Investors' Hangout: Dos and don'ts for young investors

We often say that while the list of dos is not as extensive, it is actually the don'ts that one needs to be careful about to be a successful investor. So, let's start with the big red flags.

• Trading in the stock market: Most people think that the stock market is a game and you have to trade. There is a saying that "a fool and his money soon part ways," and trading is a quick way to do that. Many believe that money is made by buying and selling something. Not really. It's very difficult—there is the cost of transactions and your ability to figure things out. Successful investing involves buying a great company and holding it through ups and downs. This requires understanding the company's promise and developing a belief about that company, which trading does not provide. So, one just incurs cost while trading.
  
• Derivatives: Derivatives are often referred to as "weapons of mass wealth destruction." It's a leveraged trade where you can ride a position much larger than your investment. If the market rises, it feels like a substantial gain with a small investment. However, the reverse is also true—if the market falls, you can lose your entire investment. A leverage trade works both ways, and that is what derivative trading entails.
  
• Investing in IPOs: People often think investing in IPOs is a quick way to make money. While you can make money, it generally doesn't work that way. Good companies' IPOs are in high demand, making it harder to get an allotment. Conversely, if a company is bad or the IPO is large, everyone gets an allotment, and the price may tank upon listing. Most IPOs nowadays are "offer for sale," where promoters sell their shares to outside investors, usually at higher prices. These promoters have taken all the risks and are now cashing in, putting outside investors at a disadvantage.
  
• Too good to be true offers: The biggest red flag is falling for something that seems too good to be true. People often encounter proposals promising magical returns, usually through illegitimate means. These offers often come from within your own circle, making them more tempting. The basic rule is that if something seems too good to be true, it likely isn't true. Approach such offers with great suspicion and doubt. Assume they are false unless proven otherwise conclusively. Don't fall for them.

Now let's move on to the dos.

• First and foremost, you need to be able to save. If you don't save, nothing starts. Saving is not just a matter of how much you earn and spend; it's fundamentally a habit. If you don't cultivate this habit, no amount of earning will take you anywhere.
  
• Second is to think long term. Saving is not enough; you need to put your savings to work by investing. If you're unsure where to start, consider a recurring deposit at a post office or a bank. This is a safe and assured way to begin if you're not yet familiar with market investments. For long-term money, consider a mutual fund SIP (systematic investment plan).
  
• It's also important to increase your investment as your income rises. Following this rule will help you accumulate a sizable amount over time and appreciate the value of compounding.

Viewer's question

Nishit asks, "I have accumulated a portfolio comprising mutual funds and stocks recommended by Value Research, amounting to about Rs 1.05 crore, which includes almost 90 per cent equity. At the same time, I have a housing loan of about Rs 1.32 crore on an under-construction apartment at an interest rate of 8.5 per cent. I also have a provident fund of Rs 35 lakh and NPS accumulation stands at Rs 15 lakh. I want your opinion on whether to prepay the loan and reduce it or invest."

I'll give him a framework, as I don't have all the additional information about his context. He has a total accumulation of Rs 1.55 crore (Rs 1.05 crore in investments, Rs 35 lakh in PF, and Rs 15 lakh in NPS). That said, some of this accumulation might be taxable, so he'll end up with a little less. His PF may not be accessible, and not all his NPS accumulation will be accessible.

Now, as he has borrowed money of Rs 1.32 crore as housing loan, he needs to consider a few things. If repaying the Rs 1.32 crore loan takes up 15-30 per cent of his total income, it is manageable. However, if he is also spending on rent while paying the EMI, this adds to his financial burden. He should aim to get the house ready as soon as possible to save on rent.

Being prudent with borrowing and repayment is crucial. Most housing loans are long-term (10-20 years), and his interest rate is at 8.5 per cent. This is the only loan I encourage people to carry, but in a prudent way. If a significant portion of his income goes into repayment, he might face difficulties, as the value of the house does not translate into an income for you. The goal should be to live in the house and save on rent.

If he can follow this framework and the loan repayment does not substantially impact his finances, he should continue with the home loan. The long-term return on his portfolio, which is mostly equity, and his NPS, which could be up to 75 per cent equity, can generate good returns. His provident fund is also generating returns close to or matching the interest on his loan.

Overall, the key is to balance his loan repayment with his investment returns and ensure he is not over-leveraged.

Click here to register for the next episode of Investors' Hangout.