So you want to learn how to invest? Then check out a couple of case studies and profiles of stock investors whose actions we dissect for the purpose of picking up some important investing lessons. I find that learning from experience — even someone else’s experiences — has been highly beneficial to helping me become a better investor.
Practical Investing Advice For The Stock Investor
Lesson #1: Diversify your holdings.
I know this guy who works in IT, is fresh out of school and has done the right thing by saving a portion of his money to start a portfolio. My friend decided to invest in a well known financial institution in October of 2008 after he perceived a big drop in the stock price of this particular company. AIG had fallen prey to the weak economy, short-sellers, and government regulation but this new investor was looking for a thrill so he invested a large amount of money in the troubled stock. He had the assumption that this company was just too big to fail and was a great buy at this level.
THE MISTAKE: Some investors think of investing as a sprint. It’s not — it’s a marathon!
Well, my friend mistakenly assumed that you could make money quickly by aggressively investing in the stock market. Unfortunately, he learned the hard way that investing shouldn’t be thought of as a big thrill ride. After repeatedly trading stocks and taking on losses, he became discouraged and wanted to give up investing altogether. But giving up is not the answer. Instead, as an inexperienced investor who needs to learn the ropes, he should focus on putting his money into safe companies that pay dividends, and use this approach as a way to acquire some investment basics.
Taking on less risk will help you stick with long term investing as it will keep your losses in check; it’s important to realize this since staying the course is the only way to make real money. The fact is, the odds are not in your favor if your portfolio is built on high risk positions. In fact, the best investors in the business don’t invest this way. The experts know something that the average investor doesn’t: the concept of hedging (which is a whole different ball game altogether).
Lesson #2: Limit your risks. Learn how to invest for the long-term.
Our second case study is about a family that wanted to invest money in order to pay for their young kids’ college education — a financial goal that a lot of families share. But this couple decided to attempt a day trading strategy given the following reasoning: they thought that a savings account or CD would not make enough money over time while a day trading strategy would be a good way to monetize gains while capitalizing on market volatility. Sounds like a decent plan? Well it isn’t.
THE MISTAKE: Trading with long-term money.
You can afford to take some risks with your fun money. Trading with fun money isn’t that big of a deal because if you lose it, you can always make more. But trading with long term money is a whole different matter. Our day trading couple found volatile stocks in order to make quick money. But their goal here is to invest for their children’s future, which requires a better risk management strategy. This isn’t the kind of situation that would call for aggressive financial moves. Statistics show that day trading does not usually lead to successful long term gains. Unless you are a seasoned and highly experienced investor, you are very likely to lose out by using a day trading approach.
This family also committed a second mistake. They failed to review savings and investing options to address their financial goal of saving for college. Most states have 529 programs that allow you to set up tax-advantaged college funds for your kids. Many 529 programs are quite flexible enough to allow you to invest in anything you’d like but I’d personally be much more careful and prudent with money that I know I’ll be needing for a specific purpose.
Investing Lessons Learned
New investors often get very antsy about investing; they often get very excited about putting their money to work right away after reading so many success stories of people quitting their jobs because of money they’ve made in the markets. But the truth is, investing is not that thrilling most of the time. Instead, wealth is made by making the right decisions over time: be patient, be educated, and be disciplined and you will come out ahead.
Contributing Author: Tim Parker from Elementary Finance
If you enjoyed this post, you can get free regular updates through our RSS Feed, or you can have our latest posts delivered to your email inbox by supplying your address here. Your address will only be used for this purpose, and you can unsubscribe anytime.
{ 2 comments… read them below or add one }
How about this piece of advice: step 1: buy a total stock market index fund from Vanguard or Fidelity; step 2: do nothing for 25 years.
According to many academic research papers, that a winning strategy.
Shadox,
I was on the buy and hold bandwagon all the way… then last year happened. I’d love to see this to be true going forward — the statistics are in favor of long term indexing to be a true winning strategy as you say. I’ve been in the stock market for around 20 years now, and so far, it hasn’t been too bad — but it certainly could have gone better if the financial crisis didn’t hit. Still there’s never 100% certainty about anything.