There are two types of newbie investors. Those who seek guidance before they invest their money and those who just invest and learn the fundamentals of investing along the way.
While waiting to learn everything before you get started with investing may be a form of procrastination, learning the fundamentals is very essential. More so when you are putting your money on the line.
Many investors, rush into the investing arena with little or no guidance. The hard knocks of investing do not spare them, unfortunately.
Investing is a game like any other. And if you want to excel, you must learn the rules and play by them. Investing is one of those fields where testing the waters or waiting to learn on the job may end up in huge financial losses.
Like the Bible says, my people, perish because of lack of knowledge. Most newbie investors aren’t different.
In this article
The Fundamentals of Investing
1. Before Investing, Comes Saving
One of the biggest mistakes newbie investors make is focusing on investing while they should be focusing on saving. With small amounts of money, one should worry more about saving more money or growing their income first and worry less about their returns in the short term. This is because their returns do not matter that much in the short term.
To put this into perspective, if you invest 5K into an asset class that would give you an annual return rate of 8%, your money will earn you a return of just 400. This is very little money considering that you earned that return for the whole year.
Saving is for the poor, investing is for the rich. Nick Maggiulli writes,
“if your Total Assets * Expected Annual Return > Expected Savings, this means that your investments are earning you more than you are saving, so you should focus on your investments. However, if you can feasibly save more than your assets can earn you in a year, focus on saving.”
Remember saving is the foundation of wealth creation. You can build wealth without a high income but you have no chance of building wealth without savings. A high savings rate gives you a lot of money to invest.
2. Create An Emergency Fund
The biggest returns from investing come from holding assets for a long period. To aid this, it is necessary to have an emergency fund so that you will not have to sell your assets in case you are faced with a financial crisis.
An emergency fund is a pool of money that is enough to cover your daily expenses for at least 6 months. However, if you only have one source of income and you have other dependents who depend on your income, your emergency fund should cover you for 9-12 months. Moreover, it’s not a bad thing when you carry more water when going to the desert.
An emergency fund comes in handy when you are faced with financial challenges such as a job loss, a huge expense that wasn’t expected, and many more.
Before you think of putting any money into any investment, create an emergency fund that will act as your source of refuge during hard financial times.
One mistake that newbie investors make is falsely thinking that they won’t land into any financial emergencies in their early stages of investing. They, therefore, ignore creating an emergency fund first and jump right into investing only for them to have to sell their assets after a short while.
3. Prioritize Liquidity
The biggest risk to your financial success is the inability to turn an asset into cash when you urgently need the cash. This is why you cannot invest all your money in solid assets. You may need to quickly sell off part of your investments to cater for an emergency that your emergency fund cannot cater for. If you are unable to do that, your money cannot work for you.
Just as travelers die in the wilderness without water, investors perish if they have no liquidity. No matter how valuable an investment may be, it’s of no practical importance to you unless it’s liquid when you need to cash out. For safety’s sake, you must erect the foundation of your financial future not on a bedrock but a reservoir of liquidity
Jason Zweig
4. Do Not Invest In Things You Do Not Understand.
With the crypto and NFTs’ recent bust, investors are putting their money in things they do not know more than before.
Most people are attracted to investments once they realize the investment presents them with an opportunity to make a lot of money easily and quickly. With crypto doing so well in the recent past, people rushed to put their money into coins they didn’t understand. Others bought NFT projects just because of the hype and it sounded cool doing so. Little could they anticipate the financial havoc that was to follow them.
Before you put your money into any investment, make sure you understand the business and you can explain to yourself why you put your money into that investment.
5. Do Not Take More Risk Than You Can Bear
The easiest and quickest way to lose your money is not by overspending or reckless spending as many people think. It’s by making poor investing decisions. It’s not easy to spend huge chunks of money at a go without questioning your spending habits. You will easily realize that you are making bad financial decisions and you will hit your panic buttons. On the other hand, an investment decision gone wrong quickly sweeps your bank account without a trace of your hard-earned money.
As a rule of thumb, do not risk money that you cannot afford to lose. Spread your risk by diversifying your investments. The last thing you want to do is to lose your money after putting all of it into a single investment.
6. Diversification
Diversification isn’t how you build wealth. It’s how you preserve wealth. In the initial stages when you are trying to build wealth, you need to build a concentrated portfolio of your best bets. These are the investments that you are very bullish about. Spread your wings narrowly and widen your horizons as you grow your wealth.
If you can identify six wonderful businesses, that is all the diversification you need. And you will make a lot of money.
And I can guarantee that going into a seventh one instead of putting more money into your first is got to be a terrible mistake. Very few people have gotten rich through their seventh best idea. But a lot of people have gotten rich with their best idea.
So I would say for anyone working with normal capital who knows the businesses they have gone into, six is plenty, and I probably have half of what I like best. I don’t diversify personally.
Warren Buffett
Remember diversification does not depend on how many investments you have. It depends on how different your investments are from each other. As a rule of thumb, never put all your money in one investment no matter how sure you are that it will do well.
7. There’s Nothing Like a Low-Risk Investment With High Yield.
One question that I often get asked is, “which is the best investment that I can use to grow my money exponentially in a very short period.”
Such an option hardly exists. You can never have low risk and high yield in the same investment. Whenever someone promises you a high yield from a low-risk investment, take your money and run away because that person is probably trying to steal your money.
8. An Investor’s Biggest Enemy is Himself
As an investor, the biggest monster is the one between your ears. You will have to overcome your logical fallacies and biases.
Richard Feynman writes,
The first principle is that you must not fool yourself and you are the easiest person to fool.
Richard Feynman
Investing is 20% head knowledge and 80% behavior. It’s not what you know that matters, it’s how you behave that matters.
9. Investing Costs Aren’t Your Friend
Newbie investors worry too much about inflation rates, which they can hardly control, and worry too little about investment costs. In the long term, investment costs aren’t your friend. That is why I highly discourage people from investing their money in managed funds other than money market funds. The costs are not worth it.
If you care about your long-term investment returns, you have to make sure you are putting your money into low-cost investments. Investing your money in high-cost investments is like watering your plants at noon when the sun is hottest. Your plants will only get little of the water as much will be evaporated. That’s what happens when investment costs are high. Your high returns will be offset by high investment costs.
Where returns are concerned, time is your friend. But where costs are concerned, time is your enemy. Over the long term, the miracle of compounding returns is overwhelmed by the tyranny of compounding costs.
Jason Zweig
10. What Returns Can You Sustain?
Investing is a marathon, not a quick sprint. It is a long-term game unless you are a day trader. You want to maintain good returns in the long term.
If you understand the math behind compounding, you will realize that the most important question is not; “How can I earn the highest returns?” Rather, the most important question is;
“What are the best returns I can sustain for the longest period?”
The only thing that matters in investing is where you are in the long run.
Experience is The Best Teacher
Some things cannot be taught; they must be experienced. You never learn the most valuable lessons in life until you go through your journey.
Roy Bennett
Yes, only a fool waits to learn from his own experiences but some lessons can only be learned from personal experience. The best way to learn is by doing. The idea of being wrong shouldn’t scare you from trying something new. Fail and learn.
See Also:
3 Ways to Avoid and Manage Debt
Retirement Planning in 5 Easy Steps
