Invest within your means, otherwise it will cost you.
If someone advises you concerning your financial affairs and they may profit through fees and/or commissions as a result, they should first interview you as this enables them to tailor their advice to take account of your personal circumstances.
However, the person who has the best knowledge of your circumstances is yourself. Not some stranger or even your best friend. You. Take advantage of it.
A quick checklist
Here are a few questions that newcomers to the world of investment should be asking themselves:
1) Am I prepared to put my money at risk? If not, look at things like gilts, deposit accounts, index-linked gilts and National Savings. Realistically, the stock market is off-limits for you because share prices can, and often do, fall as well as rise.
2) If I'm prepared to take a risk then what level of risk is acceptable? On the scale of increasing risk, you start with deposit accounts and government index-linked bonds, moving up through fixed-interest bonds, property, stock market funds and individual shares. At the top of the risk tree are high-risk punts like that Patagonian Llama farm for which your accountant swears that you'll get income tax relief..!
3) How much money should I keep aside in my 'rainy day' fund to provide some protection against unforeseen events? Two months' worth of living expenses is a good start, if only because it stops you running out of money before the end of every month like so many people are prone to do.
4) Do I prefer income or capital growth? Or a bit of both? Maximising your income now will somewhat restrict your ability to grow your income in the future.
5) How would I really react if I lost money? Be very honest with yourself.
The last question tells prospective investors a lot about themselves. Millions of people have bought shares thinking that they'll be relaxed if their price falls by, say, 25%. Yet at the first sign of falling prices they panic, sell everything and retreat to their building society account vowing never to return. They didn't understand themselves.
Don't lie to yourself
About two decades ago, I heard of a case where a couple had seen an advisor about investing a very large lump sum. When asked what they were looking for, they replied "the maximum possible income, what a stupid question to ask us" (their words).
On further questioning, it turned out that this wasn't what they wanted. They were looking for a high income but their main concern was that their capital was not put at risk.
I have no idea what happened to them, though I gather that, as a parting shot, they said to the advisor that they were going to go with someone else who had already offered them 12% a year guaranteed risk-free.
Since 12% was much more than the risk-free rate at the time, as paid by short-dated British government gilts, they were not going to be getting a risk-free investment unless they were buying an annuity, which would mean giving up some or all of their capital.
Maybe they were not as risk-averse as they claimed to be, though it was quite likely that they didn't realise what they were getting into. Either way, they didn't understand themselves and I suspect that it may have cost them.
Know your circle of competence
After a while most investors discover that they are good at some things, perhaps those fields that are related to their work, while there are others that they're quite poor at.
When it comes to the stock market, I've got a good track record when it comes to small oil companies, alcohol, publishers, consumer goods and international investment, while there are a few sectors which I generally avoid nowadays having learned the hard way!
By sticking to what Warren Buffett calls your "circle of competence", you focus your attention upon what works for you. Over time, as you improve your knowledge of investment matters, your circle of competence will grow to encompass other sectors of the stock market as well as other types of investment.
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More from Tony Luckett:
> Tony has never bought shares in a Patagonian Llama farm, though he has owned shares in a couple of companies that make a bankrupt Patagonian Llama farm seem like a great investment!
