This article is written by Anumeha Agrawal pursuing BA.LLB (Hons.) from Symbiosis Law School, Pune. The article gives an introduction to the stock exchange markets and the advantages as well as disadvantages of investing in them. It is a useful read for a new investor to know the risks of the market.
Table of Contents
Introduction
A stock exchange market is a platform for trading provided by an exchange. The members get registered with the exchange under listing agreements, these members are investors, issuers of the securities, and intermediaries like brokers, sub-brokers, mutual funds, depositories etc. Even different classes of securities of the same issuers are separately listed in the market.
What are the types of Stock Exchange Market
The stock exchanges markets can be specific to a geographical location or specific security or a category of investor or issuer.
A stock exchange only operating in a specific location i.e. focusing on issuers and investors of that vicinity are called Regional Stock Exchanges, an example of an RSE is Calcutta Stock Exchange. A stock exchange market specific to a kind of securities is Indian Commodity Exchange Ltd for the trading of commodities. A stock exchange market catering to the needs of particular investors is the Bombay Stock Exchange- Small and Medium Enterprises (“BSESME”) focusing on the trading requirements of Micro Small and Medium Enterprises (“MSMEs).
Merits of the stock exchange market
An ownership stake in a company
The shares listed in the market are either equity shares or preference shares convertible to equity shares. These shares allow the shareholders to have an ownership stake in the issuer company.
Exclusivity in transactions
Membership of stock exchange markets and resultantly trading used to be an exclusive activity. Only the brokers and sub-brokers engaged in market transactions, however with the introduction of exchanges and particularly online trading it has become quite open to the general public.
Return on investment
As the majority of the listed shares are equity shares their value is directly related to the value of the company, thus when a company is doing well there is a substantial capital appreciation in the shares of the company which provides good returns.
Good returns on investments in short time
As compared to other investment options in an ordinary scenario the returns on stock market investments are much faster. For example, the average annual return in real estate is 10.5%, for investments in gold it is 8.87% and for government saving bonds it is 7.75%. Whereas the returns on the stock investments on NSE was 16%.
Right to vote
The equity shares give a right to vote to the shareholders on the matters concerning their interests. Therefore, the Companies Act, 2013 requires the approval of shareholders in an annual general meeting or extraordinary general meeting to take important decisions. This enables the investors of the company to have a say in the companies’ operations.
Interests well-protected by regulatory bodies
The listed companies are strictly regulated by the SEBI Regulations like the SEBI ( Prohibition of Insider Trading) Regulations, 2015, SEBI (Prohibition of Fraudulent and Unfair Trade Practices) Regulations, 2003, SEBI (Intermediaries) Regulations, 2008 etc.
These regulations mandated the listed entities to maintain a standard in the services they provide, the disclosure to be made to ensure investor awareness and prevent corrupt and malafide practices. Thus the shareholders of listed companies are much better protected than the shareholders of unlisted companies.
Contribution to economic growth
The stock exchanges have notably contributed to the growth of the economy, and the growth of the economy has aided the development of the stock exchanges. The first stock exchange Bombay Stock Exchange was established in 1875 and the National Stock Exchange was established in 1992.
The economic growth can be traced to the early 1990s and the average national income growth of 5.8% from 1981-90 and the industrial growth of 10.5% of 1989-90. This led to an infuse of the foreign capital in the market and the surplus income to the general public and the investors which enabled them to invest in the capital market. On the other hand when the investments in the capital markets increased stock market capitalization to the GDP also increased, in the year 1996 30.4% whereas in 2019 it was increased to 67.06%.
Protection against inflation
The stock investments are a good measure to avoid inflation, as the stock market investments may fluctuate during a short time period but due to the general capital appreciation over a longer period the securities’ value increases at a rate greater than the inflation rate. For example, the inflation rate in June 2020 is 6% and the average return rate on stock investments has been 16%.
Easy to buy and sell
Stock market investments are one of the most liquid forms of investments, unlike fixed deposits in banks or government bonds, there is no stipulated investment period. And as compared to real estate transactions the process of transfer of title has considerably less legal formalities and quicker.
Dividend income
The companies also provide an annual income in the form of dividends to the shareholders. Although in the case of equity shareholders, the amount may differ corresponding to the profits of the company that particular year, where there are no profits they may not get any dividend whereas when there are huge profits the dividends may be of a sizable amount.
Diversification
Another crucial feature of share investments is the diversification of the portfolio allowed under it. The investors can invest in securities of opposite kinds (industries of sector-wise) which mitigates their risk and increases their chance of profits.
Tax benefits
Where earnings from several other investment options are subject to high tax rates the strategic security investments save up on tax payment, Section 112A of the Income Tax Act, 1961 allows the investors to claim tax benefit on the long term capital gains, the term varies for the listed and unlisted status of the company and the type of security itself.
Convenience
Equity investments are globally one of the most convenient forms of investment. Such convenience is largely associated due to the facility of online trading, the immense amount of knowledge available to investors in the form of television shows, youtube videos, financial magazines or newspapers and the ease and speed of conducting the transaction itself.
Demerits of stock exchange market
Volatile investments
The share market is extremely volatile as there are numerous factors affecting the value of shares like government policies, budget, sectoral events, company disclosure, change in management of the company etc.
In addition to this, the market is also susceptible to rolling effect, i.e. when a famous investor like Ketan Parekh or Rakesh Jhunjhunwala, invests of disinvests from a company the effect is manifold and smaller investors follow them leading to either exponential rise in its price or huge downfall in the prices.
High brokerage and low margin
Although the market has now become much more accessible the brokers are still needed for the smooth functioning of the market. The brokerage charge by them is high leading to lower profit margins for the investors making the investment option less attractive.
Impulsive investment
The impulsive investments like investments purely based on one’s impulses or hear-say and not on research are likely to result in losses to the investors. With experience and past losses, the investors learn the stock has to be analysed first and invested later.
Lack of knowledge
One of the clear demerits of the stock exchange is the lack of knowledge the investors have w.r.t. The investments they make and the companies they invest in. Most of the issuers rely on the advice of their brokers or the general market trend which may not be in their best interests.
Although the SEBI and stock exchanges require issuer companies to disclose relevant information for the benefit of the investors, the majority of investors are incapable of analysing and utilising this information for their benefit. There is an acute requirement of investor training and educational exercises by the regulator.
Time-consuming
By the introduction of online trading, the act of trading securities itself has become simple and quick, but the process of registration like opening a Demat account is a little more time-consuming. However, since it is a one time process it can be ignored but the research and analysis that is required before making an informed investment is still industrious.
Subject to higher risk
Apart from the volatility of the market as explained above, the equity investment carries the highest amount of risk even in terms of corporate finance. According to Section 53 of Insolvency and Bankruptcy Code, 2016– the waterfall section the shareholders are paid at last after paying all other debts of the corporate debtor, even the debt instruments to both secured and unsecured creditors.
Tips to minimise losses of the investors
Some common but indispensable tips to new investors are:
What is your goal
Stock market investments like every other investment should be made keeping a goal in your mind in terms of the initial investment amount, the time of investment and the final amount to reach. Unless you have high expertise in the capital market you should not be looking to make money on short term investments, rather plan and invest according to your personal requirements.
Relentless research
There is nothing like too much research, especially when you are new to the market. Read about the company you are investing in, read about the sector, the government policies in that sector, its management and it’s past financial statements and compare its position to its competitors as well. You can even read tips given by experts on stock investments but make sure it is a trusted individual and not a sponsored person.
Don’t put all your eggs in one basket
The advice can be understood in two manners, first is to not invest all your savings in the share market itself. There are millions of riches to rags stories of the market to make you realise the potential of loss in this market thus one should always invest only the surplus income after securing an emergency fund, general savings and other forms of investment. Gold is also a good option especially due to its inverse relation to the market.
And the second meaning is that the investors should never put all their money into one company or one sector, it is preferred that the investments are always balanced to minimise the risk. For example, investment in broad and largely unrelated industries like pharmaceutical, metals, petroleum, banking is considered safe as even if due to an event a sector crashes the others are relatively safer.
Dive in when the market is down
The best time to invest in the stock markets is when the market in its entirety is not performing well, this enables the investors to invest lower amount and then when the market revives (even to its normal) the investor is at a profit because he can already sell and earn profits a the general price of the stock.
Management is the key
The importance of management of a company cannot be emphasized. Often the right leadership is able to turn the operations of a company for better or for worse according to their skills and expertise. Thus analysing the track record on management personals or at least having a brief look at it in case of a major change is recommended.
Know when to exit
We all want to earn profits thus the rooky mistake made by investors is often to not sell the stocks on a decent amount of profit in the hope of getting a better profit. If the stock is one that you do not wish to keep and is planning to sell in the near future you should do it a price which allows you to gain decent profits and not be led by your greed to unreasonably high profits because the situation can easily be reversed leading you to be in a much worse position.
Stay updated
Probably the worst mistake investors make is to invest and not keep track of their investments, a weekly analysis is recommended in the ordinary course of business.
Conclusion
The stock exchange markets provide a good investment option but the investors need to exercise caution to safeguard their interests.
References
- https://www.adityabirlacapital.com/abc-of-money/advantages-vs-disadvantages-of-investing-in-a-stock-market
- https://in.stockinfinities.com/tutorial/1576239521/advantages-and-disadvantages-investing-stock-market46f1346
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