Knowing where to start can be the most challenging part for a new investor.
WASHINGTON, DC -- Investing can be a daunting task, but it doesn't have to be. Too many would-be investors assume they need a degree in finance to be successful in the stock market. That couldn't be further from the truth. In fact, we at The Motley Fool believe that just about anybody can learn the skills necessary to becoming a prosperous investor. That's why we're getting back to the basics this month in honour of Worldwide Invest Better Day.
For a new investor, knowing where to start can be the most challenging part. To help you find your bearings, I've compiled a list of 10 questions that many beginner investors don't think to ask.
1. How much money do I need to start investing?
Too many people assume they need to be wealthy to invest. That isn't the case. Whether you have £100,000 in savings to invest or £50 in couch change will have no impact on how well you do investing. Understanding your financial situation is far more important than the amount of starting cash you have. One rule of thumb investors of every type should live by: don't invest money you can't afford to lose.
That doesn't mean a little money can't go a long way. In fact, with as little as £50 you could purchase shares of GlaxoSmithKline (LSE: GSK) through direct stock purchase plans. Likewise, more than 1,000 publicly traded companies offer dividend reinvestment plans, also known as DRIPs, as a way for investors to buy stock directly from the company. This strategy can also help you save on costly commission fees charged by brokers.
2. What if I have debt that needs to be paid off?
Getting rid of liabilities such as high-interest debt is an important first step in reaching one's investment goals. After all, it makes little sense to own investments that could appreciate below the amount you'll be paying in interest on your outstanding credit card debt. Before passing go, be sure to pay down any high-rate debt you may have.
3. What's the benefit of using a discount broker?
For new investors with less starting capital, an online discount brokerage account is the way to go. Online firms offer beginning investors worthwhile perks such as commission-free internet trading for your first 60 days after opening an account. These companies exist to help individual investors save money.
4. What money should I invest in the stock market, and what money shouldn't I invest?
This is one of the first topics covered in The Motley Fool Investment Workbook, and for good reason. One common mistake many new investors make is thinking they can double their money overnight with the right stocks. The shorter your time horizon, the riskier your investment becomes. We at the Fool believe in investing for a lifetime. In general, only invest money that you can afford to keep in the stock market for a minimum of five years.
In his e-book 50 Years in the Making: The Great Recession and Its Aftermath, fellow Fool Morgan Housel explains: "The risk of holding stocks diminishes, even disappears, when you hold them for long enough." In summary, invest money for your retirement and not money that you need to live on now.
5. How do I earn above-average returns without taking on too much risk?
First, it's imperative that you understand that without risk, there is no reward. Every investment holds some degree of risk -- as it should. In fact, the Fool has long championed the idea that "the least-mentioned, biggest risk of all is not taking enough risk". The trick is to know your personal risk tolerance.
A conservative investor may be more suited to putting capital into stable, dividend-paying stocks like Vodafone (LSE: VOD) and Astrazenca (LSE: AZN). Both of these companies are highlighted by City super-investor Neil Woodford, the ace high-yield investor who has beaten the market for 5, 10 and 15 years to 2011. You can discover which dividend shares he currently favours in The Motley Fool's "8 Income Plays Held By Britain's Super Investor". But hurry, this special free report is available for a limited time only.
6. What type of investments should I make?
The basic components of an investment portfolio fall into three categories: bonds, shares and mutual funds. Of course, there are advantages and disadvantages to each. However, most Fools opt for shares, because they have traditionally offered the greatest return on capital. When buying a share, think of it as owning a piece of a company. As you research individual shares, it helps to think like an owner: do you want to own this business?
A bond, on the other hand, is a fixed-income agreement between the lender (you) and a company or government. The borrower agrees to pay you, the investor, a fixed interest rate on the loan over a set amount of time. Next, there's the all-too-familiar mutual fund. A mutual fund isn't a bad idea for novice investors who don't have the time to research and choose individual stocks. Put simply, a mutual fund is a collection of investments that has been cherry-picked by a fund manager.
7. When is it the right time to sell a stock?
The ideal Foolish answer may be, quite simply, never, but there are certain situations that warrant a sale. One such case is when there's a major change in the underlying fundamentals of a business, or worse, if a company's management makes an accounting error. Who could forget SuperGroup's (LSE: SGP) 40% plunge on the morning of a profit warning after it found "arithmetic errors" in its forecast for its wholesale business?
8. Should I invest in small-cap growth stocks?
Over the long haul, small-cap stocks have historically outperformed their large-cap brethren. They also give individual investors an edge over mutual funds and institutional investors. You see, unlike large funds, you have no federal regulations limiting the types of companies that you (the lone investor) can add to your portfolio.
This creates an opportunity for us to get in before the institutional investors do. Moreover, the potential upside to investing in small caps helps offset the added risk of picking smaller, lesser-known companies. Still, the key is to find companies with strong growth potential and excellent management. Because of the higher level of risk, small-cap companies should only make up a small portion of your overall portfolio.
9. What are the advantages to owning blue chips?
A "blue chip" is a large-cap company with stable profits and reliable growth. Blue chip stocks include some of the largest corporations on the FTSE, such as BHP Billiton (LSE: BLT), Royal Dutch Shell (LSE: RDSB) and Unilever (LSE: ULVR). Because a company like BHP Billiton is so massive (its market cap is more than £104 billion), the long-term risk is minimised.
10. Where do I find great businesses?
To discover winning companies, start by looking around you. Take note of the products and services you consume on a regular basis; most of these things are made and sold by public corporations. If you ask Warren Buffett, he'll likely tell you to stick to what you know. Start by considering companies within your field of expertise.
Are you looking to profit as a long-term investor? "10 Steps To Making A Million In The Market" is the latest Motley Fool guide to help Britain invest. Better. We urge you to read the report today -- while it's still free and available.
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> The Motley Fool does not own any shares in any of the companies mentioned.