It is not without a reason that equities as an asset class is considered as the riskiest investment. The biggest factor that goes against equity investment is the high volatility that is witnessed in the share market.
Though this volatility offers skilled traders and investors a chance to capitalize on the movement, for the novice or a retail trader the choppiness is a test of their nerve and their limited capital. Most retail investors are trapped in the wild fluctuation in the market and end up entering and exiting at the wrong time.
The smell of money
Markets have generally been compared to surfing in the open sea. A good surfer catches the right wave and enjoys his ride, but on the other hand a person who does not know how to ride the waves can drown. While not many individuals dare to ride the wave or surf, such caution is not visible in the markets.
Financial markets are said to be a zero sum game. This means that the amount of money that is lost in the markets by amateur investors and traders is equal to the amount of money gained by experts. A general rule of thumb is that between 97-99 percent of the people in the market lose money and transfer it to the professionals. Legendary investor Warren Buffett says, “the stock market is a device of transferring money from the impatient to the patient”.
Impatience comes from the urge of earning money in a short time frame. Many people are attracted to the equity markets on hearing stories of how easy it has been for someone to make huge amount of money in a very short time. Such ‘success’ stories have undoubtedly been the guillotine under which millions of investor across the globe have lost their head.
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Yet there are many more untrained investors who keep on coming in the lure of a quick buck. A few successful home runs in a bull market gives them the feeling of being invincible. There are cases where individuals have quit their jobs to venture into fulltime trading.
In his best seller The Art of Thinking Clearly author Rolf Dobelli discusses the term ‘Survivorship bias’ where he discusses how a few success stories results in many people trying to imitate the winner. The author cites examples from Rock Stars, writers, start-ups and finally Wall Street investors who have been lured by ‘rags-to-riches’ success stories of a few. He advises people to visit graves of once-promising projects, investments and careers before taking the plunge.
Because of its very nature of being volatile, money making on a consistent basis is difficult in the markets. People get lured in with the possibility of earning 16-18 percent per annum which has been the historical equity market returns in India.
But this return has been possible for those investors who have stayed put with the investment and not withdrew it on a regular basis. Unless one does not need the money on a monthly or even on an annual basis, decent returns can be made consistently.
However, predicting that one can earn a steady amount monthly is a difficult call to take, especially for a person who is a rookie and entering the market based on borrowed research or borrowed intelligence.
Dividend yield stocks
Having said that there are ways in some money can be made consistently, but these are small when compared with other asset classes on a percentage basis.
Say for instance someone wants to make Rs 50,000 per month or Rs 6 lakh per annum. It might be difficult to make Rs 50,000 per month every month but Rs 6 lakh per annum is a possibility.
Since one is looking for steady returns, the key to devising the strategy is a capital protection one as the investor cannot afford to lose his capital. One way of doing it is by buying high dividend yield stocks. The tax free dividend amount can be withdrawn and the money invested in buying shares can continue to reside in the portfolio till it gives a decent return.
Catching high dividend yields stocks are possible occasionally, when these stocks dip on some external events. One is lucky if he can get a stock with a 6 percent dividend yield. Normally, stocks are available between 3-4 percent dividend yields. But the bigger money will be made when the share price of the company moves higher. However, what is predictable and certain is the dividend, hence one should base their calculation on dividend alone.
Thus to earn Rs 6 lakh annually from dividend yield, one needs to have a maximum corpus of Rs 1.5 crore. It needs to be noted that at any particular time the entire amount will not be needed, but this is the maximum amount one needs to have if he is thinking of withdrawing the dividend. In reality opportunities keep on coming throughout the year as various companies announce their dividends at different times.
Apart from dividend yields there are few strategies that can be said to consistently deliver a fixed return. Many advisors call for traders to invest through stock and index options, but these are extremely risky strategies and can result in speedy capital depreciation.
Margin for error
Another point to note is that in order to withdraw money consistently on a monthly basis the amount to be withdrawn should not,on a worst case scenario, be more than 25 percent of monthly winnings. This will help as a cushion during months when the trader incurs losses.
The best traders in the world go through a bad patch and rarely are they profitable consistently. For a novice who is just starting to trade, his margin for error should be much higher.
Even before thinking on withdrawing money regularly a trader should first test out his trading for a reasonably long period of time and in different market conditions. It is important that before taking the leap of going in for fulltime trading one judges his performance during bull and bear markets. This would help him evaluate his strategy, make corrections to it and come out with a better money management process that works in all market condition.
In conclusion, for someone who is starting to trade in equities, it is extremely risky to assume that a monthly remuneration is possible. Market does not owe anything to any individual. As in any job, a more so in markets, the individual will have to show his grit and performance in the market to merit a steady monthly remuneration. Ironically, ones he becomes a proficient trader he would not have to worry about monthly withdrawals.