Tips for Investing in Stock Markets

So, you want to succeed in the share market and make a fortune out of it! Probably the answer is: Yes I am ready. Well, but before you proceed any further, you have to map out your action plan for getting there. In this article I  will share with you a few suggestions for the lesser-sophisticated investors on shares and portfolio management.

The first thing you need to consider in deciding on whether you are ready to invest in shares is to look at your current circumstances. Some of us have goals, which are a good start, but we need to see if we can actually afford the investment required to realize our goals. In other words, you need to determine if you have the spare/surplus cash to make investments in shares.

Thus, you need to construct your personal balance sheet and seek answers to some important questions to see where you stand.
Only once you have paid off all your short-term debts and paid for all you important expenses and you still have income (savings) left-over should you consider investing in shares. Therefore, first thing you need to consider, is to settle your expenses and  pau outstanding high interest debts. This is not a rule but it is a prudent advice because if you have debts that costs you say 20 per cent in interest per annum and if you invest in shares, your shares investment is growing at more than 20% per annum and that, at some stage you can sell the share to repay the debts and still remain with some profits, you are then doing very well, but this is often difficult to achieve and thus it is advisable or rather recommendable for you to take a simple approach, which says invest your savings, do not borrow or get into debts trying to make a share investment – because the moment you do that, it then amounts into speculation. I know some retail private individual investors who in often cases take this approach during Initial Public Offering (IPOs); where they borrow from banks with the speculative motives that after the IPO prices will go up and they will then be able to liquidate their investment shares, pay the debt and retain some profits

So, the first step is to look at your current financial position, i.e., your personal balance sheet. You will note that the assets have been listed in the order of liquidity. This gives a picture of which assets you can quickly convert to cash. Liabilities are obligations that you are required to pay. Whether it’s a personal and/or business loan payments, it’s an amount of money you have to pay back (sometimes with interest).

Having done that, you then need to have a closer look at your attitude towards risk. This will help you see where you would like to be in the future.
So, what kind of things do you need to look at to see where you are now?
Here are some points you need to consider:
• Age and time remaining before retirement – how much time do you have to achieve your goals?
• Occupation and employment status – do you have job security and a reliable income, or are you self-employed or a pensioner?
• Standard of living – what are your ongoing requirements for an enjoyable standard of living, including personal belongings, holidays and luxury (entertainment) items? Are you comfortable now? Are you able to budget?
• Family and dependents – do you wish to provide for your children and dependents’ education or for other needs?
• Need for financial independence – do you have a strong need for financial independence and don’t wish to rely on a pension upon retirement?
• Personal control – how much control do you like to have in managing your financial situation?
• Insurance – do you have adequate insurance against risks to your property, possessions, income and wellbeing?
I suggest you speak to a financial advisor to assess this if you do not have the objectivity or knowledge to do so.

Funding your share investment
If you’re going to invest money in shares, the first thing you need is…! Where is that money going to come from. For many investors, reallocating their investments and assets does the trick.
Reallocating simply means selling some investments or other assets and reinvesting that money into shares. It boils down to deciding what investment or asset you should sell. Generally you want to consider those investments and assets that give you a low return on your money. Re-allocation is only part of the answer; your cash flow is the other part.

Your cash flow refers to what money is coming in (income) and what money is being spent (outflows). The result is either a positive cash flow or a negative cash flow, depending on your cash management skills. Maintaining positive cash flow helps to increase your net worth.
In the mix of it, it is important that you set the right expectations and learn what to expect from the share (stock) market, learn to evaluate and analyze businesses that you intend to invest into. Most of these information and data can be obtained from the companies’ published financial statements; also company news and releases might assist. Historical precedents and information related into it are also things to consider, as it is history tends to repeat itself in the share market.

Market Psychology
Market psychology is the overall sentiment or feeling that the market experiences at any particular time. Greed, fear, expectations, circumstances, etc are all factors that contribute to the market’s overall investing mentality or sentiment.
While financial theory describes situations in which all the players in the market behave rationally, such theory, however, do not account for the emotional aspect of the market that can sometimes lead to unexpected outcomes that can’t be predicted by simply looking at the fundamentals of the economy, or the underlying performance of the company, etc.
However, analysts normally use trends, patterns and other indicators to assess the market’s current psychological state in order to predict whether the market is heading in an upward or downward direction.

Market sentiment
Market sentiment refers to the psychology of market participants, individually and collectively. It represents the general prevailing attitude of investors as to the anticipated price development in a market. This attitude is the accumulation of a variety of fundamental and technical factors, including price history, economic reports, financial performance reports, seasonal factors, as well as national and world events.
Market sentiment is perhaps the most challenging category because as it is, it matters critically, but we are only beginning to understand it. Market sentiment is often subjective, biased, and obstinate. For example, you can make a solid judgment about a share’s future growth prospects, and the future may even confirm your projections, but in the meantime the market may simply decide to dwell on a single piece of news that keeps the share artificially high or low — albeit this can especially be prevalent in emerging and developed markets. And you can sometimes wait a long time in the hope that other investors will notice the fundamentals.
Market sentiment is monitored with a variety of technical and statistical methods such as the number of advancing versus declining stocks and new highs versus new lows comparisons. A large share of overall movement of an individual stock has been attributed to market sentiment. In the last decade, investors are also known to measure market sentiment through the use of news analytics, which include sentiment analysis on textual stories about companies and sectors.

Emotions and perceptions
Share prices can change because of perceptions, greed, hype, momentum, fear, etc. Sometimes the stock market can be seen as the sum of the emotions of its human entrepreneurs, subject to the arbitrary human whims and flights of fancy.
According to a Wall Street saying, only two influences are at work on the stock market – “fear and greed”. Most of the time they are in equilibrium, with greed only staying dominant long enough to produce the long-term trend depicted on a share market graph. The 1999 – 2000 technology boom was a good example of greed taking over. The Internet, and anything connected with it, became the spice of the moment and the technology shares skyrocketed in price. But, when it all got too much later in the year 2000 — some of us may recall what happened in the Nasdaq Stock Exchange — where most internet and tech companies were (are) listed.

Bullish & Bearish
This is the other side of hype and momentum of the market. If investors expect upward price movement in the stock market, the sentiment is said to be bullish. On the contrary, if the market sentiment is bearish, most investors expect downward price movement. When a bear market sets in, fear takes share prices downward, to a long, bitter winter of discontent. During a recession nobody wants to buy shares. Only in hindsight do people realise that it was the best time to buy shares. This is what “value investors” the like of Warren Buffet operate and recommend.

“To every thing there is a season, and a time to every thing, and a season for every activity under heaven”, says the author of the Book of Ecclesiastes in the Bible. He could have been talking about the stock market as well!
Most stock markets show a distinct seasonal pattern. It has a regular seasonal correction at the end of the financial year. This is normally followed by a major seasonal rallies i.e. beginning of the tax year, periodical financial reporting seasons, etc. The stock market is more likely to rise and fall in certain months than in others; i.e. portfolio or fund managers tend to withdraw from the markets at the end of each tax year to balance their holdings. They start spending again at the beginning of the subsequent tax year.

Market cycles
Besides psychological factors that determine market prices and rates of return on share investments, there is a totally different concept to consider and that is the market cycle.
Stock market cycles are the long-term price patterns of the stock market. It is very important for investors to know where the market is in its cycle at the time when they will be investing, particularly if they are entering the market for the first time.
Two key types of models that have been developed to help you to understand at what stage of the cycle the market is in are: macroeconomic models and intuitive market models. For either type of model, the two most important factors in determining the market cycle will be the interest rates and monetary policy. To determine whether interest rates are favorable for share market investment, it is necessary to calculate their ‘real’ level (which is the current six-months treasury bills rate, minus underlying inflation).
Along with macro-economic models, the other way to identify and predict market cycles is intuitive market models. Intuitive market models are imprecise and rely on subjective inputs from the investor – for example, where you think you are in the market cycle. Although they are partially based on economic conditions, they are mainly based on an intuitive understanding of how markets work.

As we stated in previous pieces, when you buy a stock, you are not buying a lottery ticket., rather, you are actually becoming a part owner of the real operating business. The value of your shares will rise or fall based on the company’s perceived fortunes. Many stocks also pay dividends, which are periodical distributions of profits back to the shareholders. By investing in a stock, you are making the shift from being a customer to being an owner. For example, if you buy a beer or cigarette, you are a consumer of TBL or TCC products, but if you buy a TBL or TCC stock/share, you are buying your ownership of the company — and a entitled to a percentage of its future earnings, as well as its assets.
What and how much can you expect to earn as an investor of a stock? Much as this is impossible to predict, but we can use the past as a (very) rough guide on the potential earnings and gains. Historically, for those stock markets with long time of existence and experience and bigger markets, the stock market has returned an average of 10 per cent a year over more than a century. But of course if these figures are looked separately, they may seem deceptive because stocks can be wildly volatile along the way — in the process of averaging 10 per cent per annum. It is not unusual for the market to fall by more than 20 or even 50 per cent in a period of time and every few years. Analysts and observers tells us that on average the market is down once in every four years. You need to recognise this reality so you wont be shocked when stocks tumble — and so you will avoid excessive risks. However, as you do that remember and usefully recognise that the market has made money three out of every four years and continues this tend even today.
In the short term, the stock market is entirely unpredictable, despite the claims of some “experts” who here and there would pretend to know what is going on about the market! A vivid example which in more recent is that in January of 2016 the S&P 500 sank by 11 per cent — but then it made a U-turn almost during that same period and rose nearly as rapidly. Same has been in the past few days where it lost by more than 7 percent — but then changes to the positive can be seen even today — for those who follows up; why? some analysts and long time followers of stock markets trends say — there are no good reasons for the decline. equally there are no good reasons for the recovery. This is true even in our market, a keen observe would have noticed this, albeit for us the context may be a bit different given our market size and lack of sophistication.
Despite the above, in the long run, nothing reflects economic expansion or the shrink thereof more than the stock market — that’s why it is called the barometer of the economy. As it is, overtime the economy and population grow, and workers become more productive. The rising economic tide makes businesses more profitable and predicted to trend the same in the future, which then drives up the stock prices. That explains why markets soared in the twentieth century, despite all wars, crashes and crisis. By now I presume that you might have guested or reasoned out why it pays to invest in the stock market in the long term. This seemingly fact of matters makes me almost suggest that: over the long term stock markets news will be good. If you can buy into this seemingly factual statement, it will help you to be patient, unshakable and ultimately relatively rich by investing in stocks of companies listed in the stock market — and of course choices of stocks to invest into matters as well.
So what exactly does this mean — it means that if you believe that the economy and businesses will be doing better 10 years from now it them makes sense to allocate a portion of your investments in the stock market. Of course, it is undesirable that it may be a bit of a challenge to stay in the market long enough to enjoy these gains, given that needs for money for individuals may be abrupt as emergencies may dictate. In all these, the last thing you want is to be a forced seller during a prolonged bear market. But then how can you avoid such fate? For a start — either don’t live beyond your means or saddle yourself with too much debt/loans — both of these are reliable ways to putting yourself in a vulnerable position. As much as possible try to put a financial cushion, you will reduce the chances of raising cash by selling stocks when the market is crashing. Of course one way of achieving such an objective is to invest in fixed income instruments such as bonds — given their contractual nature of paying fixed amounts in pre-agreed periods.

When you buy a bond, you are basically making a loan to a government (if it is treasury bonds), or a company (if it is corporate bonds), or a municipal (if it is municipal bonds) or some any other entity on that matter. As it is the financial markets loves to make the idea of investing in such financial instruments as bonds seem complex, but if you look at it — it is pretty simple. Bonds are loans. When you lend money to the central government, it is called Treasury bonds, when you lend money to a city, or a municipal or a local government, it is a municipal bond, when you lend money to a company such as NMB Bank, or Exim Bank or TBL etc, it is a corporate bond. And when you lend money to a less dependable company and hence a high risk company, it is called a high-yield bond or a junk bond. You see! it is that much simple — do not let anyone tell you how complex the concept of bonds is, simply because it is not.
So, how much can you earn as money lender (or often called a bond holder)? — the answer is, it depends. In normal cases, lending money to the Government you may not earn as much — why? because there is little chance that the government may renege on its debt — why? because it is significant repetitional matter when a government fails to honour its bonds obligation. It basically impact the overall cost of funding in the economy. I said in normal cases, however, we have observed many a case where loaning money to some governments is a way riskier that loaning money to a corporate entity. So the interest rates in such governments’ treasury bonds ought to be much higher because of the risk related. Now, it is unfortunate for such a situation to happen, because as I said earlier it impact interest rates (cost of funding) in all other financial instruments in the economy — why? because yields in government bonds are used as benchmarks in arriving at other financial instruments’ interest rates. However, whatever the case — these are matters of trade-offs between risk and reward. A good analogue of what I am saying here as it relates to risk and return would be that of one government (or entity) asking you to cross a traffic-free rural road somewhere in Butiama on a sunny day, and another government (or entity) is asking you to cross a busy high-way in the city of Dar es Salaam on a rainy stormy night while wearing a blindfold — now that is too dangerous. That is how one need to consider the issue of risk as it relates to the entity that issues bonds.
What it is however, is that normally the odds that a company will go into bankruptcy and fail to pay its bondholders are higher than the odds that a credible and well governed government will default on its loans. So the company has to pay a higher rate of return to its bondholders compared to a government. This addition amount of interest rate is called a risk premium. Similarly, a young and small company in a risky business that wants to borrow money by issuing a bond has to pay a higher rate than a blue-chip, good brand and established company. So, whenever contemplating on investing in bonds consider this fact as well. In other parts of the world rating agencies like Moody’s, Standard & Poor, Fitch, etc provide ratings for companies, and these rate grades are used to benchmark risks and hence interest rates.
The other critical factor for investments in bonds is the duration of the loan. The Tanzania government will currently pay you about 10 per cent per annum for a 2-years bonds; 12 per cent per annum if you lend the government for 5-years. If you lend that money for 7-years, 10-years and 15-years the government will pay you 14 percent and 15 per cent respectively. And of course there is a reason why you receive a higher rate for lending the money over a longer period: it is riskier.
So, why do people want to own bonds? For a start, as we indicated last week and in the opening of this article — they are much safer than stocks. That’s because the borrower is legally required to repay you, and at the agreed rate and periods. If you hold a bond to maturity, you will receive all your original loan (called principal) bank, plus the interest payments — unless the bond issuer goes bankrupt. As an asset class, statistics — globally, indicate that bonds deliver positive calendar-year returns approximately 85 per cent of the time.

2 thoughts on “Tips for Investing in Stock Markets

  1. Moremi this well articulated, thanks bro is there an inflation component in risk free interest rate(T bills rate) thought the inflation is usually factored under interest rate premium

    Liked by 1 person

  2. Outstanding article sir. I have read several of your articles, they are informative and educative. You are inspiring. There is a wealth of knowledge in this page.Thank you !!!

    Liked by 1 person

Leave a Reply

Fill in your details below or click an icon to log in: Logo

You are commenting using your account. Log Out /  Change )

Google photo

You are commenting using your Google account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s