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Best Investment Practices A White Paper

BEST INVESTMENT PRACTICES

he investment world has become dynamic with various factors impacting the investments decisions as well as its returns in todays world. We have recently seen how the economic crisis of Greece had a major impact on the global sentiments, including that of India. Gone are the old days of investments when making money was very easy in the stock market as the number of variables were very few. Everyone knew that a company like Hindustan Lever (now Unilever) would give a 30 per cent gain each year as there was license raj that controlled everything. It was never a case of other countries economic crises impacting the Indian markets. But today the investment world has changed and become more complex. There are various factors that come into play, each of which affects the gains one can make in the equity market. Also, the numbers of companies and business models have gone through a tremendous transformation because of which the volatility in share prices as well as the companys financials has increased manifolds. Due to this volatility there are a few who are able to rake in handsome gains while there are many who cut a huge amount of losses. It is the investment process that one follows which finally makes all the difference. DSIJ, through its 24 years of rich experience, has outlined a few criteria which can help investors get better returns from the stock market. Remember that your investment should work for you and our guidelines will help you to not only reduce the risk but will also improve your chances of acquiring better capital appreciations. Therefore, please apply these criteria in totality rather than selectively to be a successful investor.

Capital Protection
The first and foremost important principle of sound investment is capital protection. In other words, take the risk but not to such an extent that it wipes out your entire capital. It is often said that higher the risk higher the returns but at DSIJ we believe that taking moderate risks can also lead to better returns. One of the best ways to reduce risk is to take exposure in companies whose business you can relate to. So keep at least 65 per cent of your equity investments in companies whose business you are able to identify with and can understand.

Keep Expectations Reasonable

Your objective as an investor should be to earn higher-thanIndian Market (Sensex) Returns average investment returns over the long term with only a Year Sensex moderate level of risk. This means one should never expect 1991 1027 extraordinary returns from your investments as such inci2010 16994 dents never occur consistently over a long-term duration of CAGR 15.9% investments. We have given returns generated by the US market since 1830 and the Sensex returns since reforms began in the country to make one understand what kind of returns one can reasonably expect from the stock market. A good return from an equity market is that of 20 per cent per annum. If you get anything above this, consider it a bonus. However, please do not confuse portfolio returns with scrip returns.

Us Market Performance Since 1830

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Diversification Reduces Losses

BEST INVESTMENT PRACTICES

Overexposure in one stock or industry can quickly lead to losses. Diversifying your risk is well-regarded amongst the most successful investors as the best way to reduce the risk factor. In building a portfolio it is therefore very important to keep it diversified. The most important diversification is sectoral diversification i.e. the stocks should be from various sectors. How many sectors you include in your portfolio comes down to judgment. Most investors choose between four and six sectors. This way the impact of a large movement in a particular share, or even sector, will have less of an impact and reduce volatility in the portfolio. For instance, if an investor had all his/her stocks in information technology companies during 2000, the returns would have been low since most of these companies underperformed the Sensex. At the same time, dont do excessive diversification by adding more than ten sectors as this will bring down the overall returns and you may produce below average returns.

Keep Away From Hype

As a thumb rule, avoid investing in those companies or sectors that are in the limelight. There have been empirical studies which suggest that sectors or companies get into the limelight only when they have come to a peak. As such, this is the time when all the positives about their performance are already built into the prices of these companies. Be fearful when the others are greedy and be greedy when the others are fearful is what well-known investor Warren Buffett has said, and rightly so.

Let Investments Grow

Miracles can happen overnight, but your investments cannot multiply overnight. The investor should understand the basic fact that share price is a function of the fundamentals of the underlying company. The company needs its own time to grow. Let us suppose that you want to capitalise on the expected set-up of a power plant by a company. You should understand then that there will be a high gestation period for the project and you have to be patient to reap the fruits of your investments till the power project starts generating a cash flow. The process of investing is like sowing seeds so that you can reap the fruits over a period of time in the form of dividend, bonus and capital appreciation. Always keep a time frame of 24-36 months for investments to mature and provide you with its fruits. However, keep reviewing the portfolio at the same time as this would help you to correct your mistakes in case you have taken any wrong decisions.

Keep Booking Profits

Your equity investments should be like a girl friend and not wife. In other words, never marry stocks as each of the scrips has its own cycle of boom and bust. There have been many instances when someone has held scrips for a couple of decades and yet has not gained any significant returns from the same. Booking profits is an art and one must master the same.

Prefer Large-Cap Companies

Choosing stocks depends on every investors objectives and appetite for risk. The first question one must answer is about the objective of the portfolio. This would normally be to achieve a certain level of return at a certain level of risk. Investors should choose stocks that carry a medium level of risk. Investors assess the level of risk a stock has by looking at a number of factors and arriving at a judgment. The various factors to judge the level of risk of a company include its competitive advantages, financial position, the quality of its management and corporate governance. But to gather such detailed information about all the companies listed in the stock market is a difficult task for retail investors. However, information related to large-cap companies is readily available, which minimises the risk associated with these companies. Therefore, retail investors should invest almost 60 per cent in largecap or A-group companies as a thumb rule. At the same time, dont keep more than 10-15 companies in the portfolio since, as per our experience, such a portfolio is ideal for capital gains.

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Never Time The Market

BEST INVESTMENT PRACTICES

It would be so nice to sell before every market goes into a downward spiral and then get back just as the good times begin to roll again. But nobody knows when the markets will turn. Investors often spend a lot of their time in trying to identify when the market is very low or high and thereby time the purchase and sale of investments. In other words, they want to time their exit when the market has reached its top and to time their entry when the market has reached a bottom. However, as Buffet puts it, Stop trying to predict the direction of the stock market, the economy, interest rates, or elections. Based on our 24 years experience, our suggestion is that you should stagger your investments in the same scrip in three stages. Thus, in case you want to invest Rs 1 lakh in Infosys, you can buy shares worth Rs 40,000 in the first lot, of Rs 30,000 after one month and the rest after a quarter of the second purchase.

Diversify Among Different Asset Classes

Equity has always been able to deliver superior returns compared to other asset classes, but it is associated with high risk. Thus, always diversify your investments, not only within your equity investment but also in other asset classes. The other available investment opportunities are fixed income deposits, gold, real estate and mutual funds, to name a few. By investing across the board in all such asset classes you can achieve balance while keeping risk at a moderate level. For example, losses in equity can be offset in part by the relative safety and interest income from fixed deposits. Basically, diversification among various asset classes works by spreading your investments over various assets which have low correlation to each other. Thus, having a portfolio diversified among different assets creates more consistency and improves the overall portfolio performance. As a general rule, all investors should keep at least 50 per cent of the surplus funds in equity while 20 per cent can be kept in debt/fixed income instruments and the balance in gold/silver and other investment classes.

Happy Investing!
About Us...
Founded in 1986, DSIJ (Dalal Street Investment Journal) is the oldest and the most trusted magazine when it comes to investment news. The DSIJ team of research analysts purely focuses on Equity markets. Backed by 24 years of stock market experience, DSIJ is the No 1 Investment magazine in India. Our strong reader base stands by us as we cut the chase and print Stock Recommendations and not News which is our USP. This can easily be seen by the large readership and the faith our readers have in us.

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