Power of the stock market for smart investments
In the world, few avenues present as much glamour in offering future growth potential as the stock market. This is immortalised by Hollywood in movies like The Wolf of Wall Street, where stock trading is depicted as a fast-paced, high-risk world. In reality, buying shares of public listed companies is one of the most accessible ways to participate in the growth of the economy. In our case, it is an opportunity to take a stake in the present optimism we sense around us regarding Sri Lanka’s economic and political future. Yet investing in the stock market can be as fraught with danger as The Wolf of Wall Street portrayed, if taken lightly. How do you make use of the stock market, rather than be used by it, to enhance your financial security?
Ms. Christine Dias Bandaranaike
What are listed shares?
The world’s first stock market evolved in 1602, to trade the shares of the Dutch East India Company. The VOC, considered the world’s first publicly traded company, had its stock listed on the newly established Amsterdam Stock Exchange, to provide its investors with an exit mechanism from the otherwise 20+ year lock in period. By 1606 the VOC share price was up 200 per cent and by 1610 the company declared its first dividend. Since then, public listed shares have offered investors the opportunity to easily buy, as well as divest, an ownership stake in a company. The market permits companies to access capital through listing and in turn offers investors the potential to earn a return – by receiving dividends and making capital gains when selling their share at a higher price than they purchased.
However, while the stock market offers opportunities for growth, its inherent danger lies in its price fluctuations. Share prices are determined primarily by three factors: “your” company’s present and expected future performance, market sentiment (relating to your company, as well as confidence in the economy and capital market variables) and supply and demand of its share. To get a sense of how the market is performing we can look at the index. In Sri Lanka, investors can track the All Share Price Index (ASPI) and the Standard & Poor Sri Lanka 20 Index (S&P20) to gauge market performance. There are also additions to these indexes to include dividends, known as Total Return Indexes (TRI) – adding in the contributions of dividends to an index’ return.
When share prices move downwards instead of upwards, this risk is what troubles investors. This is particularly so if they need to access their money at a time when the company’s performance declines or the whole market experiences a downturn. Besides, during periods of market downturn, it can be tempting to give into emotions and panic sell. Rather than “buy low and sell high”, what investors often do is “buy on greed and sell on fear”. Emotional decision-making is often the culprit for bad investment decisions.
So, what do you need to start using the stock market for smart financial planning?
First, clearly defined financial goals. Are you saving for retirement? Trying to grow your wealth over time? Wanting to build an “emergency fund”? (an emergency fund is a certain number of months of expenses that you set aside to tide you through tough times, without disturbing your investments). Each goal will require a different investment approach.
Next, understanding your time horizon – this is critical as to how you invest your money. For a short-term goal, the stock market is not a suitable choice. Entering the market expecting to exit within a few months is not vastly different to gambling (even if you are a seasoned trader with a high-risk tolerance). If your goal is to build a fund for emergencies or for your annual holiday, invest it in a money market fund. However, for retirement planning, saving for your young child’s future education or building your wealth, in other words, when having time on your side, choose shares – by investing directly or through an equity unit trust. (An equity unit trust gives an investor immediate access to a basket of shares, invested by a professional portfolio manager.)
Select the types of shares to buy. This is a crucial decision and making it can be overwhelming at the start. That’s why starting off your stock market journey by investing in an equity unit trust is often the best route for a new investor. (Buying units in an equity unit trust gives an investor immediate access to a basket of shares professionally run by a portfolio manager). That way, you have time as you go along to examine the companies held in your unit trust and notice their performance. The types of companies that interest you will depend on both your level of knowledge and investment goal. They can vary from dividend paying companies, large/small capitalisation, those with sectoral exposure (eg to tourism, or construction or banking) or export/currency focus. Take time to find what interests you.
Lastly, the key to investing in the stock market is having grit. Successful investors are often characterised as disciplined, knowledgeable, and possessing strategic thinking. However, grit is often their defining factor. In the face of market fluctuations and uncertainty, grit helps investors stick to their strategy and not be swayed. Every investor will experience setbacks, whether a poor investment choice, a market crash, or a failed strategy. Grit involves at times the ability to stay invested and at others learning from mistakes, adapting, and moving forward rather than giving up after a loss.
So, in short, the stock market can work for you. Understand your financial goals, whether short or long term. Diversify so that you move your investment portfolio towards the Efficient Frontier. Understand your own personal risk tolerance and how to put your money to work within its constraints. Don’t allow your emotions to dictate your investment process. Be aware of tax advantages. Annually review and adjust your portfolio. Take the time to educate yourself on the financial markets. Your time is well spent.
(The writer is a discretionary wealth management professional and CEO at JB Financial).
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