Over the last few weeks a lot of people have approached me for help with their stock investments. I will take two popular questions today.

I.            Should I invest directly in stocks or should I invest in mutual funds?

II.            Is it possible to invest money in the stock market in a safe, risk free way?

Before I answer these questions I want to talk a little about the very idea of making money in the stock market.

2 Rules of Money Making

Since the beginning of all civilization, 2 principles about money have not changed at all:

a)      Hard work makes money; and

b)      Money makes money.

There is no third way of doing this.

In the first sense, money is made when a farmer works in his field, when a doctor treats his patients, when a teller counts cash in the bank, when an employee works 9-5 everyday, all of which is hard work.

In case (b) money is invested to pay for the hard work of case (a) people. In the stock markets, this happens in an organized way. Companies raise money by selling fractional ownership in the form of shares. With the money they raise, they run agro companies, hospitals, banks and software companies where case (a) people work.

In effect, your money is put to work by a corporate management who get entrusted with the duty of making case (a) people work. To that extent you need to pay close attention to the integrity and workings of the management. In addition, the very business you invest into should do well for your money to make money. If you invest in a foolish idea or in a company with only debt and no assets, you should surely consider investing in mutual funds on the next occasion!

Planning to Invest in the Stock Market?

Often it is said that stock markets are only for the rich. I disagree. But I do agree that stock markets are a place for those who do not need money. Take the below 2 examples.

Stock Markets are a place for those who do not need money.

Example 1 – 35 year old Devan is the vice president of an MNC and gets a fat paycheck of Rs. 3 lacs / per month. He likes to fine dine and entertain his friends too. He loves fancy clothes, watches, phones and cars.

– By the way, there is nothing wrong with any of what he does, so long as it is done in moderation.

Devan’s Expenses:

House rent 60,000
Food and house utility bills 28,000
Travel (car fuel) 12,000
Restaurants and clubs 65,000
Insurance & one big monthly purchase 35,000
Savings 1,00,000
Total 3,00,000

Example 2 – 35 year old Mansukh bhai runs a grocery store and nets Rs. 1,50,000 / per month. He lives in his own house and hardly ever eats out. He is a teetotaler and is still using a cell phone he purchased 6 years back.

Mansukh bhai’s Expenses:

Food and house utility bills 44,000
Travel (car fuel) 3,500
Restaurants and clubs Nil
Insurance 2,500
Savings 1,00,000
Total 1,50,000

Mansukh bhai and Deven both invest their savings in stocks but their needs and aspirations are different. While Deven wants to have enough money in 2 years to buy a Mercedes (may be a C class), Mansukh bhai’s admiration for his stock holdings is comparable to 4 year old boy’s love for collecting stamps. He never sells a thing and has no future targets in mind.

Let’s say 2 years later Deven and Mansukh Bhai both have Rs. 30 lacs in savings. While Deven goes ahead and buys his Mercedes for Rs. 36,50,000 (on road price) with a 5.5 lac car loan from a bank, Mansukh continues with his binge buying of stocks.

Again, while one may argue that Manukh Bhai seriously needs to alter his lifestyle, I can assure you that in 10 years, he is likely to have a lot more money than Devan. In fact, if Mansukh can manage this for 20 years, he may actually be able to finance a Mercedes from dividend payments alone.

Where Do You Start?

Discipline Discipline Discipline and kill your Greed!

Remember Gordon Gecko from The Wall Street – “Greed is good”, so long as it’s directed towards something good. Be greedy to learn, to read more and to listen to others, it will make you a better person. Be like Mansukh bhai, be greedy for stocks and in time you will do really well. The problem is that for most of us, our greed is directed towards money and only money. This has to change.

If you are someone who puts away short term spare cash in stocks, STOP! The moment you commit your money to stocks for the short term, you have entered the realm of speculation if not outright gambling.

If you must, have two portfolios, one where you actively trade your money and the other where you invest for a long term. Over the next 5 years, half (i.e. 25) of the Nifty 50 stocks will give 300% returns, in addition to whatever dividends you get along the way. All you need to do is pick the right mix of stocks and hold on to them. That said, an ideal stock portfolio should have a good mix of stocks from out of large, mid and small cap companies.

The Number One Secret of Making Money in Stocks

You can read as many investment books, advisory articles and attend as many education sessions on this topic. None of that will teach you how to be disciplined with your money. Set a threshold – a minimum amount that you will be investing in stocks every month and invest it in such a way that you lose control of that money, i.e. you cannot liquidate your holding for a few years. Think of it like an insurance premium payment and do it to safeguard your future.