If you are new to investing – there are a few things you should know before you start betting your hard earned money on the next hot stock. Learning how investing works, having the right mindset, and setting a few rules can help you become a better investor. Here are 10 things you should know about investing before you get started.
1. BEWARE - There is an Endless Amount of Information, Experts, Critics, and Gurus out There!
Everywhere you look you will find people steering you in different directions when it comes to your money. Invest in this. Don't invest in that. This is the next big thing. That is about to crash!
Read everything with a grain of salt.
Digest the facts and be weary about opinions.
No one can predict the future of an investment. Learn everything you can so you are able to make the best decisions for your own money.
2. Think like a Business Owner (not a stock picker)
When you own an investment – you are a fractional owner of the business (shareholder). If you think like a business owner, you are less likely to make rash decisions with your investment.
Imagine that you own a small coffee shop that makes $50,000 in profit every year.
One day someone comes in an offers you $200k for your business – that feels good!
The next day someone offers you $1000 – seriously?
The next day another person says its worth $49k –eh.
The point is that the market price for your business will change everyday. What it is worth to you is completely different. Only sell your investment when you are ready to cash out or have a better plan for your money..
3. Valuation does not Equal Price
The price of a share does not reflect its value. You can't compare one stock price to another.
If Apple's share price is $100 and Tesla's share price is $1000.
This does not make Tesla 10 times bigger than Apple.
The valuation of a company does not simply equal the current share price. Stock prices are a reflection of cash flows, future growth and the durability of the business divided by the number of shares.
Don't compare the price of one share when deciding on an investment.
4. Know When to Sell (or when you were WRONG)
Being a long-term investor does not mean you are holding your investment forever. In fact you only truly MAKE money when you sell an investment. Owning an investment means you should be consistently monitoring the fundamentals of the business.
To help when to decide when to sell your investment ask yourself these three questions...
Has the business deteriorated permanently or shifted away from the reason you invested?
Are there are better opportunities out there for my money?
Was I wrong about the business?
If you answer YES to any of these questions, it's probably time to sell your investment and find a new home for your money.
If you are on the fence, consider selling 50% of your shares. You can always sell the rest or even add more shares at a better price.
5. The Difference Between Short-term Trading and Long-term Investing
We're fans of Long-term Investing here at The Afford, however there can be a place for short-term trades in your investing journey. You just need to know the difference – and have a plan for each.
The main difference is the "goal". Are you looking for long-term wealth or a quick extra income? Both are acceptable answers in your overall journey – but you need to make a choice when allocating your money.
Long-term investing is a slow and steady race of generally "safe" investments such as long-historied blue chip stocks, index funds and ETFs. Real Estate can also be considered a long term investment. If you are looking for long-term wealth and a "set-it-and-forget it" with your investment dollars – long-term investments is where you need to be.
Short-term investors are trading stocks– buying and selling in a day, week, or month. This is good for people who understand the specifics about the businesses to stocks they’re trading. Most short-term investors have a lot more information than others about their investment and indicators on when to get in or get out.
Long-term wealth is created by using the power of compounding over time. Its nearly fool-proof.
Short-term investments are made on events, trends, and speculation.
Your goal determines your expectations.
6. Investing is a Marathon, Not a Sprint
The best investors of our time, have built their wealth over decades. Rarely do you hear about the guy who hit it big on one stock. In fact, more often you hear about the guys who lost it all on one stock.
If you are building long-term wealth – you simply need regular investments and time. Making a one-time, lump-sum investment requires timing.
Many good investors use dollar cost averaging – a consistent purchase of your investment on a regular basis, regardless of price. This lowers the impact of market timing on your investments – and increases your stake.
Let’s say you have $6000 to invest.
Putting that $6k into one investment today requires picking the right investment at the right price.
However, if you invest $500 a month into more diversified investments, you can worry less about the price of the market and simply let time do its magic.
The best strategy is to add to your investments on a regular basis.
7. The Market Goes Up AND Down
Anyone who puts money into an investment (especially at first) only envisions the green arrow going up. But market corrections, bear markets, and crashes happen – you can bet your money on it (pun intended).
If the markets never went down – the whole investment game would fall apart. It's just how things work.
A correction happens when the stock market drops at least 10% from its most recent high. This happens once every 2-3 years. This tends to happen because of a major event or major economic change that makes investors sell more than buy. Often investors will sell simply because others are selling.
A bear market is a decline of 20% or more and can lasts anywhere from a few months to more than a year. Bear markets tend to occur every 7 years in recent decades. Low economic growth proceeded by a long run of positive returns can cause bear markets. They suck, but it happens.
Long-term investors can simply stay the course. While it hurts to see your investments in the red, there’s no need to sell and try to time the market. In the long run, it’s meaningless because you only care about the price in 10, 20, or more years when you sell.
Markets go up. Markets go down. It’s just part of the game.
8. Dividends are not FREE Money
Let me start with this – dividend stocks deserve a place in your portfolio. However, many new investors see dividends as free money that the company uses to reward its shareholders each quarter (or even monthly).
Some of the best (and biggest) companies pay dividends. And dividends are great to see when they hit your account – whaoo, FREE money!
But the cost of dividends is growth.
Dividend payments are what non-dividend companies (growth stocks) use to grow their business. This does not always mean that non-dividend stocks will grow faster than a stock that pays a dividend. It simply means that the two companies choose to do different things with the money they make.
Dividend stocks are great investments for people who want regular income in their portfolio. If you are a young investor – many times growth stocks will outperform a dividend paying stock in stock price because they are using their profits to grow their company. But dividends are great for older investors with a shorter timeline and need regular income.
Divided stocks and growth stocks that don't pay a dividend deserve a place in your investment portfolio. Just understand the difference.
9. Cheap Stocks are Not Always Good Investments
Investing in the stock market essentially breaks down to "buy low and sell high".
If you buy a stock for $20 and sell it for $40 – you double your money. Thats stock investing in a nutshell. Nice work!
Value investors look for investments that have fallen from a recently higher price. They purchase shares at a discount with the hopes that it will rise again in the future. Buy low, sell high.
In corrections and down markets you will find nearly all stocks trading at a discount. These are great opportunities to find good investments at cheaper prices.
However, sometimes stocks get cheaper because their company reported a bad quarter, missed revenue targets, or have been caught in a scandal. In these cases buying a stock trading lower than a recent higher price, is an indication that the investment is no longer worth what it once was.
Be sure to learn WHY an investment is trading cheaper – maybe its a valuable deal – or maybe its an indication to stay away!
10. Find Your Own System and Strategy - What Works for Others May Not Work for You!
You may read a story about the person who found the next Amazon. But they wont tell you how many other investments they made first.
You may hear about the person who found the next short squeeze and made a million dollars overnight. But you wont hear how much money this person lost on day trading.
Some investors get lucky. But most investors have systems and strategies to find the best investments and limit their losses on the bad ones.
Systems and strategies are simply a set of rules or steps in finding, investing, and managing your investment.
For example, the person who found the next Amazon, likely did not simply make one single investment and hit it big. This investor may pick a new stock every week and have a portfolio of hundreds of stocks. He may even have a million dollars in cash. Do you have the funds to guess each week?
The person who made a million dollars on GameStop or found the next short squeeze, may have a sophisticated software that triggers a specific event in the market and helps him find the needle in a haystack. And then when a trade goes sideways, there are systems to limit his risk and sell the investment. Do you have the stomach to loose all of your money on one stock pick?
My point is that you will never truly know everything others do to find and manage their investments. So don't think you can replicate anyone. Find a system that works for you, and stick with it.
Some advice on systems – find an investment resource (like a newsletter) you trust to feed you ideas. Do your own homework on every investment. When you find an investment you like, start a small position and give yourself the option (cash in reserve) to buy more next week or next month. Contribute an amount that works for you. Invest more on a schedule that works for you – maybe its weekly, or monthly.
Are you ready to get started investing?
Check out: How to Get Wealthy Investing in Stocks