Investing mistakes are easily – and sometimes often – made by those just getting started in the stock market. Rookies might put too much money in one asset class such as cryptocurrency that they currently like or that is getting media attention. Or they might spread their money across too many asset types without really understanding what they are doing.
I often find that beginning investors want all the upside of the stock market and get upset when they see the market fall. Many times, they will pull the trigger too early and sell. They don't realize that markets will have dry spells and that some volatility is inherent in the investing process.
But how can folks avoid some of these investing mistakes? Here are some simple rules to follow when first starting your investing journey. The goal, we hope, is to help you avoid typical beginner investing mistakes.
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Prepare for volatility. Unless you put all of your money into certificates of deposit (CDs) or money market funds, you can expect to see some variability in your returns. One tool to gauge how volatile a specific stock is in relation to the broader equities market is its beta.
The S&P 500 has a beta of 1.0. So, a stock with a beta above 1 typically means it is more volatile than the broad market, while a beta below 1 signifies that the equity is less volatile.
Don't invest money that you've set aside for emergencies. Emergency funds are important and we have them for a reason. Leave enough cash to have in case of emergencies or being let go from work. Put this money in a high-yield savings account or even your checking account that you can easily access.
Ideally, you have enough saved to cover at least three to six months of living expenses. By not putting this money in the stock market, it will not be subject to any kind of volatility or sudden price drops. Additionally, emergency funds should not be put in a CD or similar account where there are withdrawal penalties.
Don't borrow money to invest. Investment returns are not guaranteed, especially in the short term. You could end up paying more in interest and being stuck in more debt if you borrow money to buy stocks.
Along similar lines, don't use money that should be spent on paying down current debt. Debt reduction comes ahead of investing. Once this is under control, especially with your credit cards, you can put the after-debt excess in various investment vehicles.
Build a pyramid of liquidity. For example, keep some of your excess cash in easy-to-reach vehicles such as savings, checking or money market mutual funds at a brokerage firm. This will allow you to leave your best long-term investment stocks in your portfolio and grow their returns over time.
Diversify slowly. After that, some portion, not the bulk of your excess investment assets, can be put in CDs. Don't put all this excess money into stock market funds. This will allow for a no- to low-risk way to grow your money. And rates are attractive right now, with several 1-year CD rates above 5%.
Money market accounts also give folks a safe place to store their money and get a decent rate of return. Some of the best money market accounts right now are offering yields over 5%.
Study your investing options. Still, arguably the best way to grow your money over time is in the stock market. For beginners, investing your hard-earnings cash in the stock market is best handled by first buying mutual funds, especially no-load mutual funds that don't have a commission or sales charge, and/or low-cost ETFs (exchange-traded funds). These are baskets of equities that spread the risk around, and investing in these first will allow you to develop a feel for the intricacies of the equities market.
Only after doing that for some period should you venture out and invest in individual stocks.
Stick with dividend-paying stocks. The best outcome over time for both beginning investors and long-time market participants is to buy stocks with larger market capitalizations (i.e., over $100 billion in market value) that pay regular dividends.
An example of one of the best dividend stocks around is Coca-Cola (KO), which has a roughly $260 billion market cap and has paid out and raised its dividends annually for the past 62 years. If you don't believe us, just ask Warren Buffett, who first added KO to the Berkshire Hathaway equity portfolio back in the 80s. In his 1988 letter to Berkshire shareholders, Buffett said he expected to hold on to the stock "for a long time" and indeed he has.
Don't invest in speculative stocks. Avoid tip stocks (someone gave you a tip about a potential high-flyer) with no earnings, no dividends and a small market cap.
The best stocks to buy are those that you can live with over a long period. Don't try and make a killing with your first investing forays. The odds are arguably not going to be in your favor. This is especially true with penny stocks and/or cheap stocks trading below $5 to $10 per share with no dividends.
Among the many reasons to avoid these low-priced stocks is the lack of liquidity, or the number of shares being bought and sold. This makes the stocks "the perfect vehicles for "pump-and-dump" schemes where stock promoters lure investors to buy shares, increasing the stock price," writes Dan Burrows, senior investing writer at Kiplinger, in his feature on why you should stay away from penny stocks. "Once the price gets high enough, the pumper sells his shares, causing the stock to fall and leaving investors with poor returns, or even losses. Anyone here see The Wolf of Wall Street?"
Also avoid stocks with earnings so low that their price-to-earnings (P/E) ratio is very high (i.e., over 30x for the coming year).
Find good investing research. There are plenty of free websites such as Kiplinger that offer sound information to help guide your investment journey. Many sites such as Yahoo Finance, Morningstar and StockCharts allow folks to research potential investing opportunities.
Doing your proper research and coming up with a plan will allow you to improve your long-term investment returns with decent results. It will also allow you to weather difficult investing periods when the market takes a downturn.
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