Many Investors prefer to Invest in Direct Stocks. They believe this strategy can be a useful tool to generate long term wealth. There are some inherent risks in this path. I want to highlight some of those in this article.
- Inherently Individual stocks tend to be volatile. Historically Individual stocks have been more volatile than all other asset classes except for maybe Cryptos (which according to me is not an asset class). This inherent volatility can cause Stock prices to move in a single direction for an extended period of time. Large movements on either side can cause Investors to behave emotionally. Such emotional decisions driven by greed or fear usually cause losses for Investors.
- Stock prices usually move in sync with fundamentals. Top management and Promoters of companies are more attuned with the key fundamental changes that may impact the prices of their Company’s stocks. Thus, they are at a significant advantage when making buy/ sell/ hold choices regarding their own stocks. This information asymmetry in favour of insiders is disadvantageous for common investors.
- Stock prices are volatile because many factors impact them. Competition, regulatory changes, changes in taxes, raw material/ manpower availability, demand, substitution of goods/ service provided, disruption by a start-up, attrition among Key Management Personnel, possible accidents, frauds, legal Risks, currency Risks, Market can all impact the financials of a company and in turn its stock prices. For investors to keep in touch with so many factors of many different companies is practically impossible. Therefore, making well-informed choices regarding buy/ sell/ hold in a scientific manner becomes impossible. There are examples of many companies like Satyam, Reliance Power, Reliance Communications, Future Retail, Unitech, Punj Lloyd, Suzlon, Yes Bank, Bajaj Hindustan and countless others, whose stock prices have collapsed due to some or the other factor mentioned above.
- Many sophisticated operators manipulate stock prices, sometimes in cahoots with promoters. Operators handle the market mechanisms and facilitate price rigging of the stock via circular trading. Promoters manage positive or negative news flow regarding the stock via PR agencies based on Operator’s needs. This makes it tougher for investors to decide which stocks are going up based on fundamentals and which ones are going up thanks to manipulation.
In my experience, Mutual Funds are a more suitable route for Individual Investors to generate long term wealth.