Article

Why Do People Invest in Shares?

date December,  2023
time 8 mins read

Explore Benefits, Risks, And Considerations

Investing in shares is a financial journey that intrigues many as individuals seek avenues to grow their wealth and secure their financial futures. Shares are also known as stocks. They represent ownership in a company and offer investors the potential for capital appreciation and dividends. This form of investment enables individuals to participate in a company’s success and benefit from its profitability. The captivity of potential returns, coupled with the excitement of being part of a business’s growth, motivates people to dive into the world of shared investment.

But what factors drive individuals to choose shares as a preferred investment vehicle? Let’s find it out in this article.

What are Shares?

A share signifies ownership in a company, granting shareholders a stake in its equity. Shareholders are eligible for dividends, a share in profits, and also shoulder losses. Essentially, being a shareholder means owning a percentage of the company corresponding to the shares held. This ownership is commonly managed through a share market app, providing a straightforward way to track and trade shares.

There are two primary categories of shares: equity shares and preference shares. These classifications differ in terms of profitability, voting rights, and their treatment in the event of liquidation.

Bonds vs. Stocks

When it comes to investment choices, bonds and stocks stand as distinct options, each with its unique characteristics.

Here’s a comparative glance at the key differences between these two financial instruments:

Criteria Bonds Stocks
Ownership Debt instrument, represents a loan to issuer Equity instrument, signifies ownership
Returns Fixed interest payments Dividends and capital appreciation
Risk Generally lower risk, steady returns Higher risk, potential for higher returns
Voting Rights Typically no voting rights Voting rights for equity shareholders
Maturity Has a fixed maturity date Perpetual existence, no fixed maturity

Understanding these distinctions is crucial for investors to make informed decisions aligning with their financial goals and risk tolerance.

How Money Is Earned from Stocks/Equity Shares?

Investors can earn money from stocks or equity shares through various means:

1. Capital Gains

Investors earn from stocks through capital gains, categorized as short-term (STCG) for shares held under a year, taxed at a higher rate, and long-term (LTCG) for shares held over a year with tax benefits. Profits from selling shares yield capital gains, providing a key avenue for financial growth, subject to the duration of shareholding.

2. Dividends

Investors can earn money from stocks through dividend income when companies distribute profits to shareholders. As part of their profit-sharing, companies issue regular dividend payments to stockholders. This provides a reliable income stream for investors, enhancing overall returns. Dividend-paying stocks are particularly attractive to those seeking a combination of capital appreciation and a steady income flow.

3. Bonus Shares

Companies issue bonus shares as a reward to existing shareholders. These are additional shares distributed free of cost, proportionate to existing holdings. While the overall value of the investment increases, the proportionate ownership remains the same. Bonus shares are a way for companies to share their success and enhance shareholder value without affecting their financial position.

4. Rights Issues

Shareholders can benefit from a company’s rights issues where existing shareholders are offered the privilege to purchase additional shares at a discounted rate. This enables investors to increase their shareholding at a favorable price, potentially enhancing their overall returns when the company issues new shares to raise capital or finance specific projects.

5. Stock Splits

Stock splits involve dividing existing shares into multiple shares, adjusting the price proportionally.  For example, in a 2-for-1 stock split, shareholders receive two shares for each one they previously held, halving the share price. This makes shares more accessible to investors without fundamentally altering the company’s market capitalization.

What Are the Benefits of Equity Investment?

Equity investment in India offers numerous benefits.

1. Potential for Higher Returns

Equity investment offers the potential for significant returns as the value of a company’s shares can increase over time, leading to capital appreciation. This potential for profit attracts investors seeking higher returns than other investment options. However, it’s important to acknowledge that with the potential for higher returns comes a corresponding increase in risk, as stock prices can be volatile, and there is a possibility of incurring losses.

2. Capital Appreciation

Capital appreciation involves the potential increase in the market value of stocks over time. As underlying companies grow and generate higher profits, stock prices may rise, allowing investors to benefit from the appreciation in the value of their holdings. This leads to potential financial gains.

3. Dividend Income

Dividend income involves companies distributing profits to shareholders. Investors receive regular payments, providing a steady cash flow. This income is distinct from potential gains in stock value and adds a stable element to returns, enhancing the appeal of equity investments as a source of both capital appreciation and periodic financial returns.

4. Ownership Stake

Being a partial owner of invested companies, investors gain influence through voting rights at shareholder meetings. This ownership stake allows them to participate in crucial decisions affecting the company.

5. Liquidity

The liquidity facilitates the easy buying and selling of stocks. This attribute is advantageous for investors, as it ensures they can convert their investments into cash swiftly. Liquidity is a key factor that contributes to the efficiency and accessibility of the Indian stock market. This allows market participants to execute transactions with relative ease.

6. Diversification

Diversification involves spreading investments across various assets to reduce risk. In India, equities offer an avenue for this strategy. By investing in different stocks across sectors, investors can mitigate the impact of poor performance in any single investment. This approach aims to achieve a balance that can potentially enhance overall portfolio stability and resilience to market fluctuations.

7. Inflation Hedge

Equities can act as an effective hedge against inflation, preserving and potentially increasing investors’ purchasing power over time. Historically, the returns from equities have often outpaced the rate of inflation, providing a valuable means to combat the eroding impact of rising prices on the real value of financial assets.

8. Tax Benefits

Long-term capital gains on Indian equities may enjoy favorable tax treatment, with exemptions up to a specified limit. This tax benefit encourages investors to keep onto their stock assets longer, which may boost returns and encourage portfolio stability.

What Are the Risks of Investing in Shares?

Investing in shares has risks like any other investment. Some key risks associated with investing in shares are:

  • Market Volatility: Share prices can be highly volatile, influenced by market trends and economic conditions.
  • Company Performance: Poor financial results or mismanagement can lead to a decline in share value.
  • Economic Factors: External factors like inflation, interest rates, and global economic conditions impact share prices.
  • Liquidity Risk: Some shares may be less liquid, making it challenging to sell them quickly at a desired price.
  • Regulatory Changes: Changes in Indian financial regulations and policies can affect the stock market.
  • Currency Risk: Fluctuations in the Indian Rupee can impact returns for foreign investors.
  • Lack of Diversification: Investing in only a few stocks increases portfolio risk.

How Beginners Can Start Investing in Shares?

Making your first investment in Indian shares might be rewarding. Beginners must plan carefully and comprehend the market. For beginners, here are some steps to start investment journey:

1. Set Financial Goals

Set clear financial goals to guide your investment journey. Define whether you seek short-term gains, long-term growth, or specific objectives like a home purchase. Understanding your investment goals helps align your strategies, risk tolerance, and time horizon. This provides a roadmap for making informed decisions in the dynamic stock market environment.

2. Assess Your Risk Tolerance

Assess your risk tolerance by evaluating how comfortable you are with potential financial losses and fluctuations in your investments. Consider your risk appetite – whether conservative, moderate or aggressive. Align your choices with your risk profile to make informed decisions that suit your financial goals and emotional capacity for market fluctuations.

3. Build a Budget

Before investing in shares, create a comprehensive budget that outlines your income, expenses, and savings. Ensure you have an emergency fund to cover unexpected expenses. Determine the portion of your income available for investment, aligning it with your financial goals and risk tolerance to establish a solid foundation for your stock market journey.

4. Open a Demat Account

Open a Demat account with a reputable brokerage firm to facilitate the electronic holding and trading of shares. A Demat account eliminates the need for physical share certificates, making transactions more efficient. It serves as a secure platform for investors to buy, sell, and manage their securities, essential for participating in the stock market in India.

5. Start Small and Diversify

Start with small investments and gradually increase as you gain experience. Diversify your portfolio across different sectors to spread risk. This approach helps mitigate potential losses and provides a more balanced exposure to the market. It also allows for a better understanding of various industries and their performance. This contributes to a well-rounded investment strategy for beginners in the Indian stock market.

Different Ways of Investing in Equity Shares of Any Company

There are various ways to invest in equity shares of companies. Common methods are:

1. Initial Public Offering (IPO)

Participating in an Initial Public Offering (IPO) involves buying shares of a company before they are publicly traded. Investors can subscribe to the IPO during the issuance process. This early investment provides an opportunity to capitalize on potential stock price appreciation when the company is listed on the stock exchange, potentially offering favorable returns to early investors.

2. Stock Mutual Funds

Stock Mutual Funds pool money from investors to create a diversified portfolio of stocks. Investors purchase mutual fund units, and professional fund managers allocate the funds across various stocks.

This method allows investors to benefit from a diversified investment strategy, reducing individual stock risk. Returns are based on the overall performance of the stocks in the mutual fund portfolio.

3. Exchange-Traded Funds (ETFs)

ETFs are investment funds traded on stock exchanges, mirroring the performance of a specific index or sector. Investors buy ETF units through brokers, gaining diversified exposure to a basket of assets. ETFs offer liquidity, low expense ratios, and flexibility in trading. Their market-driven returns provide indirect ownership of the underlying assets. This makes them a popular choice for passive investors seeking broad market exposure with reduced risk.

4. Systematic Investment Plans (SIPs)

Investors can opt for SIPs in mutual funds, contributing a fixed amount at regular intervals. This disciplined approach minimizes the impact of market fluctuations by averaging the purchase cost. SIPs offer a convenient and automated way for investors to steadily accumulate shares over time, aligning with their long-term financial goals.

5. Portfolio Management Services (PMS)

PMS involve professional fund managers handling individual investment portfolios for clients. Tailored to the client’s risk and return objectives, PMS provides a personalized approach to equity investing. It’s used by wealthy people desiring active management and skill in building and managing several stock portfolios.

6. Employee Stock Ownership Plans (ESOPs)

ESOPs allow employees to acquire shares in the company they work for, often as part of their compensation. This can be through stock options at a discounted price. ESOPs align employee and company interests, promoting a sense of ownership. However, it may result in limited diversification, as the investment is tied to the performance of a single company, potentially exposing employees to concentration risk.

What Are Popular Equity Investment Strategies?

Investors use various equity investment strategies to achieve their financial goals, but we have shortlisted 5 popular strategies. Some popular equity investment strategies are:

1. Value Investing

Value investing involves identifying stocks trading below their intrinsic value. Investors focus on companies with strong fundamentals, such as a low price-to-earnings ratio and high dividend yield. By assessing financial statements and ratios, they aim to uncover undervalued opportunities, anticipating that the market will eventually recognize and correct the stock’s true worth, leading to potential capital appreciation.

2. Growth Investing

Investors practicing growth investing focus on stocks of companies poised for above-average earnings and revenue expansion. This strategy involves identifying firms with high growth potential, often in emerging sectors. Investors analyze factors such as historical and projected earnings growth to capitalize on the expected upward trajectory, seeking capital appreciation over the long term.

3. Dividend Investing

This strategy focuses on selecting stocks from companies that consistently distribute dividends to shareholders. Investors seek stable or increasing dividend payouts, providing a reliable income stream. Dividend investing is favored by income-focused investors aiming for a combination of capital appreciation and regular dividend income.

4. Momentum Investing

Momentum Investing involves capitalising on recent stock price trends. Investors identify securities with strong recent performance, anticipating that these trends will persist. This strategy relies on technical analysis and the belief that assets showing upward or downward momentum are likely to continue their trajectory.

5. Contrarian Investing

Contrarian investing involves strategically going against prevailing market sentiment. Investors identify stocks currently undervalued or out of favor due to negative sentiment, anticipating a future reversal. This approach relies on the belief that markets sometimes overreact, presenting opportunities when sentiment diverges from a company’s fundamentals.

Conclusion

People invest in shares for various reasons, driven by the pursuit of financial growth, wealth accumulation, and portfolio diversification. The stock market offers opportunities for capital appreciation, dividends, and a hedge against inflation. Additionally, investors seek ownership in companies they believe in, contributing to their success. While the potential for returns exists, it is crucial for individuals to conduct thorough research, assess risk tolerance, and adopt a long-term perspective to navigate the dynamic nature of the stock market effectively.

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