“Investing in stocks for beginners”. If you Googled that or a similar search query to get here, you are already better off than most beginner investors who jump the gun and invest their money in a stock that they are impulsively excited about. Emotional investing is usually poor investing. Investing needs to be based on reasoning and information. Below are basic but strong foundation tips that will help you as a beginner who is looking to invest in stocks.
Investing in stocks for beginners
Set a realistic timeline!
The first thing you must do as part of your beginner investment process is to set a timeline for your investment in stocks. Whether it is $1,000, $5,000 or $10,000, you need to have a very clear picture of how long you want to stay invested in stocks. This doesn’t mean that you have to stay stuck with a particular stock for whatever time period you commit, but it will definitely do you a world of good if you don’t change your mind and keep liquidating stocks to cash before your timeline is up. Don’t also make the mistake of setting short term targets. Setting short term targets will mean that you will pull out of your stocks in volatile times, even at losses, to then riskily reinvest with even more aggressive returns, causing a downward spiral.
Most beginner level investors go wrong at this basic step of choosing a timeline for their investments. Investing is not something you should get into to make quick money. A one year investment period is considered bare minimum for a good equity investment. 5, 10 or more years is even better.
Most beginner level investors buy a stock, for let’s say $100, panic when it drops to $90 in the second month, pull out the cash, invest that $90 in another stock, then again pull out when it drops to $80. It leads to a vicious circle or gambling with the principal investment amount, taking on more and more risks. When you buy and sell often, your brokerage fees are substantially higher and it will eat into your profits. You will also miss out on tax exemptions that you receive when you stay invested for more than a year. Most importantly, short term investing will almost always average out, meaning that there will be just as many losses to go with your profits, often leaving you in the red, because brokerage fees and taxes will add to your losses.
Investing is about earning about 8% to 15% returns over a year, not about earning 3% a month and thereby trying to earn 36% a year. Most beginner level investors run aggressive back of the envelope calculations just like the 3% a month or 36% a year and then are very disappointed when it doesn’t materialize. When high profile investors themselves earn low double digit returns or maybe a max of about 20% returns a year (on average), how can you as a beginner earn 36%. It just isn’t probable. We say probable and not possible because some will get lucky and will even double their money, or even more. But the average tale for the beginner level investor who wants aggressive returns is usually the disappointment of earning negative returns, sometimes steep negative returns.
If you can’t wait a year to earn about 8%, 10% or 12% or such a reasonable figure, you don’t want to invest, you want to gamble. Change that mindset. If you can’t change it, you are better off not investing.
Diversification with index and ETFs
Diversification is extremely important.Almost everyone has heard about cliche statements like “don’t put all your eggs in one basket” Yet, the exact same mistake is made over and over again, by millions of new investors. If not the mistake of investing in just one company, they invest in 2-3 companies, thinking it is diverse enough. An ideal diversification however is when an investment portfolio has investments in 15 to 20 companies, that too across various sectors. Such diversification is easily achieved with investments in index funds or exchange traded funds, as discussed below.
You know what the Dow Jones and S&P 500 are, right? They are indices that basically reflect the collective performance of prominent companies that are leaders or benchmarks in their space. The upside to investing in such funds is that your investment is automatically divested into a large number of high quality companies. The downside is that there are not much realistic chances to earn very aggressive returns either, returns that might be possible if you handpicked small or mid cap companies that have high growth potential.
Below is a chart that gives you the average return of major indices, over various investing timelines. As you can clearly see, the longer you stay invested, the greater the chance of earning impressive returns.
|Index||1 Year Return||5 Year Return||10 Year Return||25 Year Return||40 Year Return (Since 1976)|
|Dow Jones Industrial Average||12.71%||71.50%||63.01%||510.23%||1824.68%|
|12.71% per year||14.3% per year||6.3% per year||20.4092% per year||45.61% per year|
|10.81% per year||18.87% per year||6.76% per year||18.16% per year||51.30% per year|
|Nasdaq 100||14.51%||135.80%||204.87%||132.48% (From 1999, 17 yrs)||n/a|
|14.51% per year||27.16% per year||20.48% per year||7.79% per year (for 17 yrs)||n/a per year|
|6.91% per year||17.95% per year|
Returns are as per what charts indicated in Google Finance
Returns do not include various investment costs such as load fees, expense ratios, tax deductions etc
Numbers are essential to investing
If you want to be a good investor, you will need to learn about fundamental investing. Understanding fundamental financials like balance sheet, income statements and cash flow statements is essential to understanding if a company will be a good investment. A company might be amazing at what they do. But, this doesn’t necessarily have to translate to their financial performance. They are two completely different aspects.
If you are investing in specific companies, you are without a doubt going to have to understand what balance sheets are, what P/E ratios are, if cash flows are healthy, if debt repayment is too much of a burden, what EBITDA is, and so on. Even if you don’t understand such technicalities intricately, you will need to interpret these numbers at least a basic level when you invest. Our article on how to pick a stock to buy will summarize what basic technical details you will need to familiarize yourself with, before picking a stock. You can also peruse our investing section at Money Looms, to find more posts that might interest you.