There are people who mistakenly compare investing in the stock market to gambling because they don’t know what they are doing or make mistakes like day trading based on the latest headlines. Others make mistakes that cost them their entire investment and become warning sirens against investing in the market at all. Here are four essential tips for first-time investors to avoid becoming one of these horror stories.
Invest for the Long Term
Day traders lose money more than ninety percent of the time because they trade to feel like they are doing something, react to various headlines and trends instead of investing for the long term, and buy what seems hot instead of what is a sound investment. They pay more in capital gains and various fees than necessary, cutting into the profits they make by selling when the market is falling, and buying when the trend is up.
A better system involves buying good stocks and mutual funds and holding. Your grandmother’s portfolio of dividend paying stocks that sent her dividends every month while increasing in value over time is the model you should follow. If you don’t want individual stocks, buy well-managed mutual funds where professional fund managers like those at CarnegieInvest.com do the analysis of each stock and sell when it is appropriate.
Don’t Invest in Your Employer
One of the horror stories from the Enron and other company collapses were those that invested their entire retirement plan in their employer’s stock, something encouraged by their awarded stock options or discounted stock purchases as employees. They lost their jobs when the companies went under, and when the stock price plummeted to zero, they lost their retirement accounts as well. Don’t invest in your employer’s stocks. Instead, invest in the industry as a whole if you are familiar with it, such as buying stock in similar companies, suppliers or customers. This takes the emotion out of investing.
Do Not Use Borrowed Funds to Invest
Debt raises the risk of investing, and it is an unnecessary drag on the returns investing yields. Don’t borrow against your home to raise money to invest in the stock market. The promise of ten percent returns funded by a 4% mortgage puts your home at risk if the returns are less than the interest rate on the mortgage debt.
Understand Your Risk Tolerance
Suze Orman once said that you should sell the percentage of your portfolio that you cannot sleep at night, so if you’re up half the night worried about your money, sell half the portfolio. The better choice is to understand your risk tolerance and invest in products that match your risk tolerance.
Invest for the long term based on your goals in products that yield long-term returns, not based on what is hot or not today. Don’t buy your employer’s stock or keep too much of your net worth in company stock options; this is a violation of the principle of diversification. Never use borrowed funds to invest and invest based on your risk tolerance.