A lot of new investors are entering the stock market these days.
They are pushed by negative interest rates and lured by the success others have had in a very long bull market.
But with market volatility running high, these are uncertain times to be a newbie in the market. Trying to invest without knowledge or experience and without a strategy is no better than trying to become rich by gambling in a casino. You need a plan, and you need to avoid the most common pitfalls.
So what are the most typical mistakes that you should avoid? I will tell you right here.
1. Not Getting Started
This is the first mistake and one of the most common.
People get stuck in analysis paralysis.
They save money, open a trading account, watch YouTube videos, and join investing groups on Facebook.
They do everything – but they don’t invest.
This kind of beginner often has quite a lot of money saved up.
Why don’t they begin?
Ironically, the more money you have the harder pulling the trigger can be.
This investor doesn’t feel safe. He or she is afraid of making mistakes. They are very good at saving because they fear mistakes in real life too.
What this investor needs is a guide to lean on.
2. Not Having an Emergency Fund
Then there is a completely different kind of newbie who is more risk tolerant and invests every single penny from the beginning. They forget to keep some money for rainy days and catastrophes.
Why is that a problem?
Life is full of unexpected twists and turns.
You could get fired; you could get sick; someone in your family might need you; or your car could break down.
They say that misfortunes never come alone.
So of course you would lose your job in the middle of stock market crash, forcing you to sell stocks at a loss.
How big should your emergency fund be? Around three months expenses is good.
3. Not Investing Enough
The power of compound interest is magic. But it’s only a little magic if you invest a little money. In order to become financially free, you have to invest more than a little.
Many articles have been written about how far you can go if you stop drinking latte and invest the money instead.
But really, using your latte budget is not nearly enough.
How much is enough? Well, you can easily calculate that with a spread sheet and a simple formula, and I could do that for you during a strategy call. It’s very nice to know your numbers and know what you need to do to get there.
But until you have your goal set and your monthly target, I would say invest as much as you can. The more you invest now, the sooner you will get there.
4. Not Thinking About Tax benefits
Most people simply don’t give taxes much thought. But you should.
Taxes are going to be your largest single expense. They are worth thinking about and optimizing.
In every country there are accounts that allow you to invest with tax benefits. These are typically retirement accounts like Roth IRA in the states (investment made with taxed money, but payment is tax free) or 401K which are typically matched by your employer.
Some countries also have a system for investing your normal savings with lower or no taxes. In the UK this would be an ISA account. You don’t have to pay taxes on the dividends and returns as long as you stick to the limit of how much you can place in your ISA that year (in 2020 it is 20k).
The rules will be different from country to country, so you will have to figure out which tax efficient accounts are available where you live.
My general advice is to use them.
5. Not Figuring out if it is Cheap or Expensive
There are two main types of beginner investors.
There are those who buy shares based on how they have performed in the past. Before investing in a fund, they will look at how much revenue it has made annually the last five years, and they will buy the one with the largest increase. In a way that makes sense, but really it doesn’t – they risk buying at the peak.
This type of investor has more or less the same system for individual stocks. If it has gone up, it must be good and must continue to go up.
The problem with this kind of thinking is that you cannot extrapolate the past into the future, and they often buy stocks that are very expensive. They also risk buying at the peak and losing a lot of money when the market falls.
Then you have the other kind of newbie who get the idea that you should buy low and sell high, so they go for what has dipped recently.
But the problem with that is that they still don’t look at the value of the company. Just because something has fallen in value, it doesn’t mean that it’s cheap.
You really have to look under the hood to see what’s there.
If you want to learn how to calculate the value of a company you can learn to do that in my free e-book here.
6. They Lack a Strategy
Some buy stocks and shares the way they shop in a flea market. They randomly notice something and buy it right away.
The problem with shares is that they are so easy to buy. You just open your laptop and push a button. or you can even use your phone.
The beginner investor might have heard about a company in a podcast. They might have read some strangers eulogy of it in a Facebook group. Or maybe they copy their neighbor’s portfolio. Oh, yes. People do that.
You have to have a strategy, and I will recommend two you can chose between here.
- If you know that you are not going to research individual companies, I suggest you stick to index investing with ETF’s (Exchange Traded Funds). You should do that through the method called Dollar Cost Averaging where you invest the exact same amount into the same fund every month.
- If you would prefer to know exactly what your money is doing, would like a greater return – and also know that you would enjoy researching the companies, I suggest you learn about value investing. This is where you buy stocks in companies when they are on sale in the stock market and sell them again when they are overpriced (or keep them in your portfolio). You can learn about this method in my free e-book.
7. They Seek no Guidance or Education
No one drives a car in traffic without taking lessons and getting a driver’s licens. No one climbs the Himalayas for the first time without preparing and bringing a guide.
Yet, many people believe that they can climb the stock market and read the traffic signs all on their own. The quickest and easiest way to make a good return from investing is to learn from others who have had success doing it.
Do you want to learn how to evaluate and calculate the value of a company? I teach you how to do that in my e-book Free Yourself. You can download it here.