The storming recovery seen in global stock markets since March has been accompanied by a surge in new account openings from those who previously had no interest in investing. Since studies consistently show that owning equities is generally the best way of increasing your wealth, I think this is (potentially) great news. That said, I do think there are a few key things new investors must learn early on.
Stock market goals
Forget the quick wins — good investing rests on solid foundations and knowing what you want to achieve before throwing every penny you have at stocks. Simply ‘wanting to be rich’ isn’t enough because it won’t help you refine your strategy (there are many ways of making money in the markets).
So, what are your financial goals? Is it saving for retirement in the future or generating income now? Are you saving for your child’s university tuition fees or a deposit on a house?
Just as important is knowing how much energy you’re willing to commit to investing. There’s little point buying single company stocks if you’re not prepared to follow their progress (or lack of). You’ll probably be better off buying funds managed by professionals or, alternatively, low-cost index trackers and doing something else with your time.
Speaking of which…
Take advantage of time
One powerful advantage retail investors have over the professionals is that the latter’s scorecards are continually scrutinised. If they don’t perform, their careers are cut short. This is unfortunate since investing success can/should only really be judged over years and ideally decades. The short-term moves of stock markets tend to be pretty meaningless.
As retail investors, we don’t have this problem. They’ll be no one to hand us a P45 if we underperform for a while.
More importantly, we can use this to our advantage through buying shares in undervalued companies experiencing temporary problems. Assuming all goes well, we’ll reap the rewards later down the line.
Diversify (but not too much)
Throwing all your cash at only a few stocks is a recipe for ruin, particularly if they’re in volatile sectors such as oil and gas or biotech.
Having said this, being overly diversified can hold you back too. The more shares you own, the less you deviate from the market as a whole.
To beat the stock market, you need to do something different to the market. It’s no surprise, therefore, that some of the UK’s most successful money managers are those who only invest in their best ideas. Think 20-30 stocks…think Terry Smith or Nick Train.
There’s no magic bullet when it comes to defining how many shares to hold but here’s a simple acid test: if you’re losing sleep over your portfolio, you’re likely taking on too much risk.
Stick to your script
It can be easy to deviate from your own script in pursuit of riches, especially when others appear to be doubling their wealth overnight. How many usually-calm private investors were rushing to invest in Synairgen last week? Quite a few, I imagine.
Even the professionals sometimes struggle to do it and they’re managing other peoples’ money (see Neil Woodford’s fall from grace last year).
Don’t follow the herd. Avoid unnecessary commission costs that erode returns. Learn to sit on your hands. Learn to buy and hold.
