What New Investors Don’t “Know” Could Hurt Them
New investors learn best through personal experience – both good and bad. It’s important to keep in mind the "DO NOTs" of investing from the very beginning, ie. while you are learning (which never really ends).
DO NOT: Gamble
Unfortunately, some newbies view investing as a game…as gambling. Don’t. Those with gambling tendencies should probably head to Vegas, where they’ll likely contribute to building more of those beautiful casino monuments.
By definition, newbies know very little about equity markets. This lack of knowledge and experience is an important reason to focus first on highly diversified mutual funds rather than on individual stocks. It is a less risky first contact with equity investing because owning small pieces of many companies helps mitigate the damage caused by a few poor performers.
And it’s important for newbies to do their own research. Word of mouth information can be tempting, but without background information it must be taken with a big grain of salt. Rumor and hot tip investing are pathways cluttered with pitfalls.
DO NOT: Fantasize
The marketplace is like a fancy restaurant, full of background noise and soothing music, but tinged with misinformation and inflated news about someone else’s good fortune. Be patient and maintain realistic expectations about what’s possible, and be cognizant of your yield expectations. I consider a yield of 8-12% very good, and why not? From 1957 through 2022, the S&P 500 averaged an annualized 10.15%¹.
In short - dare to be average. It’s a rare investor who earns 10% over time. As a beginner, don’t compare your results with those of experienced investors. They have years of acquired knowledge which often trumps inexperience.
DO NOT: Time the Market
Attempting to time the market is ultimately a fool’s game, so get rid of the crystal ball. An important trait of a good investor is patience. Make infrequent, but confident decisions based on solid research. Frequent trading increases brokerage fees and other costs, including taxes on short term versus long term gains.
Always…always…keep cost in mind, particularly opportunity cost. Try to develop the habit of thinking like the Oracle of Omaha, Warren Buffett, who said:
The real cost of any purchase isn’t the actual dollar cost. Rather, it’s the opportunity cost—the value of the investment you didn’t make, because you used your funds to buy something else.
You obviously can’t control what happens in the broad market, but you can control that one all-important factor…cost. When trading individual stocks, investors will incur costs each time individual shares are bought and/or sold. Many fund companies offer no-load funds…they don’t assess fees when units of that fund are bought or sold. However, each fund has what’s called an annual operating expense ratio to cover the cost of the fund’s management, administration, marketing and distribution fees. Keep an eye out for inordinately high expense ratios. They’re still around. Remember: The lower the ratio, the more of the fund’s yield an investor gets to keep.
DO NOT: Be a Sheep
Don’t follow the thundering herd into the abyss. Follow your own instincts. Your gut is often quite revealing of right and wrong. Pay attention to it. The herd is inclined to rush for the exits during market corrections, often suffering three negative consequences:
Taking premature gains, resulting in unnecessary taxes
Absorbing unnecessary losses on quality investments by losing faith due to fear
Suffering opportunity costs by re-entering a recovering market too late
DO NOT: Get Emotional
Human nature programs us with certain physiological biases that too often affect investment decisions. Examples of these biases include:
Confirmation bias – Dwelling on information that supports prior beliefs or values.
Anchoring bias - Relying too heavily on the first piece of information or experience you have with a topic. This tempts investors to hang onto poor investments based on the original purchase price rather than “changed” underlying fundamentals.
Buyer’s remorse - Experiencing a sense of regret, often associated with making an expensive purchase.
Recognizing these biases can help you avoid or control them. If not, they can negatively impact your long term investment yield.
The lesson here? Avoid making emotional decisions when it comes to your investments.
Be a cautious investor, not a trader.
¹The S&P 500 is a market-capitalization-weighted index of the 500 leading publicly traded companies in the United States. It became a composite index tracking 90 stocks in 1926. The average annualized return since adopting 500 stocks in 1957 through Dec. 31, 2022, is 10.15% (Source: Investopedia)