Should one trade frequently?

One of my friends called me asking for a tip, so that he could make some money in the stock market in the short run. The next question I asked him is, how much does he plan to invest and he proudly said Rs.20,000/- to 30,000/- to really make big money, you actually need to invest big and your bets should always go right. There are many more costs involved, which most of us do not consider when we talk of trading frequently in the stock market. Let us look at some of them. For every purchase and sale of a stock you have to pay brokerage costs. Why do you think brokers happily keep giving you tips? The tips are so that you trade and with every trade they make money. Remember that whatever profit you make from that a certain portion has to be paid as brokerage costs, both at the time of purchase and sale. So this brings down your profit. In addition to this brokerage fee, you also have to pay a transaction fee to stock exchange and depository charges, add to this the service tax. Now look at your profit. It would be quite miniscule.

The next thing to consider is taxation. Frequent trading means capital gains. Short term capital gains is taxed at 15%. So from whatever you made after paying the broker, stock exchange and government, the Income tax department would be standing at your doors for their share of 15%. Short term capital gains has to be paid for any stock sold before one year from the date of purchase. But if you had held it for at least a year, there is no capital gains tax. From the tax angle, frequent traders are sometimes treated as doing business of buying and selling of shares, in such a case, if you are in a higher tax bracket, you might not get the benefit of capital gains tax.

You might make some money in the short run by doing frequent trading, but with so much volatility, it is better to be careful. In the past few days you would have seen the sharp volatility in the prices of stocks. So go stop looking for short term gains and make money by investing in good stocks for the long haul.

Asset Allocation of a portfolio

Everyone says that Equity investment is the best option for long term capital appreciation, but as we have seen it is difficult for us to decide on which stocks to buy or sell at any point of time. So the next best option is Mutual Funds. It sounds so easy, but when we go to invest in mutual funds, you have so many choices. One of the easiest things to do is first invest in ELSS schemes, this is the best because you do not have to think too much and it will save you tax. The maximum tax deduction under section 80C is Rs.1.5 Lakhs per year. This has a lock-in period of three years.

Now that the easy part is done, which schemes should we invest in? Your portfolio should be made up of Large Cap, Mid Cap and Small Cap funds. The Large cap funds are usually passively managed funds, there are actively managed funds as well, look at the track record over a long period of time and choose the fund. Then there are Mid Cap funds, these funds are a bit riskier, but they offer better returns then large cap funds. Then there are small cap funds, these are the riskiest, but here again the long term returns are the best. If you have 3 good funds one each in Large, medium and Small Cap, you would have covered most of the market, then you do not need to go for multi-cap, thematic or sectorial funds.

As regards debt, you could have some savings in Provident Funds or you could go for some debt funds. Then there are balanced funds, these are for people who are closer to their retirement, and looking for regular returns. These funds invest in Equity as well as debt. Depending on your stage in life, you could decide on going for debt oriented or Equity oriented balanced funds. The good part of balanced funds is the gains made in equity are protected by debt component. The risk of these funds is usually moderate. Asset Allocation depends on your stage in life or the purpose of investment, so choose wisely, it should not happen that you invest for a particular purpose and when you need the money, the market is down, so sit with your financial advisor, before deciding on your asset allocation.

Easy ways to make money

We regularly hear from people how they brought a stock and held on to it and today the value is so high. Well that is true for many stocks. If that was so easy, I think all of us would have been millionaires by now. Yes, in equities, holding for a long period helps generate high returns. But then not all stock will continue to give good returns for years together. Way back there was a stock called Century Mills or till recently there was Satyam, both of these were giving good returns, now where are they? Therefore if someone says buy a stock which is on the Sensex and hold on to it for life and it will give you good returns does not make sense. As both these stocks were part of the Sensex, today they are not. So is the strategy that as soon as it is removed from the Sensex sell it good? Well by the time it is removed from the sensex, that particular stock would have already lost steam.

So what should one do? One of the things would be to review the stocks you have in your portfolio on a regular basis. Daily is also regular, but at least once a year would be good enough. While reviewing if you notice that a particular stock is losing steam, get rid of it and look for some other stock which would be a good bet to replace in your portfolio. I keep telling people that the sensex has given an average ten year return of 16%, if a person had kept investing systematically. But then as I told you earlier, the sensex stock have always kept changing. So you too should keep changing the stocks in your portfolio, you would like to have such return. The easiest way to do it is invest in a mutual fund, where the fund manager would do the managing for a small fee.

Since making money in the stock market over long period of time is easy, but it needs some discipline in investing, for a fund manager, he is governed by rules, so he will follow the rules, set for the fund. This helps in disciplined investing. You keep hearing that many people made money by investing in midcap or small cap stocks, but for lay investors, it will be too much of research, stick to sensex or nifty stock and stick to them, this way the chances of losses will also be limited. Remember money is there to be made by investing and letting it appreciate, but regular review is a must. Write down your rules of investing and follow them. You might make some bad decisions, but if the rules are followed, the percentage of good decisions will always be more than the bad decisions. Isn’t this the best way to make money? Make the rules and follow them and watch your money grow.