Capital market investments don't have to be risky

Investment plays a pivotal role in an individual's financial planning, representing a crucial aspect of long-term financial security. Investment in the capital market has long been considered a very significant and lucrative long term investment avenue around the world. Bangladesh has been no different. 

However, the volatile nature of our market, lack of investors' confidence and incidents of past scams have long kept investors' wary about investing in the capital market of Bangladesh. But investing in the capital market does not have to be overly risky and fraught with possibilities of losing one's savings. 

By adopting a thoughtful approach and conducting thorough research, individuals can navigate the capital market effectively for long-term investments.

Invest for the long-term

It is essential for any investor who wants to invest in any equity share of a company to internalise the fact that he is investing in a business and should align his mindset accordingly. 

No sane person would invest in a business and would think of selling his shares within a week. The same logic applies to capital market investing. 

By buying shares, an investor owns a piece of the business that he believes is going to yield substantial returns in the long term. 

Important financial metrics investors must know

For an investor in the equity market, it is important to familiarise themselves with several important financial terminologies. 

First and foremost is the concept of revenue which is also called 'top line'. Investors must look for businesses with positive revenue growth over a consistent number of years. Investors must also assess how vulnerable the business is to macroeconomic factors. They should look for businesses that can withstand external shocks without significant impact on their top line. 

Another essential metric for investors to consider is Net Profit after Tax and Earnings per Share (EPS) and the trajectory of these two indicators over the years. EPS communicates how much money a company is earning for each share. 

However, just knowing these indicators on their own is not enough. Investors should also consider the P/E ratio which suggests the price investors pay per share relative to the company's earnings. Generally, a lower P/E suggests a more attractive investment. 

But in the case of financial institutions, the more important indicator to look at is the P/B ratio which measures the market valuation of a company relative to its book value. Profitability margins provide crucial insights such as Return on Equity, which measures how effectively a company's management is utilising shareholder's capital to earn profit, and Return on Asset, which measures how efficient a company's management is at utilising its assets. 

Long-term investors also emphasise the importance of dividend yield, representing the percentage return solely from dividends. Dividend is equivalent to fixed income and long-term investors should want a lucrative dividend yield along with potential capital gain from their equity investments. 

Value vs growth investing

Investors can approach capital market investing in two ways: value investing and growth investing. 

Value investors prioritise companies with high dividend yields, low risk and steady growth over a long period. 

Growth investors focus on companies with exceptional growth potential for the maximum capital gain and are not focused on dividend yield primarily. 

Investors may choose one approach or a combination of both based on their financial goals and risk tolerance.

Avoiding pitfalls: Key considerations for new investors

While investing in the capital market, new investors should be aware of pitfalls that can impede their success. An example of such a pitfall is the reliance on anchoring, where decisions are influenced by the initial purchase price of a security. Investors should avoid such a strategy and instead develop a coherent approach to decision-making. 

A common misconception among new investors involves continuously averaging the price of a share, believing that it will eventually lead to a positive capital gain. While this strategy can be beneficial, it is crucial for investors to assess both the fundamentals and current price action of a stock before committing to such decisions. 

Another misjudgment is the assumption that a stock trading at a 52-week low automatically signifies an attractive price. However, investors should be aware that the stock may be trading low because of its weak fundamentals and the price may go down further. 

Additionally, investors should guard against confirmation bias, approaching information objectively and critically. While margin loans are prevalent in the Bangladeshi stock market, new investors should avoid this before gaining confidence and achieving a track record of successful and profitable investments in the stock market. 

Many cautionary tales exist of investors losing everything through aggressive leveraged investing. It is preferable to invest with moderate return and lower risk instead of being aggressive and losing everything. 

The capital market is volatile and an investor is going to face ups and downs. However, this should not mean investors should change their investing strategy every six months. Those who adhere to a winning strategy, irrespective of temporary market volatility, are more likely to emerge as winners in the long term. 

Passive investing in Bangladesh

What we have so far discussed is called active investing. Another avenue of investing in the capital market is passive investing. Passive investing can be done through mutual funds, index funds or exchange-traded funds (ETFs). 

Bangladesh has yet to introduce index funds or ETFs. Nonetheless, investors can engage in passive investing by opting for either closed-end mutual funds or open-end mutual funds. 

Units of closed-end mutual funds are traded in the secondary market while units of open-end mutual funds are redeemed by the asset management companies that issue them. 

Mutual funds are managed by professional and experienced asset managers who are adept at managing risks and augmenting long term wealth of the investors. 

Diversification opportunities 

Investors also have the option to diversify their portfolio by investing in long term government treasury bonds and corporate bonds in the Dhaka Stock Exchange. Here, investors can choose to invest passively through fixed income funds managed by asset management companies or can actively buy and sell bonds themselves and participate in auctions. 

The tax rate on coupon payments in government bonds for investors is only 5% which is a lower rate than other available fixed income investments in Bangladesh. 

Additionally, there is no upper limit on investment amount and has greater liquidity than other fixed income investment alternatives. 

Prepare for a marathon, not a sprint

Investing in the capital market may sound exciting and risky. However, it encompasses not only thrill but also requires patience, determination and perseverance. 

And more importantly, capital market investing can serve as a significant avenue for attaining financial freedom. 

By dedicating time to educate oneself, one can anticipate that the market will reciprocate with substantial gains, making it a rewarding endeavour.

Arif Abdullah is a Senior Research Associate at EBL Securities Limited.