Investors beware of: Brokerage and taxation!

You probably know the concept that all your transactions in the stock market are done though a "stockbroker". A stockbroker earns a commission on whatever transaction you make. Suppose you make a transaction of Rs.2000, and the stockbroker charges you a 3% commission, then you have to pay the stockbroker Rs.60 (3% of Rs.2000) for the transaction. So your total investment in the transaction in “not Rs.2000”. The total investment in the transaction is Rs.2060/-

So after sometime, if the price of the stocks you invested in goes up to Rs.2060 then you have not made any money because the total amount you invested was Rs.2060/-

What is more, even when you sell the stocks, you have to pay the broker brokerage of 3%. This means that, when you sell the stocks for Rs.2060, you have to pay the broker Rs.61.6 so the profit of Rs.60 you made on the transaction is gone, in fact you actually make a loss of Rs.1.6!!

So in effect even though you made a profit of Rs.60 because your stock price went up, you have actually made a loss.

If combine this with the fact that inflation reduces the value of money over time, you are just loosing money if you do not invest wisely without understanding brokerage and inflation.

Important note about brokerage: Brokers make money on whatever transaction you make. Whether you buy or sell, brokers will make money. Because brokers basically make money on transactions. Because of this, brokers tend to encourage you to trade. They don’t really care about whether you make a profit or loss. They just care about whether you are trading. The more money you are using for trading, the more they will make. Because of this, it would be wise to not blindly follow your brokers advise. The broker will give you “hot tips” etc. not because they are looking out for you and your profit, but because they are thinking about their own personal profit!

There is even one more factor that eats into your money. Tax!!!

Please note: We are not in any way encouraging you to not pay tax! We are just educating you about it. 

There is a “short term capital gain tax” in our country. For a short term (less than one year) you have to pay tax on any capital gain you make though the stock market trading. How much % tax you have to pay, depends on which "tax bracket" you fall in.

Just to give you an idea. If I make Rs.100 though a transaction in the stock market, since I fall in the 33% tax bracket. It have to pay Rs.33 of that to the government!!

Please note: The government encourages you to be a long term-investor by having no long term capital gain tax. If you make a capital gain by investing for a period greater than one year, the you do not have to pay any tax on the money you make.

Now combine this short term capital gain tax with brokerage and inflation! Think about it for some time. You will almost make nothing on a small profit gains! If you want to make money out of the stock market, you must make large profit gains.

Conclusion: As a general rule, just for the sake of simplicity, your investments must grow at a minimum rate of 15% per year to stay ahead of inflation, tax and brokerage!! Remember this when making all your investments.

This concludes our basics of the stock market guide. There is lot more to learn! And the best way to do it is to start investing! (Don’t invest too much in the beginning but do start!) Once you have your money in the market, you will start to understand things a whole lot better!

Best of luck!

Jai Hind.

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Table Of Contents

  1. What are stocks?
  2. Why do companies issue stocks?
  3. What causes stock prices to change?
  4. What are the Sensex and the Nifty?
  5. 3 important things that every investor MUST remember!!
  6. How to decide which stocks to buy?
  7. Basics of fundamental analysis!
  8. Earnings per share (EPS) ratio and what it means?
  9. Price to earnings (P/E) ratio and what it means?
  10. PEG ratio and what it means?
  11. Inflation and how it silently eats your money!
  12. Brokerage and taxation…