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Invest Right, Don’t Speculate

The lure of high returns and quick gains from equity tips, cryptocurencies, and equity F&O can be enticing. But remember, return of capital is more important than return on capital

Investment happens when you save from your earnings and invest in a financial instrument to make it grow in the future. Speculation occurs from investing in a high-risk instrument with the intention of making a quick profit. Investment is about method, planning, adequate time horizon and fundamentals, while speculation is like a whack off the last ball in a T20 cricket match, which could easily get caught.

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Equity Derivatives

Speculators also serve the market: they impart liquidity by taking trading positions and risks.

However, it is important to note that professional traders, such as broking entities and foreign portfolio investors (FPIs) have the bandwidth to understand the risk, deep pockets, and expertise to take equity derivative positions. But as an individual, you would not have the same bandwidth or funds or expertise to trade in derivatives.

Unless you are full-time into trading and have an experience of many years, there is no comparison between a professional broker-trader or financial institution and you as an ordinary investor.

Equity F&O

You should invest in equity either directly if you have the bandwidth, or through a mutual fund.

Recent data by the Securities and Exchange Board of India (Sebi) shows that 91.1 per cent of individual traders (about 7.3 million traders) lost money in the equity futures and options (F&O) segment in 2023-24 (FY24).

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Being optimistic is good, but in case of trades in equity futures and options, the dice is loaded heavily against you

On an average, they saw net losses of Rs 1.20 lakh per person in FY24. During FY22-FY24, 11.30 million individual traders incurred a combined net loss of Rs 1.81 lakh crore in F&O. Only 1 per cent managed to earn profits exceeding Rs 1 lakh, after adjusting for transaction costs.

The ‘smart boys’, the proprietary traders and FPIs, do it through computer algorithms, known as algo trades, and 97 per cent profits of FPIs and 96 per cent profits of proprietary traders came from algo in FY24.

Almost half of all the F&O traders in FY24 (4.2 million traders) were those who had traded for the first time in three years in the segment.

This indicates that young individuals fall for the dreams sold by certain ‘finfluencers’ that you do a short course which will make you an ‘expert’ in derivatives trading, and you can earn in crores.

The individual traders who lost money come from humble background, not having the kind of money that can be used for speculation. Over 75 per cent of individual F&O traders (6.54 million traders) in FY24 had declared annual income of less than Rs 5 lakh.

More than 75 per cent of the loss-makers persisted with trading in F&O, despite making losses in the preceding two consecutive years. This is a behavioural trait. People tend to be over-optimistic or over-confident that despite making losses, they can recoup them in the future and persist with their trading in the hope of earning profits.

Being optimistic is good, but here, as the data shows, the dice is loaded heavily against you, and you hardly stand a chance, more so if you are from a middle-class background.

Cryptocurrency

This is another area you should avoid. Data shows that Bitcoin and other cryptos have appreciated greatly in recent years. There are also various mobile apps where you can buy Bitcoin in small affordable sizes.

Though you will own a part of a Bitcoin, you would be participating in the price movement in the market. The attraction of rising prices lures fresh investors. And this is different from equity derivatives, as most people who have invested in crypto have made money. For all you know, prices can go up in future as well. However, the point is, at what level of risk you want to subject your hard-earned money.

For any investment, it is a pre-requisite that you have a basic understanding of what you are getting into, and what the risks and returns are—the risk-reward ratio.

In cryptocurrencies, the basics are a grey area. Though it can be treated as a currency as it is gaining increasing acceptance, but the other side of the “coin” has to be considered too.

Usually, a currency becomes a currency by sovereign acceptance. In the case of Bitcoin, the only one country to approve it as legal tender is El Salvador. More countries may follow suit in the future, but by and large, major countries of the world are against it. This means, that it is a “currency” by private acceptance, without legal sanctity.

Though cryptocurrencies are gaining increasing acceptance, lack of regulatory support and high risk are major concerns

In April 2018, the Reserve Bank of India (RBI) released a circular captioned “Prohibition on dealing in virtual currencies (VCs).”

It said that entities regulated by RBI (banks, and other regulated institutions), shall not deal in VCs or provide services for facilitating any person or entity to deal with or settle through VCs. It meant that the formal banking channels cannot be used for settling trades in cryptos or for to-and-fro flows from real money to cryptos.

However, the Supreme Court, in a judgment in March 2020 set this circular aside. Hence, for clarity, RBI issued a circular in May 2021. This circular said, “It has come to our attention through media reports that certain banks/regulated entities have cautioned their customers against dealing in virtual currencies . . . are not in order, as this circular was set aside by the Supreme Court.”

So far so good. Citizens have the right to use real currency to purchase virtual currency and vice-versa. However, one thing is clear. RBI does not endorse cryptocurrencies and is allowing transactions only because of the Supreme Court judgment.

Broadly, there is no regulatory support for crypto, which is there in other investments, in the form of a regulator, an exchange, the legal framework, and so on.

In case of any dispute or theft through hacking of your computer or other technical issues, such as your computer crashing or the misplacing of your password, you do not have a redressal mechanism in case of crypto.

So, before you invest your hard-earned ‘real money’ in exchange for a virtual ‘coin’ or a ‘token’, you should have clarity on what is it that you are investing in? Is it an asset class, such as equity or bond? You should also have clarity on the logic. Are the apps making it easy to invest or are you convinced about it?

Conclusion

Since you work hard to earn the money you invest, your criteria should not be the delivered returns, or the lure of high returns, but rather the risk level you want to subject your money to. Besides these risks, there could be other schemes, such as “plantation schemes” which are not regulated by a regulator, where they sell dreams rather than investments. Return ‘of’ capital is more important that return ‘on’ capital.

By Joydeep Sen, Corporate Trainer and Author

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