Why emotional investing is dangerous for your wealth?

The markets are going up and you see all and sundry investing in stocks. Next day the markets crash and everybody panics and starts rushing out from the markets, thus aggravating the market conditions. US economy is down in dumps and the FIIs start pulling out their money, so even your neighborhood uncle withdraws his money from stock markets.

This type of investing is called as emotional investing where human emotions like euphoria, panic, greed and fear impact the decisions made by the investors. But not many know that emotional investing is bad for your wealth. Here is why.

When emotions take over he person’s rational thoughts, he cannot think clearly. He is easily swayed by the emotions and takes decisions that his emotions tell him to do. He doesn’t realize that markets work in cycles. What goes up comes down and vice versa. So if you manage to hold on though the tough times and avoid over exposure to stocks when the markets go up, you can easily make money in the stocks.

Unfortunately not many understand this principle. They lose focus when they get emotionally charged. They make wrong decisions and so don’t make money in the stock markets. So if you don’t get swayed by your emotions, you can rest assured that market movements will not affect the value of your investments in the long run.

Tips to become wealthy in stock markets

We all know that from amongst the various asset classes, equities have managed to give the highest returns. This makes stock markets very attractive to those looking to make money. However not many have managed to become rich in stock markets. This is because they don’t know the secrets of becoming wealthy in stock markets.

So if you are wondering what they are, here is what you should know to become successful in stocks.

  • Understand the macroeconomic and industry outlook. E.g. if RBI decides to increase the interest rates on loans, those sectors that are impacted by rate hike such as automobiles, realty and banks will be affected. Similarly recession in US will affect IT and export sectors. You should be aware of these developments. Many people tend to overlook these aspects and instead concentrate on the stock prices.
  • Find out the quality of management and promoter reputation. The company you are investing in should have progressive management and the promoters should have clean background. This will help prevent scams like Satyam and Enron.
  • Find out if the company pays dividend regularly. It implies the company is profit making and has sufficient cash to tide over the tough economic conditions. However don’t make this the sole reason to ignore those stocks that don’t pay dividends as the company may be very strong financially like Bharti Airtel.
  • Read the company’s financial reports. It will give you an idea of the way in which the company plans to move. You will also get an idea of the company’s past performance and can catch any anomalies in the company’s performance immediately.
  • Find out about the company’s financial ratios. Ratios like PE, ROE, RONW give you an idea whether it is worth investing in the company. You will also understand how the company is performing vis-à-vis its peers.

However this is just the beginning. Once you have invested in the stock, you need to monitor its performance closely to prevent nasty surprises.

Make the most of your equity investments

We all know that equity is the best asset available to help you become rich and achieve your various dreams. However you need to be very careful when investing in equities. So how do you become a smart investor? What should you do to get the best returns from your investments? Here are some important tips that you must follow to be successful in equity investing.

• Think long-term: Equities are a long term investment option. Ensure you remain invested in the stock market for at least 5-6 years.
• Invest in quality stocks: Look at the company’s performance, its various ratios like PE ratio, debt-equity ratio, EPS etc. Compare these ratios with its competitors’ ratios. Find out the company’s growth prospects and check if the company has sufficient cash in hand to tide over any financial emergencies.
• Don’t listen to noise: Noise is the useless information that emanates from the stock markets. E.g. during the recent financial crisis, many large FIIs withdrew their monies from Indian stock markets. This led to market crash, which scared many local investors, who withdrew from the markets, thus worsening the situation. But despite all this, Indian economy remained healthy.
• Check out the reputation of company management: Find out what is the reputation of company management. This will prevent the occurrence of Satyam-like episodes to a great extent.
• Don’t be swayed by market movements: Market movements are for the traders, who are interested in making the quick buck from the stocks. You, as an investor should not worry about market movements as you are going to be in the market for a long time. Over a period, stock prices even out, helping you recover your losses.
• Read the company’s financials carefully: Go through the company’s balance sheet carefully. Attend the AGMs of the company and understand more about the company’s future plans.
• Be aware of the risk-reward ratio: Certain stocks like mid and small caps are very rewarding but very risky. These stocks can easily become very illiquid, or the companies can close down. This exposes your investment to excessive risk. So be aware of it before investing.
• Diversify your portfolio: While equities should comprise 70% of your portfolio, divide the balance amongst other asset classes like FDs, gold and realty. This will protect you against market downturns.

Investing in stock market is a long term game. It is risky, yet rewarding. It is important to balance your risk vs rewards to get the best from your stocks.

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