New investors find it difficult to understand investing especially investing in the stock market. First-time investors lose savings and face a difficult time believing any friend or tip or investment guru another time. They prefer to park their money in risk-free government bonds paying very little interest and end up a lot poorer than they would have been if they followed some simple rules of investing. Here we compile three basic factors first-time investors fail to consider when they rush into investing.
Investing without a plan
You need to have a plan as a first-time investor. What are you investing in and why are you investing in that asset class? Say you have chosen to buy gold. Why? Because it has appreciated by 300% between 2005 and 2012? But it has also gone down in prices a little since 2012 (no growth for 6 years).
So gold is not something that promises endless growth in value. Nor does land or stock of petroleum companies or fracking outfit your friend thinks will make you a millionaire. You have to study the asset class in detail. Research into its historic highs and lows and why it happened. Such research was unavailable to the ordinary layman till the internet happened. But now it is neatly presented through several websites and YouTube videos. No one can say they were ignorant anymore.
Understand that each asset class carries an inflection point and at that point the curve changes from upward to downward – for gold it started in 2012 and it happens for every asset be it Apple stocks or a gold fund.
Guessing is NOT an investment strategy
“I guess that since everyone uses Amazon services in some way, prices of Amazon can only go up” – not really bad in theory and Amazon has indeed risen by about 575% in last 5 years. But what you do not know as first-time investors are that Amazon makes very little profit. Its stock rises because people expect that it will one day become very profitable. But it may not. Massive companies like General Electric have gone under. So has Compaq, Kodak, Enron, Nokia, Pan Am – veritable legends and powerhouses of their sector.
So do not guess but do your homework. Observe the world around you carefully. Notice what the trends are, what are the “sunrise industries” (by the time the pink papers write about it few million people will already have bought stocks in that sector). Buy carefully and after a lot of thought, not based on tips and rumors and hunches.
Understanding risk well and setting loss limits
Every investment comes with risk. That is the very nature of investment and first-time investors need to really, really understand it well. Investment in bonds of large sovereign economies like Norway, Austria, Canada, Singapore, USA (all with AA or AAA rating) is the closest you can get to risk-free investment but it pays very little maybe 2% at most. To grow your wealth you need to look at 10% and higher returns which usually means land or stocks.
Purchasing either is risky and you need to have the appetite for trouble. Let’s say you bought a stock for $20 on Monday and the day after Federal Reserve raised interest rates and your stock became $18.50 or less. Then the company suffered a bad quarter and it went to $16.75. What is your appetite and exit price? Only you can decide if stop loss will be at $18 or $15. No broker can decide it for you. Facebook shares debuted at $38 in 2012 went to $19 and hit $200 a few months back. Do you want an exit price of $25 or $150 is entirely up to your risk understanding?
Investing is hard work and hours of careful study or alternatively, you can hand your money over to a good fund manager and let him decide (which comes at a cost). Do your homework, be careful, never ever be impulsive, be calm in a time of a crisis and as a first-time investor you will come out on top.