No, I am not going to give you insider tips about which stocks to buy and how to make money in the stock market. Neither is this a scandal that I am going to tell you about (though I must admit that the title does sound scandalous).
I am sure some of you are already seasoned investors and hence you already might know whatever I am going to write below. But I am writing this because most of the people I meet have no clue about the stock market. They are either completely distrustful of the market or over-confident about their ability to beat the market.
Have a few people beaten the market? Yes, they have. But this ability of theirs has come from the fact that this is what they do day-in and day-out. No, I am not talking about the next stock market advisor that calls you. Those guys are idiots. Think about it, if I had a knack of selecting stocks like Rakesh Jhunjhunwala, I would not be advising other people. I would be buying stocks for myself. But you need not be Rakesh Jhunjhunwala to learn how to make money from stock market. Decent money, that can be a source of passive income.
Before we dig deep let’s understand what is a stock?
To put it simply, it’s a part of the company that you own. Owning a share gives you the right to attend the shareholder’s meeting for that company, vote on important company decisions, and a share of any future earnings that company makes. This share of earning is what people call as dividend.
Some companies reinvest this dividend for future growth. The idea is to get even more dividend in the future. Theoretically, true value of a stock depends entirely on how much money the company will make. But no one actually knows how much money would a company make. All we hear is short-term blabber. Sometimes there is a crisis in the middle-east and everyone starts buying shares of oil companies assuming there will be oil shortage. The other extreme is the noise about economic slowdown making people believe that consumption is going down and hence people will drive less car. In turn, fuel consumption will go down, hence there is noise about selling shares of oil companies. “There is a crisis in the middle-east. There would be oil shortage, let’s buy shares of oil companies.”
These are the sort of noise you would hear in every stock market for most sectors.
But how do I make sense of this crazy market?
You have two options. First, is the Warren Buffett way which means you should invest in the companies whose business you understand. You can ignore the noise and figure out which business would make a lot of money in the long-run. For example, one of the investment guru I heard talks about investing in companies that make habit forming products like alcoholic beverage companies. Is that hard? Of course it is. So what option does a regular working guy like me have?
Here comes the second option. Yes, stock market is crazy but in the long run it turns out all these crazy theories cancel each other out. Hence, over time stock value goes up as earnings of the underlying companies go up.
The next question is which stocks to buy?
So should you buy Reliance Industries or Page industries or should it be the an IPO? Actually the easiest answer is, buy them all. Yes, if you believe that, overall the market will grow in the long run just invest in the market. The best way to do that is invest in an index fund. Index fund is a type of mutual fund that maps the index that they follow. For example, a Nifty 50 fund would mirror the portfolio of Nifty 50 index. That is, it will invest in all the 50 companies that form Nifty 50, in the same weightage that is allocated to these companies in Nifty 50.
While some companies will go up and some will go down, in the long-run index would go up, as everything averages out. Of course, the returns would not be super-phenomenal like 20%+ but there are very high chances of ~12% return if your investment horizon is 7 years or more. Additionally, the charges/ expense ratio on index fund is much lower than actively managed funds.
But my friend has an SIP in one mutual fund which is giving her 18% returns
Indian market is still a relatively younger market, hence some mutual funds will beat the index. Some actively managed funds have consistently beaten the index by ~4%. However, choosing the right mutual funds requires some knowledge and effort. You may want to read about how to evaluate mutual funds basis risk and return.
At the end of the day, if you want to make money from the stock market, you have to stay invested for the long run. If you do not want to invest a lot of time, you may simply invest in an index fund. That is the only sure-shot way to make money from stock market.