Psychology

Stock market investment is like lending money to a friend

Most investors get into the market during its ‘bull phase’ – when there is positive news all around, the markets are hitting new highs everyday, business channels are giving bigger targets and you begin to hear even your friends making a lot of money from lesser known ‘multi-bagger’ stocks that are doubling and tripling.

Sounds familiar? If yes, then you’ve already seen the euphoria of the 2017 bull market in small and mid caps. The euphoria did not last and at the time of writing this article (October 2019), most of those stocks have fallen 50-60% from their January 2017 highs.

Like life itself, ups and downs will always be a part of the stock market, but the problem lies in investing in bad companies.

Companies that are not making profits, have high debt or poor management quality; are almost certain to fall even if they double or triple in a raging bull market. The problem is, most new investors don’t even do basic analysis of the financial statements and balance sheet of a company. Stocks are purchased on advice from friends, ‘tips’ on WhatsApp groups or targets given on business channels.

The simple yet effective way of approaching investing is to consider the money that you invest in a stock, as money that you would lend to a friend. You could also think of it as investing your money in a friend’s business.

Consider the following scenarios:

  • Would you lend money to a friend who doesn’t work and earn? Then why invest in a company that does not earn profits?
  • Would you give money to a friend who has borrowed a lot of money from others and hasn’t yet returned it back? Then why invest in a company that has borrowed a lot of money from the bank and is struggling with high debt?
  • Would you give your hard-earned money to a friend who doesn’t have a good character or has been involved in a crime previously? You wouldn’t even want to be friends, right? Then why invest in companies that have poor management?
  • Would you invest in a friend’s business if he isn’t passionate about his work? Then why not do some reading on the CEO of the company that you are investing in. Read and learn if the guy who runs the company is passionate and has a vision.

Look out for good qualities that you would like to have in a friend or a business partner. Apply those same basic rules to investing in a listed company and see how your very approach to stock market investing changes.

This simple way of thinking may not ensure success in the stock market (you have a lot of learning to do and experience to gain if you are a beginner), but it would help you avoid those initial blunders that have the potential to completely wipe out your invested money.

Bad companies, like bad friends, are best avoided.

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