expenses means you are effectively spending your future income today, which is not desirable. At Value Research, we believe that spending on assets that enhance productivity or reduce expenditure is desirable. Of course, in emergencies, borrowing may be necessary, but it's crucial to evaluate the economics of your decisions in a cold and objective manner. For example, if you buy a house worth Rs 50 lakh, a simple calculation shows that for every lakh rupees borrowed, you will have an EMI of Rs 1,000 for the next 15 years. This is not necessarily a bad thing because you will be acquiring an asset that saves you from rental expenses. Additionally, there is the potential appreciation of the house, which may make it more valuable in the future. Consider these factors together, but ensure you plan prudently. Do not allocate more than one-third of your income towards EMIs, as this could make you hostage to your debt. If needed, either reduce the size of the house or wait until you have enough down payment to lower your borrowing level. Following these basic guidelines will help you make informed decisions and avoid becoming overwhelmed by your financial commitments.

I'm planning to go on vacation next year, but the time span is very short. Where can I invest my money for such a short period?
It's important to have a framework for investing based on your goals. There are two types of goals: negotiable and non-negotiable. If the money for your vacation is negotiable and not crucial, you can consider different options. However, if the money is needed for non-negotiable goals like your child's education or retirement, you need to approach it differently. If you're simply adding to your savings to cover the vacation expenses, you can guarantee your goal by saving a specific amount each month. But if your vacation budget is higher than what you can save in a short period, you'll need to grow your money faster or extend the timeframe.

For a short timeframe like yours, investing in equity is not advisable as it carries higher risks. Instead, you can aim for a modest return slightly higher than a bank deposit or savings account. One option could be a conservative hybrid fund, where a small portion of your money is invested in equity and the rest in debt. This combination can potentially deliver superior returns. However, if the market performs poorly during this period, you may need to adjust your plans and delay your vacation. Keep in mind the negotiability of the goal and set reasonable expectations. Avoid expecting unrealistic returns like doubling your money in a few months. Also, ensure you have enough accumulated leaves or vacation time to support your plans, as going on vacation while experiencing a decrease in income may not be ideal.

Should I rely on mutual fund investments considering the exit loads and taxes on capital gains?
Don't worry too much about exit loads and taxes. Exit loads are triggered in equity and hybrid funds if you sell your investments before one year. Most equity investments should be made with a long-term timeframe of five years or more, so exit loads should not be a concern if you invest wisely. When it comes to choosing conservative hybrid funds or similar options, they generally have shorter periods for exit loads or may not impose them at all.

Regarding taxes, it's important to remember that they are levied on gains. Having gains is a positive outcome, and if you have substantial gains, the capital gains tax of 10 per cent is the lowest possible rate. For example, if you accumulate Rs 1 crore and generate Rs 50 lakh in gains over time, you would only need to pay Rs 5 lakh in taxes. Additionally, it's worth noting that gains prior to 2018 are not subject to taxes. Although you cannot go back in time to start investing, it highlights that taxes are not as burdensome as income taxes and can be managed effectively.

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This article was originally published on June 30, 2023.