I was in my office when a marketing person from a broking firm came to me and offered a deal. He asked me to open a demat account and day-trade based on their advice. They promised, almost, that I will make 2% every day. I was astounded by this proposal. 2% every day means 400% every year, assuming the market is open 200 days a year. This means I will have 6 crore and 25 lakhs after 4 years if I start with 1 lakh today, thanks to the power of compounding. Amazing return, isn’t it? Where are you Mr Buffet?
If this is so easy, I wonder why many people who day-trade, are not millionaire and billionaire. I am not trying to criticize people who do day-trading. This is certainly a legitimate practice and there have been speculators who have made killing in the market by day-trading. In fact, some of us have made decent money sometimes in short term. However, the only way to create significant, sustainable wealth in stock market is by long term investing.
In this article, we will discuss some of the long term strategies in the stock market for common investors. We will see a separate article on short term strategies.
Buy & Hold Strategy
Buy and hold is very common long term strategy not followed by common investors because it requires patience, faith in the company and your analysis, and power to do nothing when it is required. This investment strategy is very popular among value investors such as Rakesh Jhunjhunwala and Warren Buffet. They have earned tremendous returns using this strategy.
Buy and hold strategy gives returns in 3 ways:
By dividend – When you hold the stock, you get the dividends and also are entitled to all the future dividends that company will pay.
By stock appreciation – The price of stock of good companies will move up in the long term. If you hold the stock for long term, you can earn the returns by price appreciation too.
Stock split, Bonus, one time dividend – These are extraordinary events that benefit investors by providing them with bonuses in the form of money or more stocks, or one time large dividend. At the same time, the company splits the stock when the price becomes unaffordable for investors. In most of the cases, stock split further appreciates the price.
Rupee Cost Averaging
In this strategy, investors buy stocks at regular interval irrespective of the price of the unit. This is done to nullify the temporary effect of price fluctuation in the market. As the name implies, this strategy averages the buying price of the stock. When the prices go down, investors can buy more of the unit by investing the same amount. When the prices go up, they can buy less. Overall, this strategy makes the price fluctuation irrelevant.
This also prevents investors from worrying over the price of the stock. This has been the most successful strategy in stock investing. Benjamin Graham, the Guru of value investing, has called dollar (or rupee) cost averaging is most successful way to build wealth over a long time for investors who cannot spend much time on stock tracking.
Another method very similar to rupee cost averaging is Systematic Investment Plan or SIP which is generally used for mutual funds. SIP works on the same concept. Investors put specific amount of money at regular interval in a mutual fund. If the NAV goes up, the amount can buy less; if the prices go down, the same amount can buy more.
SIP and rupee cost averaging not only save investors from price fluctuation but also imbue a disciplined approach to investing. Discipline is the key to building wealth.
Investing in Index Fund / Exchange traded fund
Index funds are funds that track a basket of securities forming an index. Hence the returns from index fund resemble the returns from index with a slight margin of error caused by management fee. The difference between a mutual fund and index fund lies in the response of fund manager to changing market situation. While a typical mutual fund manager actively manages the fund by adding new companies and selling off old ones based on market condition, the index fund manager manages the index fund passively. He has no say in deciding which companies should be in the index.
Usually fund management fee for index fund is much less than that of mutual fund. This further adds to the returns of investors. In the long term, market index such as Sensex and Nifty have given good returns. The long term returns given by Nifty have been in 14%-20% range.
Investing is only long term. As Warren Buffet says, “investing is simple but not easy”. With long term planning and financial discipline, investing can create great wealth for investors. In our next article, we will discuss few short term strategies.