[This article originally appeared in Dignity Dialogue‘s December 2012 issue.]

Equity investing – everybody’s an expert and nobody knows a thing. Your friends give you ‘tips’ on ‘hot stocks’, the papers talk about ‘multi-baggers’ and ‘bull runs’. You hear about ‘fabulous returns’ and you wonder, “Can I get me some?”

First, the basics: Equity investing is investing money in equity stocks (shares or scrips) of companies. You can do this by directly buying the shares either when the company issues them (primary investing) or on the stock exchange using a broker (secondary investing). You can also buy shares indirectly by investing money in equity schemes of mutual funds.

Should I invest in equity?

Absolutely.

a.) Over a long term, equity investments have usually done better than other options, like debt or fixed deposits.

b.) Capital gains made by selling shares that you’ve held for at least a year are tax-free. Dividends paid by companies or mutual funds are also tax-free. This makes equity investing the most tax-effective investment option.

c.)  Shares are liquid, meaning you can convert them into cash faster and easier than say, selling a house and the process is fairly painless.

How much should I invest in equity?

A useful rule of thumb is to invest that proportion of your portfolio in equity that is 100 minus your age. So, if you’re 65, invest up to 35% of your portfolio in equity. Periodically re-balance your portfolio, shaving off some equity profits and parking those in debt investments.

I have x lakhs/thousands to invest in equity. How? Which? Where?

Our advice is simple – forget about investing in specific companies unless you have the time, access and knowledge to research them thoroughly and decide which have the brightest prospects. Instead, invest in equity mutual fund schemes. Equity fund managers do the stock picking for you. They have the means and the expertise to undertake sophisticated research on which companies are likely to do well and when. They also have a lot more funds at their disposal than you do, which means they can pick up bargains easier than you can. Picking good equity schemes is easier than picking stocks.

How do I invest in equity?

Some guidelines:

1. Never invest in a lump sum. If you have twelve thousand rupees to invest, invest a thousand each month for 12 months. If you have twelve lakhs, invest a lakh a month. This is called a Systematic Investment Plan and you can set up instructions to do this automatically each month for a year or longer.

2. Automate the process. Invest your chosen sum each month automatically, whether the market is up or down and whether you’re in a good mood or bad. This takes the emotion out of investing and because you’re doing this over at least a year, it tends to average your cost so short-term market fluctuations tend to get ironed out at least somewhat.

3. Don’t fragment your investment, which means the smaller your portfolio, the lesser the number of investments you should have. Fragmenting your investment means potentially fragmenting your returns. It’s like backing a horse in a race – betting on all 20 horses is not going to make you money; betting on 1 to come first or second or third is more likely to make you money.

4. Invest for the long-term. Don’t expect to make money fast. Equity investing generally only pays off if you stay invested for at least a year and usually for more than 3 to 5 years.

5. Don’t get greedy. Don’t look / wait for spectacular returns. Don’t get impatient. Equity investing is not for the faint-hearted, but if you’ve allocated the right proportion of your portfolio towards equity, you know you can ride out a bad market, because you’ve got your other investments safe.

Is it risky? 

Yes. But you can mitigate the risks via these guidelines.

Returns are unpredictable and depend on multiple factors; some are sentimental in the short-term rather than logical. In the long term, however, the market does have a logic: if companies are prospering, prospects look good and the economy’s future looks reassuring, values will go up. If any of those is reversed, values will go down.

What stocks should I buy?

We’re not going to tell you. Two examples why:

Five years ago, if you had decided that that cellphones were a booming business, you’d have been right. You would have wisely chosen to invest in the top four companies in this sector: Nokia, Ericsson, Blackberry and Motorola. Between them, they had about 85% of the market. Today, Apple and Samsung have that 85% and the old four are….

Second example: Some years back you’d have read that India’s domestic travel was growing, how we had a shortage of good airlines, how more travelers were opting for air over rail: you’d have thought it a great time to invest in a new Indian airline that had a solid business pedigree and a truly world class service: Kingfisher. Right.