Here at the Fool UK, we think it’s never too soon to begin investing. Thanks to the power of compound interest (or the ‘snowball effect’), the earlier you get involved, the better your chances are of making a mint from the markets.
Having said this, there are a few things all new investors should really try to avoid.
1. Starting without a solid foundation
Three things need to happen before you buy a single stock, in my opinion.
First, make sure you’ve completely wiped any high-interest debt. Investing is all very well, but doing so while still carrying debt is the equivalent of taking one step forward and two back.
Second, have some ‘rainy day’ savings for life’s little emergencies. A few months’ of expenses should be sufficient to get you by.
Third, open a Stocks and Shares ISA. Fail to do this and you’ll end up handing back a proportion of what you make to the taxman.
Those who choose to bypass the above will be taking far more risk than necessary before they’ve even get started.
2. Investing everything in one go
As a market newbie, it can be tempting to assume you need to put all your money to work in one fell swoop.
Thankfully, this isn’t the case. While it’s never a good idea to stay in cash for too long (inflation will gradually erode its value), all major brokers now offer the option of making regular monthly investments. As well as paying less in commission to acquire stock, this strategy also ensures you won’t invest everything at the top of the market.
Not needing to rush is one of the few advantages private investors have over professional money managers who are required to chase performance to keep their jobs. Don’t squander it.
3. Ignoring diversification
Even the best companies experience setbacks. If you’re going to pick your own stocks from the outset, it’s therefore vital to spread your money around.
This usually means buying stocks in different industries (such as housebuilders, retailers, pharmaceuticals) but it could also be applied to the size of businesses (not too many small-caps). Moreover, it’s a good idea to buy firms that aren’t too dependent on trading in just one part of the world.
How many stocks is enough? Research suggests roughly 20-25 should give you all the diversification you need.
4. Buying what’s popular
Another rookie error is to only buy those stocks that have had a good run in the last few weeks or months.
While it can be very profitable, the issue with this approach — known as ‘momentum investing’ — is that momentum can disappear very quickly, causing share prices to fall. This is usually exacerbated in popular stocks as they tend to have very rich valuations.
If you must buy something hot, try balancing it out with something that offers value and/or income.
5. Not being bothered
The rationale behind stock picking is very simple: we buy shares in the hope of selling them on for a higher price. In reality, it requires effort, patience and the ability to keep emotions in check.
If you suspect that your commitment to researching companies and monitoring their performance may last about as long as your 2020 gym subscription, it may be best to avoid buying individual stocks and put money in cheap, market-tracking funds instead.
