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Friday, September 10, 2010

Why to Invest in Stock Market?

Traditional investments like fixed deposits are good and safe and one must have a part of their savings invested in such risk free options. However, your portfolio is not complete and balanced in the absence of stock investments.

If invested wisely, you can minimize the risk of loss in stocks and increase the earning potential of your hard earned money.

Here are some statistics for you:

As compared to fixed deposits, investments in equity will pay 26.5 percent higher returns in 5 years. Even for a longer term, investment in stocks pay higher returns even in comparison to real estate and gold.

To begin with, when you purchase equity in a company, you must ensure that the stock prices are reasonable. If you over pay for stocks of a company, naturally you will have to wait longer to make profits on them.

This is because, if you buy stocks at a time when the prices are soaring at unreasonable levels, you will have to face an immediate setback when the market comes to normal levels, and the stock price drops to its average range.

To understand if the stock price is reasonable, you have to understand how stock prices are determined. The price for a stock depends upon the demand for it amongst buyers. The base line of a stock price is its EPS (Earnings per Share).

The market price of a stock is generally a multiple of its EPS. The multiple depends upon the demand the stock fetches. Demand for the stock depends upon company's reputation, customer relations, financials, current news feeds, economic environment in general, political news, market sentiments etc.

If you are new to the stock market, it is best not to buy stocks when the market is influenced by a certain news feed as market sentiments prevail over logic at such times.

For example, the Sensex shot up in mid 2009 after the Congress led UPA Government was elected in the Parliament. Such price upheavals are temporary in nature.

A calm market is good for new investors. If you are looking at stocks as an investment it is best to hold stocks for long term. Further, one should invest in good companies with sound management.

Investing in stocks for the long term

If you invest in stock of good companies for the long term, say 5 years, you will most likely earn good returns on your investment. This is because, a good company with a stable history and excellent growth charts, will grow over time.

Its EPS will also move in a forward direction as the company grows. Over time the demand for the shares will also increase and so will the PE multiple. Therefore, your initial investment will multiply over time if you hold on to the stocks. Also, companies pay dividends and issues bonus shares. These factors add to returns.

Option of investing through mutual funds

If you are vary of investing in stocks or are confused about the company where you should put your money, the option of mutual funds may be right for you.

This way you can invest in stocks of different companies, though indirectly, and gain the benefits of the stock markets without having to research stocks, study the market etc.

Fund houses have researchers and experts to study and analyse stocks.

You automatically have a diversified portfolio since mutual funds invest in multiple companies and different industries- this reduces the risk factor. Further you can make a modest beginning since most mutual funds are available for a small investment of Rs 5,000. You can start SIP (systematic investment plan) with as low as Rs. 500 a month.