Beginning Investors Guide and Considerations

Investing can be intimidating and confusing. For people who’s wholely unfamiliar, the slight thought could be scary and give a headache. It’s like stepping in a foreign land where people speak a different tongue, and one would be in deep trouble if nature happens and bathroom is nowhere to be found.

I was like that. But I was not ready to run away. So I “paid” the market to learn.

After 3 years, I am still no expert. I learned a few things from experience and much magazines reading, news studying, and internet browsing. I put together today’s post as a stepping stone for you who are beginning to invest or still thinking about it. Hopefully it will give you a sense of direction.

Why invest? And getting ready

Investing is for people looking to grow their money beyond the rate of high yield saving account and certificate of deposit. If you feel saving is not enough and too slow to lead you to financial freedom, it will do you well to learn to invest your money. As the saying goes, “Make your money work for you.”

Before you start investing, it will be good to pay off debt with high interest rate, especially ones with doublt digit rate and/or are not tax-deductible. Doing so basically means you make a rate of return equivalent to as if you invest the amount of the debt. Additionally, how can you invest with a clear mind when debt is nagging you constantly.

Once the debt is paid off, saving up a comfortable amount of money is the second line of duty. By “comfortable” I mean an amount of money that will allow you to stay cool in case of emergency (ie. loss of job, doctor visits, urgent car fix…). More on this later under risk tolerance.

Investing is not…

… a get-rich-quick scheme. If that’s what you are looking for, you are looking at the wrong place. It’s important that we get this clear.

Know your time horizon

You must know the amount of time you can keep your money invested in the market. Anything less than 5 years is not enough to ride out the turbulance of the market. It is the general concensus to assume your money to grow 11% on average in stock market, but remember that 11% is an average taken over couple decades. Correct me if I’m wrong.

I would suggest to only consider investing when you have at least a 5 years horizon. Time is your best friend and greatest asset in investing. The more time you have, the more time the money can grow. The more time you have, the better hedge you have against the turbulance in the market.

What about short-term trading? Day trading?

If you can only invest in less time than that, I suggest to choose either cash account or short-term bonds. If you plan to buy a house in a year or two, keep the downpayment money in cash saving. Obviously, you don’t want to lose that money. But I can’t stop you if you want to do otherwise. It is your choice.

If you want to trade short-term or even day trade anyways, first assure that you have the time and effort available to do homeworks:

  • study and understand the balance sheet, income statement, cash flow, and other stats
  • read news about the market sector and undertand its flow and future
  • learn the structure and behaviors of the management of the company
  • learn as much else about the company as possible (if you cannot make sense of the business, forget it)

Again, I don’t suggest doing this because it’s not easy, and it’s more dangerous than it is fun.. But I am not here to stop you, nor can I. I did it at the beginning myself to learn NOT to do it anymore. I paid to learn a lesson that I think is worth every penny. Short-term/day trading is more like gambling. Sure you can hit a jackpot, but you can lose it all just as easily. Plus, you will have “a lot of fun” entering your transactions at tax time.

Know your risk tolerance

Can you stand to see your money fluctuate a lot? Will you sell everything out of panic when you see your portfolio down 20%? You should select investment relative to your risk tolerance.

If you are not very risk tolerant, your portfolio should contain more stable investments that fluctuate less (ie. blue-chip companies and bonds). If you don’t give a darn about the money you are investing, you can bet on riskier investment vehicles. With greater risk, comes possibility for greater gain, and loss.

Your risk tolerance is closely related to how emotionally you are attached to the money you are investing. If you invest money that is of great importance like the fund for an engagement ring, consider yourself divorced. Go create your online dating account before dropping the money.

What I’m saying is that your chance of losing money is much higher due to panic caused by your emotion. This is why it is important to have saving for emergency before you plunge into the market. You don’t want to be forced to sell at a loss because you need to feed your dog.

Basically, the more you can emotionally detach yourself from your money, the better.

Allocation and Diversification

To lower the risk in investing, you diversify. Simply put, don’t bet it all on ONE thing.

Spread your money into different piles. That’s diversification.
Deciding how big each pile is. That’s allocation.

Once you know where to diversify, you decide an allocation that fits your risk tolerance. Your allocation should also change over time. For example, if you observe instability in domestic stocks for the near future, you will want to re-allocate bigger amount to bonds or foreign market. As you approach retirement when you cannot afford to lose your money, you will want to allocate to bonds or even cash.

Watch the expense

If you trade stocks, most brokerage account costs you each transaction, though I know that Zecco offers free trade (I use TDAmeritrade). Assuming otherwise, transaction cost can greatly lower your rate of return, especially if you day trade. If it costs you $10 to buy $1000 of stocks, you automatically lost 1% up front. Another reason to invest long-term.

This is also true for funds. You need to pay attention to its expense ratio. Don’t just look at the rate of return. Your true gain is the rate of return minus the expense ratio minus tax rate. Remember that.

The Simplest Way – Index Fund

Since I talked about cost, it would be blasphemous if I don’t mention index fund. An index fund simply traces a specific index in the market. If you bought an index fund that traces the S&P500, you would have made 11% annually for past few decades. If I further explain, it will becomes insulting to your intelligence.

The greatest benefit of index funds is their low expense ratio, versus traditional mutual funds or privately managed funds. You can have an entire portfolio of index fund, which keeps the cost low. And because they are already diversified, it saves you the tedious job of picking individual stocks and at the same time, provides you with safer and more stable growth than individual stocks.

If you go with index fund, all that needs to be done is to contribute regularly and control your portfolio’s allocation on intervals (quarterly or yearly). Doing so is enough to maintain a steady growth. It’s as simple and easy as it gets! Oh, and Vanguard has been wonderful.

Special accounts for retirement and college fund

Just a reminder… If you are investing for your retirement, you can open an IRA or Roth IRA account that provides tax benefits. Same goes for college fund, whether for you children or yourself, there are 529 plans available that differ by state, each with its own pluses and minues.

Some words of wisdom

Don’t be greedy because it can only be harmful. Don’t try to time the market because it’s a fool’s job. You can never catch the top nor can you catch the bottom.

Understand that a huge part of the market is based on speculation, and speculation is based on human emotion. Human emotion is never a predictable thing in itself and most fickle in nature. Conversely, how can you accurately predict the market? Especially when experts with advanced analysis tools have failed to do so.

Three key points

  • pick solid investment
  • diversify and allocate
  • invest long-term

With that, I’m done. But don’t just take my words and because this is only a quick guide for beginner.
Go study, read, try, and learn from your own experience.
Go build your own intuition of the market.

Let me know how you are doing later.

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