Should you invest directly in equities?

Go ahead. Who am I to tell?

However, there are a few things that you should keep in mind.

#1 You cannot become rich watching CNBC or by acting on stock tips

You need to have the skill to pick up the right stocks and you should be willing to research the stocks before you invest.  And you need time to do all the research.

You can’t take a shortcut and watch CNBC or other business channels to pick up stocks. You will never make money this way. There is just too much noise on business channels.

Another shortcut is to take tips from friends or experts in your circles. This is another recipe for disaster.

Frankly, there is no short-cut.

If you are an investor, you need the skill to read and understand financial statements, understand the underlying business of the company, understand industry dynamics and competitive structure etc. You can just rely on Price-Earnings multiple to pick up your stocks.

If you are a trader, you need to understand chart patterns, risk-reward, trade sizing and trade management.

And all this requires time.

I do not doubt your skill but only you know whether you have the time.

Read: How Traders and Investors have different expectations?

#2 There is no free lunch

A few of my clients have checked with me whether they should invest some amount in equities. All of those wanted to invest in equities for fun or because direct equity offered greater potential for return.

They are right. With direct equity, the potential for return is much higher since your bet is concentrated. However, at the same time, there is a greater risk of loss too.

No free lunch.

When I ask them where they would invest, a common answer is that they will invest in IPOs and whatever their friends recommend them to invest in.

As discussed above, it does work this way.

#3 Is it meaningful?

Your overall portfolio is Rs 50 lacs and you decide the invest Rs 50,000 in direct equity.

Essentially, you are tasting equity and not investing in equity.

Do you think this investment will ever make a meaningful difference to your finances?

Highly unlikely.

In all likelihood, you are merely investing for “fun”. This will never take you anywhere.

Even if you hit a jackpot (again unlikely that you will hold on to the stock long enough), it will be a fairly small portion of your wealth.

In that case, is it worth your time? In my opinion, no. Why waste it, then?

And it won’t be long before you realize it.

What may happen next is a much bigger problem. You may think about taking even aggressive bets (to make the bet meaningful without investing a meaningful amount).

If somehow you stumble upon derivatives (futures and options) because derivatives offer much greater and swifter potential for return (than even direct equity), you are most likely heading for disaster.  Once you have tasted blood (doubled or tripled your money in a day), you will have perennial hope (despite having lost money on most derivative trades).

Remember unlike direct equity, derivatives are a zero-sum game. For you to make money, somebody has to lose money.  In such a case, it is likely that experienced traders will make merry at the expense of inexperienced traders.

By the way, this does not happen just with direct equity. Something similar happens with equity mutual funds too.

If you are investing Rs 50,000 per month but only Rs 2,000 goes towards equity (or equity funds), it will not make a meaningful difference to your finances.

#4 You need much greater discipline in direct equity

Once you have spent 2 weeks researching a stock, you will somehow manage to find good things about a stock and ignore bad things. And invest in that stock.

You will sell your winners and hold on to your losers. You will not sell a losing stock.

Once you have invested, you will seek information that confirms your decision while conveniently ignore information that does not suit your narrative.

Investing in equity funds requires discipline too but this is nothing compared to what you need for direct equity.

I do not want to venture into behavioral finance. There are many good online resources available that you must go through so that you are aware of such common behavioral mistakes.

PersonalFinancePlan Take

Investing in direct equity can be a richly rewarding experience. However, as mentioned above, it requires a lot of skill, time and effort. There is no short-cut. And there is a great risk too.

Investing or trading in direct equity is serious work. Acknowledge this aspect before you venture into direct equity

If you can’t find time to research and shore up your skill, do not invest directly. Taking the mutual fund route to equities is a saner approach.

If you are serious, invest a meaningful amount.  You can start small but the aim should be to reach a meaningful percentage. “Meaningful” is subjective.

1. Do not invest for “Fun”. It will not take you anywhere.
2. Do not invest in derivatives.
3. Do not confuse luck for skill. A rising tide (bull market) lifts all boats (stocks).
4. Be humble. Overconfidence can kill you.

Disclosure

My experience as an equity trader or investor has been nothing to boast off.  Therefore, my not-so-rewarding-experience may have shaped my opinion.