Should you invest in the risky but rewarding stock market?

Stock investors must know how the market works to be able to act shrewdly. (Pixabay pic)

Investing in the stock market is risky. How do you choose profitable stocks and generate higher returns in the short-term?

Should penny stocks be considered since they are lower priced but highly speculative? Beware, because trading penny stocks can wipe out your investment in the blink of an eye.

Or, should you invest in blue chips that are more established and financially secured?

These are valid questions and reveal what most people understand about stock investing, which is far removed from what true stock investors think.

To truly understand what stock investing is, read on.

1. Investing in the stock market is not risky

Stock investing is not risky. It’s buying shares without knowing what you’re getting into that is risky. It is this lack of knowledge that kills many sincere investors who just want to make money in the stock market.

If you ask those who lost money, you will find that most did not do their homework before buying a share. That, in essence, is gambling or speculating, and definitely not investing.

2. You shouldn’t hope for high returns in the short-term

Stock investing is a systematic way of building long-term wealth via investing in a portfolio filled with stocks which are great businesses at their lowest possible prices.

This is widely practised by billionaire investors such as Warren Buffett, Charlie Munger and sovereign wealth funds like Temasek Holdings, pension funds like the EPF and CPF and insurers around the world.

When they invest in their preferred stocks, they often hold the stocks for the long-term, sometimes over many generations or forever.

They don’t buy a stock for RM1 with the intention to sell it for RM2 in the shortest time frame. That is what traders, speculators, and gamblers do but not investors.

Most first-time stock investors make the mistake of being impatient with their investments. (Rawpixel pic)

3. You should be wary of penny stocks that are ‘low-priced’

Stock investors aim to buy good stocks cheap. Cheap may not necessarily be affordable (low-priced). A high-priced stock may not be affordable but it can be cheap and of great value.

To explain this: Imagine two condominiums. The first is priced at RM300,000. The second is priced at RM500,000. Which of the two is cheaper?

If you say RM300,000, you might be wrong. Why?

What if more information is given about the two condominiums – the first one is a 300 sq ft studio and the second one is a 1,000 sq ft three-bedroom, two-bathroom unit.

Now, which of the two is cheaper?

If you compared the two, you would now say the RM500,000 unit because it costs RM500 psf while the first unit cost RM1,000 psf.

The RM500,000 unit is therefore of greater value.

Likewise, “low-priced” stocks may not necessarily be cheap.

Stock investors compare the prices of stocks with their earnings, book value, and dividends by calculating valuation ratios.

This is how stock investors avoid buying into overpriced stocks when most people acquire them thinking that they are “cheap”. That is very dangerous.

With adequate patience and knowledge, the financial bounty one will get from stock trading will be immense. (Pixabay pic)

4. ‘Trading’ penny stocks can wipe out your ‘investments’ easily

Most people think stock investing and trading are the same thing. It’s not. Investing differs from trading in terms of thinking and reasoning.

Stock investors want to buy good stocks at their lowest possible price. Thus, when a good stock falls in price, stock investors are interested to acquire more because they are cheap and of good value.

But stock traders may not.

In fact, when a stock falls in price, stock traders avoid buying it as they are more interested to find stocks with prices on the rise.

The mindset, tool sets, and set of skills are totally different.

5. Blue chip stocks are more well-established – well, not all

Many people think blue chip stocks are stable investments because they are large in size and are recognisable by the public.

To a certain extent, some of these blue chips are decent investments. However, most aren’t. Some do not perform well financially on a consistent basis.

It is a mistake to assume that all blue chip stocks are stable investments.

Then, what should you invest in?

If you have not studied the business model, finances, management, future plans, and valuation of stocks, do not invest in anything.

You can then save yourself thousands of ringgit from poor stock purchases. Remember, stock investing is not about “trying it out”.

If you are interested in stocks, invest your time and money on reading books about investing. You can start with Mary Buffett’s Buffettology – a classic among stock investors around the world.

This article was published in kclau.com

Ian Tai is the founder of DividenVault.com, a platform that empowers retail investors to build wealth through ownership of fundamentally solid stocks that pay ever-growing dividends year after year.