You are in your twenties or thirties and as you have accumulated savings, you are starting to look for alternative ways to invest your money. You know that stocks are a good place to start, as you don’t require a huge amount of capital and companies pay good dividends. Does this sound like you?
The Australian benchmark index, the S&P/ASX200 has averaged nearly 10% return since 1992, which includes the Global Financial Crisis in 2008, making stocks one of the most attractive long-term investment opportunities.
However, not every investor achieves these kind of returns. If you’re new to the share market or if you’re a seasoned veteran, there are common mistakes that should be avoided.
Sticking to a few basic principles, can ultimately separate a good investor from a bad one. Read below for five common mistakes that should be avoided if you are just getting started in the world of finance.
Don’t risk more than you can afford to lose
Knowing your risk tolerance and acting accordingly is the most important rule to know before you start investing. Always think of the risks first before you think of the potential returns. Many investment stories that have ended in financial ruin could have been avoided with an appropriate risk management strategy.
This rule does not necessarily mean that you have to be ultra conservative and only invest your money in low risk assets, the question is how much risk can you comfortably afford to take?
There is no definite answer to this question and it will depend on your personal circumstances, risk tolerance, family situation or your earnings. The best way to get started is to come up with a financial plan or investment strategy and work out exactly how much you are willing to invest and what your overall strategy is.
Ask yourself the following: if the market was to crash tomorrow and you would lose 50-75% of your investment, could you still pay your rent or provide for your family? I’m not saying that the market will crash tomorrow, but factoring in the worst case scenario helps you understand the implications of investing in stocks.
Don’t put too much money in one stock
Mr Warren Buffett’s once said that you “should never put all eggs in one basket,” Which is great advice for the current market conditions. He is, of course, referring to the benefits of diversification and the potential risks of putting too much money in one single stock.
You may have heard that the big banks are ‘safe investments’ or that Telstra pays a good dividends and therefore want to invest in these companies. Whilst many of these assumptions may be correct, it is important to diversify across a broad range of stocks in order to offset potential losses from a single investment. This can be achieved by
– Investing in a number of stocks from different sectors/industries/markets
– Investing in mutual funds or ETFs (Exchange traded funds)
Whilst there is no correct number of how many stocks you should have in your portfolio, it is safe to say that anything between five and fifteen (max. twenty) stocks will likely yield the best returns. However, this will largely depend on your overall portfolios size and personal circumstances. On the contrary, having too many stocks in your portfolio is often referred to as excessive diversification and will likely harm your portfolio.
Don’t invest in the short-term
If you want to make a lot of money right now, go to the casino or buy a lottery ticket. You can’t just demand returns like your mums meatloaf.
The stock market has been and always will be a long-term game. The majority of your investment portfolio should be invested in companies with a strong long-term outlook and stable earnings.
It’s okay to dedicate a certain portion of your funds to short-term trading opportunities, but it’s no coincidence that the most successful fund managers have invested in long-term opportunities.
For most investors, the primary source of income remains a full-time job and treating the stock market as a complimentary source of income.
Don’t get emotional
One of the biggest mistakes that rookies make is getting emotional and selling their positions when the market pulls back. Daily volatility is normal and will always be a part of high-risk assets.
Stocks move on a daily basis depending on market sentiment, current events and sometimes for no reason at all. You are doomed to lose if you follow the crowd, buying when the market rises and selling when the market falls. Learn to turn off your emotions and think objectively when it comes to trading.
In today’s day and age it has become so easy to buy and sell shares online, so that many investors have forgotten that they actually buy a part of the business. If you were the owner of a business, would you sell it just because its value decreases by 2% overnight? Yes, sometimes it is hard to see the value of your investment diminish, but history has taught us that those who don’t get emotional and sit tight during volatile periods have achieved the best returns.
Don’t pay too much attention to the media
There is plenty of noise on the internet, the newspapers or on television. Every day someone will have an opinion as to where the market will go next or tell you that the market will crash tomorrow.
During your investing journey you will come across many people with different views, but always keep in mind that these are just opinions. Frankly, nobody knows in which direction the market is heading and often one of the most valuable tools is your very own common sense.
Don’t just invest in stocks, but also focus on education, as it will help you to differentiate the importance of the news you see. When you read an article, I encourage you to always ask yourself: What is the author’s motive? Newspapers often use ‘sensational’ headlines to generate more clicks, or a certain research note may have been sponsored by a company to create positive publicity.
Overall, I think most investors spend too much time reading unnecessary commentary which could lead to poor investment decisions.