Getting started as an investor can be a daunting task. This is especially true if you are a methodical and careful person before starting such a big business before you have acquired enough knowledge, expertise and confidence.
In the meantime, creating a short list of everything a novice investor should know inevitably runs the risk of excluding many vital points. Indeed, successful investors are bound to differ widely on what they would include in their top ten lists if rushed to replicate this exercise.
That said, we offer what we hope will be a useful checklist to help you get started as a successful investor. We have chosen to focus on key personal attitudes and overarching strategic frameworks that we believe will help you become a smart investor.
Key points to remember
- Have a plan, prioritize savings and know the power of compounding.
- Understand risk, diversification and asset allocation.
- Minimize investment costs.
- Learn classic strategies, be disciplined, and think like a landlord or lender.
- Never invest in anything you don’t fully understand.
1. Have a financial plan
The first step to becoming a successful investor should be to start with a financial plan, which includes goals and milestones. These goals and milestones would include setting targets to have specific amounts saved by specific dates.
The goals in question may include, for example, having enough savings to facilitate the purchase of a house, financing the education of your children, building up an emergency fund, having enough money to finance a business or having enough money to finance a comfortable retirement.
Also, while most people think in terms of saving for retirement, an even more desirable goal would be to achieve financial independence as soon as possible. A movement devoted to this goal is Financial Independence, Retire Early (FIRE).
While it’s possible to create a solid financial plan on your own, if you’re new to the process, you might consider hiring someone like a financial advisor or financial planner, preferably a Certified Financial Planner ( CFP). . Finally, don’t delay. Seek to put a plan in place as early in your life as possible and keep it as a living document, updated regularly and in light of changing circumstances and goals.
The FIRE movement
The FIRE (Financial Independence, Retire Early) movement advocates for the rapid accumulation of wealth long before the traditional retirement age to give you more options in life, sooner.
2 . Make savings a priority
Before you can become an investor, you must have money to invest. For most people, this will require setting aside a portion of each paycheck for savings. If your employer offers a savings plan such as a 401(k), this can be a great way to make saving automatic, especially if your employer will cover some or all of your own contributions.
When setting up your financial plan, you can also consider other alternatives to making savings automatic, besides using employer-sponsored plans. Wealth creation is usually based on aggressive saving, followed by shrewd investments aimed at making those savings grow.
Additionally, a key to saving aggressively is to live frugally and spend prudently. In this vein, a smart addition to your financial plan would be to create a budget, track your spending closely, and regularly check to see if your spending makes sense and provides enough value. Various budgeting apps and budgeting software packages are available, or you can choose to create your own spreadsheets.
3. Understand the power of compounding
Saving and investing on a regular and systematic basis and beginning this discipline as early in life as possible will allow you to fully leverage the power of compounding to grow your wealth. The current prolonged period of historically low interest rates has to some extent diminished the power of capitalization, but it has also made it more imperative to start building savings and wealth early, as investments will take longer to mature. interest-bearing and dividend-paying double in value than before, all other things being equal.
4. Understand the risks
Investment risk has many aspects, such as the risk of default on a bond (the risk that the issuer will not meet its obligations to pay interest or repay principal) and equity volatility (which can produce sharp and sudden increases or decreases in value). Moreover, there is, in general, a trade-off between risk and return, or between risk and reward. Simply put, the path to getting higher returns on your investments often involves taking on more risk, including the risk of losing some or all of your investment.
As part of your planning process, you need to determine your own risk tolerance. The amount you may be prepared to lose if a potential investment declines in value and the continued price volatility of your investments that you can accept without causing undue concern will be important considerations in determining the types of investments that suit you best.
At its most basic level, investment risk includes the possibility of complete loss. But there are many other aspects of risk and its measurement.
5. Understand diversification and asset allocation
Diversification and asset allocation are two closely related concepts that play an important role in both managing investment risk and maximizing investment returns. Broadly speaking, diversification involves spreading your investment portfolio among a variety of investments, in the hope that below-average returns or losses in some can be offset by above-average returns or gains. the average in others. Similarly, asset allocation has similar goals, but with an emphasis on allocating your portfolio among major investment categories, such as stocks, bonds, and cash.
Again, your ongoing financial planning process should regularly review your diversification and asset allocation decisions.
6. Keep costs low
You cannot control the future returns of your investments, but you can control the costs. Additionally, costs (e.g. transaction costs, investment management fees, account maintenance fees, etc.) can significantly impede investment performance. Likewise, just to take mutual funds as an example, a high cost is not a guarantee of better performance.
The importance of costs
Investment costs and fees are often a key determinant of investment results.
7. Understand classic investment strategies
Some of the investment strategies that the novice investor should fully understand include active versus passive investing, value investing versus growth, and income-oriented investing versus earnings-oriented investing.
While savvy investment managers can beat the market, very few do so consistently over the long term. This leads some investment experts to recommend low-cost passive investment strategies, primarily those using index funds, which seek to follow the market.
In the realm of equity investing, value investors prefer stocks that look relatively cheap relative to the market on measures such as price-to-earnings (P/E) ratios, expecting these stocks have upside potential and limited downside risk. Growth-oriented investors, on the other hand, see greater opportunities for gain among stocks that show rapid increases in revenue and earnings, even if they are relatively expensive.
Income-oriented investors seek a steady stream of dividends and interest, either because they need cash available at all times, or because they see it as a strategy that limits investment risk, or both. . Among the variations of income-oriented investing, one focuses on stocks that offer dividend growth.
Gain-oriented investors are generally unconcerned about the income streams of their investments and instead look for investments that seem likely to generate the greatest price appreciation over the long term.
Classic investment strategies
Income vs Earnings; Value vs Growth; Passive vs. Active.
8. Be disciplined
If you do invest for the long term, according to a well-thought-out and well-constructed financial plan, stay disciplined. Try not to get excited or shaken by temporary market fluctuations and panicky media coverage of the markets that might border on sensationalism. Also, always take statements from market experts with a grain of salt, unless they have a long, independently verified track record of predictive accuracy. Few do.
9. Think like a landlord or lender
Stocks are shares of ownership in a business enterprise. Bonds represent loans granted by the investor to the issuer. If you intend to be a smart long-term investor rather than a short-term speculator, think like a potential business owner before buying a stock, or like a potential lender before buying a bond . Do you want to be a co-owner of this company or a creditor of this issuer?
10. If you don’t understand it, don’t invest in it
With the proliferation of complex and innovative investment products, as well as companies with complex and innovative business models, newbie investors today are faced with a vast array of investment choices that they may not fully understand. – be not entirely. A simple and wise rule of thumb is to never make an investment that you don’t fully understand, especially regarding its risks. A corollary is to be very careful to avoid investment fads, many of which may not stand the test of time.
Avoid the unknown
Avoid investments that you don’t fully understand. They can present great hidden dangers.
Addendum: A classic reading
If there’s one book you should read as a new investor, it’s Extraordinary popular delusions and madness of the crowds by Charles MacKay. Written in 1841 by a Scottish journalist, this is the first masterful study of the psychology of crowds. The first three chapters, “The Mississippi Scheme,” “The South-Sea Bubble,” and “The Tulipomania,” all deal with financial follies that ended in disaster and foreshadow many of today’s financial schemes, bubbles, and manias. today. As a result, these chapters have been cited by a number of current financial writers.