It is a highly risky act that can leave you bankrupt.
by Sajjad Bazaz
A Kashmiri investor, after hearing overhyped stories of profits earned in the stock market, became a victim of his ambition. He invested in the stock market only to see his entire capital amount lost. However, he didn’t let the loss discourage him from investing further in the market.
He analyzed his mistakes and re-strategized his investment pattern in line with his risk bearing capacity. Today he is counted among trustworthy market analysts in India.
Some time back, I had an opportunity to talk to talk to him. Being an authority on the subject now, he narrated his own tale of losses. He ventured into the stock market when he saw some of his friends multiplying their money while investing in some shares of companies. To make quick bucks in the same stream, he obtained a cash loan of Rs.50,000 from Citibank and invested it in the stock market. To his delight, only after six months, his half a lakh rupees investment appreciated and stood at Rs.2 lakh. He started calculating appreciation on his investment at the same pace and without any planning and knowhow of the market mood. He reinvested the money in some other stocks with an objective to gain more and more. But after some time, he was shocked to see that the value of his portfolio of stocks had gone down considerably. He had even lost 50% of his original investment of Rs.50,000.
Even as he was shocked and surprised, he kept his cool and thoroughly tried to understand the market. After some time, he was able to hold a grip on the tricks of the trade which led him to becoming a leading analyst on the stock market in India. Not only this, he became country head (equities) and is one of the leadership members of a reputed new generation private sector bank in India. Today, he counsels investors by way of his expert comments on the movement of the stock market on various reputed television channels. But the story isn’t same when it comes to other Kashmiri investors, as most of them have turned out to be losers in the market.
The investor scenario in J&K as compared to the rest of India, such as markets in Mumbai and New Delhi, continues to be quite primitive. The investors are often unaware of the opportunities there in the market vis-à-vis their quality. After having easy access to the capital market, most of the local investors exercise investment options freely without properly assessing the quality of the options and the quantum of risk they may face.
We don’t have financial clinics for wealth management services here. Most of our investors are more into the business of trading. And borrowing money for trading is a passion catching up fast among these investors. If local market players are to be believed, most of these traders end up losers. Most of them don’t analyse their mistakes and consider investing in the stock market as a part time activity. They have turned themselves into a rudderless boat.
Investors use different ways to borrow money to pay for stocks. They take a personal loan or pledge their property or gold. They count on friends, borrow funds from them and invest in stocks. In this case, they don’t have to pay interest or any other charge. Brokerage firms have kept borrowing facilities at the disposal of their clients.
Why do investors borrow money to stay invested in the stock market? I have come across investors who resort to borrowing after working out some calculations on paper. They work out a handsome gap between the return on investment in stocks and interest payable on loan amount. Calculations on paper may look like they are practical. But in reality, borrowing money to pay for stocks is an extremely risky strategy. This strategy simply multiplies risk of losing money.
Let’s have a look at the facility made available by brokers where an investor can borrow money to pay for stocks. This debt trap is extended by the brokers under a palatable name: margin. This margin facility, of course, increases the purchasing power of the investors, but simultaneously exposes them to the potential for higher losses. Before taking a route of margin to maximize returns on investment, investors first need to understand its operational mechanism.
Primarily, margin facility is not suitable for everyone. An investor can lose more money in the market than he has invested. If the stock price decreases, substantial losses can mount quickly. For example, your stock which you bought for Rs.100 falls to Rs.50. If you fully paid for the stock, you’ll lose 50 percent of your money. But if you bought on margin, you’ll lose 100 percent, and you still have to come up with the interest you owe on the loan.
In case of loss, an investor whose portfolio consists of stocks bought on margins shall be asked by the broker to deposit additional cash or securities in his account that too on short notice to cover the losses. Brokerage firms may even sell some or all the stock without consulting the investor to pay off the loan extended in the shape of margin.
However, you can bank on margin facility for a temporary purpose. In case you are looking for a particular stock and that stock is now at the price where you want to enter. You have money in your bank, but you’re not in a position to transfer it now. Here you can avail margin facility from your broker and pay it back immediately.
Precisely, you should not borrow funds to pay for the stocks. It is a highly risky act and can leave you bankrupt.
Meanwhile, the financial market is flooded with varied financial instruments and it is impossible for an individual to understand everything that is available for them. In this crowd of financial instruments, individuals cannot pick what is best for them. Only a good financial advisor can help an investor to put the investments in the right place.
A financial advisor is like a medical doctor for an investor. You may think of yourself as a knowledgeable investor for having access to financial information, but the fact is that, in the present times, the advice of a financial advisor in the matters of money management, especially in the stock market, cannot be overlooked. The advice based on your particular situation and goals can help you minimize financial risks. And remember, even though he may be sharing some investment tips with you, a stock broker is not a financial advisor.
