Novice investors may see the task of investing for their future as a very daunting, possibly scary task. Some investors may have no idea where to start, some may feel like they are not qualified or educated enough to invest their own money. I am here to tell you that anyone can invest like someone on Wall Street, you just have to keep some basic rules in mind when investing. This list has 10 basic rules that every investor should know. While some of these rules may be common sense, I did my best to go more in-detail on WHY the rule is on the list and hopefully you will be able to learn a thing or two.
1. Buy Low, Sell High – This is Investing 101, and this is arguably the MOST important rule when buying and selling stocks. You would be surprised how many people forget this. By buying a stock when the price is low, you have essentially locked in your profit because you bought at such a cheap price. Novice investors get scared easily and second guess their investing abilities and unfortunately they lose a lot of money by forgetting this simple, common sense rule. When a novice investor owns a stock and the price starts to fall, a newbie investor might get scared seeing the price drop and would sell their stock- thereby locking in those losses. However, an experienced investor would just recognize that stock price fluctuations are common and they would hold onto their shares and wait for the stock price to rebound, in fact, experienced investors may look at this as an opportunity to buy even more shares of the stock while it’s cheaper. Keeping this rule at the forefront of your investing decisions will ensure that you make smarter investment choices.
2. Buy What You Know – The great investor Peter Lynch actually came up with this rule in his bestselling book “Beating the Street”. If you can’t explain, in simple terms to a 10 year-old, what the company does or how they make money then you don’t understand the company. This is an important rule and it can actually give you an edge to earning higher returns than Wall Street. For instance, if you are an IT professional, and you see that a company, let’s say Microsoft, has come out with a software that will revolutionize the IT profession forever. Upon release of the software you don’t see a change in their stock price but due to your background and IT expertise, you can see the potential growth of the company.
3. Pay attention to fees – This can be a major cost when investing, but by picking the right brokerage firm or lost cost fund you can save A LOT of money! Some brokerage firms charge a flat fee per transaction so this can mean that you get charged $5-$35 for each time you buy or sell shares which, for novice investors that don’t have a lot of money, this can be a lot of money to pay. If you buy a stock that costs $50, and the broker charges a $5 fee, you are really paying $55 for that stock, which means that stock would have to increase 10% to $55 just to break even. Mutual funds, especially actively managed ones, tend to charge very high fees, usually as a percentage of the money you have invested. These fees usually range from 1-3% but can go as high as 8% in some cases. That means that if you earned a return of 10%, and your advisor charges a 2% fee, you really are only earning 8%, and the worst part is that even if the person managing your money is losing money, they are still taking their commission. That is why I usually recommend index funds and low fee, passively managed mutual funds. If you want to manage your own money, I recommend using Robinhood (which I also personally use) which is a free investing app. They don’t charge commissions on trades and they don’t have any hidden fees. I will include the link to sign up for Robinhood below, I believe if you sign up with the link below you will get a free stock, like Apple, Ford or Facebook.
4. Invest for the long-term – When you invest, you want to make sure you will not need that money for at least 5-10 years. Your money grows when you allow it to sit there and let the interest compound. In addition to tax penalties, you may incur other penalties if you withdraw money from your 401(k) or other IRA before you have reached retirement age. Apart from your investment account, you should have some money in the form of cash, this is for two reasons, this will protect you from borrowing from your 401(k) or IRA because having cash reserves can act as a safety net if you fall on rough times. Another reason to have some money in cash is that if there is a very attractive investment opportunity, you won’t have to sell shares of other stocks to free up cash, you will already have that money available. When buying a stock, it is always good to try to imagine where you see that company in 5-10 years, if you see them growing and expanding their business internationally, then that would be a good company to invest in. If you think the company’s key products and/or services will be obsolete in 5-10 years because the company hasn’t innovated their products or services then that company would not have a positive earnings outlook.
5. Diversify your portfolio – Diversification is so important to lowering your exposure to risk when investing. If you’ve ever heard the old adage “Don’t put all your eggs in one basket” then you would understand why outing all your money in just one or two stocks would be a bad idea. There are two kinds of risk when it comes to investing, one is systematic risk and the other is unsystematic risk. Systematic risk, also called market risk, is the probability of loss with the entire market or segment whereas unsystematic risk, also called diversifiable risk, is a specific risk that is associated with a certain industry, segment, or security. You don’t have to necessarily worry about systematic risk, because that is just the risk associated with investing in the stock market, which is inherently risky. However, you can completely eliminate the unsystematic risk of your portfolio just by diversifying. This means that you buy stock in different companies, across different industry segment. Research has shown that by just owning 10-20 different stocks, you have eliminated most of the unsystematic risk of your portfolio. In fact, after about 20 stocks, the marginal decrease of unsystematic risk of adding additional stocks is negligible, so a portfolio of 500 stocks has roughly the same risk as a portfolio with 20 stocks. That should be promising to a novice investor with not a lot of money because they can easily diversify their portfolio.
6. If it’s Too Good To Be True, It Probably is – Enron and WorldCom are just a couple of examples of companies that seemed like great stocks to buy in the 2000’s. But always do your homework on a company before you decide to hand over your hard-earned money to own their stock. Beware of advisers or fund managers who also promise outrageous returns, because there are plenty of fraudsters out there who want will say anything to get your money. Bottom line: do your research before investing and always be wary of a deal that seems too good to be true.
7. Take Advantage of Free Money – So many people are losing out on free money. How? Well, many employers offer 401(k) match, usually up to a certain percent. If your employer has a 401(k) match up to 5%, then if you invest 5% of your income, they will match your 5% investment, so in theory you are investing 10% of your income. Many people don’t realize they are missing out on free money so talk to someone in Human Resources to find out if your company offers a 401(k) match, if so, make sure you are utilizing it to its fullest extent.
8. Create Financial Goals – Creating financial goals is important in determining your investment strategy and making sure you’re on track to reach your goals. Without creating financial goals, you’d just be investing aimlessly and crossing your fingers, hoping by the time you’re 65 you have enough money to retire. By creating benchmarks, you can make sure you are investing enough to stay on track. For instance, let’s say you want to save money for your child’s college tuition, you have 18 years and over that time you would like to earn $100,000. How do you know how much to invest to make sure you reach that goal? How much should you have after 6 years, 11 years, etc.? Well, that is exactly why you need to create your financial goals because you can’t make sure you’re on track if you don’t know what you’re working towards.
9. Continue adding to your investment – Continuing to add money to your investment portfolio is like planting a seed and continuing to water the seed. Over time, your seed turns into a plant and it will continue grow and flourish when watered. The same is true with your investment portfolio. To illustrate this point we will do some math, let’s say you invest $10,000 now and don’t invest any more money and you expect to earn a 10% return, in 40 years you would have about $450,000. Now let’s say you continue to invest an additional $10,000 every year during that 40 year span, you would earn over $5.3 million. Which would you rather have, $450,000 or $5.3 million? If you answered the latter, then as long as you keep investing, your investment will continue to grow and compound interest and you will be a millionaire before you know it.
10. Don’t Speculate – Many novice investors are enthralled by the idea they could be the next great investor. They think that if they can invest in the next Amazon, Apple, or Microsoft type stock that they will be the next millionaire or billionaire. Many people do this by investing in penny stocks because they think that the upside is unlimited but the downside is you lose all of your money. Unfortunately, the stock market isn’t a get-rich-quick-scheme, and if it was as easy to invest in the next big company then everybody would do it. The truth is, most of the original investors in companies like Amazon, Microsoft, or Apple were “insiders” and these people are employees, friends or family of the employees, venture capitalists etc. Additionally, don’t ever buy a stock just because you think someone else will want to buy it at a higher price. This is what people did with real estate before the housing market imploded in the late 2000’s, people got stuck with houses that were worth 3 times more their intrinsic value. Once the bubble burst, they were on the hook with an asset that they could only resell for a fraction of what they paid for it. The same thing is true with the stock market, always buy stock based on its intrinsic value, rather than what you think you might be able to sell it for in the near future. Speculating is not real investing, it’s gambling and just like most gamblers, you’ll probably lose your money.