Learn How To Invest: Develop An Investment Plan

Investing in the stock market? Develop an investment plan first.

I’d like to share some cautionary stories about the topic of investing, and I hope you’ll indulge me. I’ll present a couple of case studies that portray common investing mistakes that people find themselves committing, especially when they first start out.

Investing As A Sport: Manage Your Risks

Lesson #1. Start slowly. Don’t make big bets.

I’ll begin with an analogy: let’s say that you dream of becoming a great tennis player. You’ve never played tennis before, so you decide to take lessons. You even go so far as to study tennis from a theoretical standpoint — you may decide to pick up a few books on it. Maybe even read some inspiring and educational articles on the sport, picking up some stories online from discussion boards or “how to” sites. At some point, you feel prepared for your first tennis match.

THE MISTAKE: Now let’s say you feel extremely confident about your abilities at playing this sport so you figure you’ll use your skills as a way to make money. You want to put your new found skills on the line and so you decide to make a small wager. Let’s say you decide to wager $10,000 that you’d win your first match, and that you’d like to take on the best guy in your tennis club. Perhaps he’s got a reputation — one that rivals Roger Federer’s, whom you just might have heard of. Roger Federer is the best tennis player in the world, and regarded by many as the Tiger Woods of tennis. You decide to bet $10,000 that you’d beat his top-seeded clone in your very first tennis match.

Well, you can guess what will probably happen here. You won’t score a point, you’ll be unable to return any serves commanded by your powerful opponent and you’re likely to lose your $10,000 bet. Ultimately, you’ll find out that you’re not quite ready for this kind of match just yet; you’re not as good as you think you are, and sadly, it’ll take the loss of $10,000 to convince you of this matter.

So after thinking through this hypothetical situation, do you wonder who in their right mind would actually believe that they were ready to take on the best after simply taking a few lessons and reading a few books? Surprisingly, the answer is this: a huge number of people who are entering the world of investing.

TIP: Beware, therefore, of making such mistakes when you invest. I recommend that you start slowly by committing smaller amounts of money to the stock market as you learn the ropes. Don’t bet big when you’re still learning the basics of investing.

Learn How To Invest: Develop An Investment Plan

Lesson #2. Learn how to invest on your own and develop your own strategy.

Now what follows is a story that is all too common for those who are new to managing their money. I’d like to relay the tale of a young married couple who decided take charge of their finances. With little experience in the stock market, they wondered what to do with a $5,000 bonus the husband received from work. So they talked to a relative who recommended that they use that money to buy Ford stock because it was “cheap” and will no doubt recover. They proceeded to put their entire $5,000 into Ford.

THE MISTAKE: Our couple in the story decided to buy Ford stock based on free financial advice from family; but they listened to advice from a well-meaning relative who may not be too well-versed with the stock market. They acted on a random tip in the absence of an investment strategy and financial program that should address their long term goals. By doing so, they are putting their $5,000 in Ford stock at risk. Their money isn’t diversified or part of a bigger diversified portfolio, plus I wouldn’t consider this choice of stock ideal for new investors. I believe that investing in Ford at a time when auto stocks are under extreme pressure is a move only for the most seasoned investor.

TIP: So what do we get out of this story? Don’t trust somebody else with your money unless they have a proven track record as a professional. And don’t put your money at risk before you have an investment plan or strategy in place. Also, your first stock investment should be the most boring, safe investment you can find. Begin by putting your money in diversified investments and watch how your money grows this way.

You should use your first investment to learn how the stock market works and how economic stresses affect your funds. By sticking to less risky investments, you’ll grow your money while making sure you are managing your risk.

As for these investment stories? I hope they help. Remember that a seasoned student will not only learn from books and articles but also by analyzing the mistakes of others.