5 things to understand before you start investing

Christopher Ruane lays out a handful of principles he would bear in mind if he was to start investing for the first time today.

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It can be exciting thinking about the possible returns of investing in the stock market. That helps explain why some people rush into it and start investing before they really understand what they are doing.

If I was going to begin investing for the first time, here are five things I would like to know.

1. Costs matter

Some investment trusts charge an annual management fee, often a low-single-digit percentage number. Buying or selling any shares usually also attracts fees. They can also sound low on paper, again in the single-digit percentage range.

But a few percentage points here and a couple of percentage points there can soon add up. The more one trades, the sooner such costs are likely to add up.

I would begin by comparing different share-dealing accounts and Stocks and Shares ISAa to see which one looked most appropriate for my needs.

2. The future is not the past

Past performance can be very helpful when investing. For example, knowing how a business did in the past can help me decide whether its business model looks proven and what sort of seasonality it has.

But past performance is not necessarily a guide to what comes next, even for a proven business with a long history. Fortunes have been lost by investors sinking money into fallen giants, only to see them keep on falling.

3. Chasing yield is a fool’s errand

The dividend yield is the amount one receives each year as dividends as a percentage of the cost of the shares.

For example, Diversified Energy currently has a yield of 16%. If that is sustained, spending £100 on Diversified shares today ought to earn me £16 in dividends annually. Even at a time of high interest rates, that sort of yield grabs my attention.

But dividends are never guaranteed. A common mistake when people start investing is simply to look at yields, without understanding the business concerned. A high yield alone tells me nothing. Instead, I need to understand the business concerned and judge how able I think it will likely be to maintain its shareholder payout.

4. Diversification is simple but important

Many people have their eye on what they think is an amazing share when they start investing. Anyone who has ever heard someone in a pub drone on about how they almost bought Amazon or Tesla shares before the companies grew huge, will have experienced this first-hand.

While some companies do well, others perform terribly. There are lots of ways to form an opinion on what is likely to happen – but there is no way to know for sure ahead of time.

By spreading my eggs over multiple baskets, I can reduce the risk to my portfolio if one share I choose later performs badly.

5. Stay calm

Investing involves risking one’s money. The twists and turns of the stock market can seem exciting – or nerve-racking.

Investing is ultimately about making money. I think a valuable lesson when one starts investing is always to stay calm and try to avoid emotionally driven decision-making.

As legendary investor Warren Buffett says: “When forced to choose, I will not trade even a night’s sleep for the chance of extra profits.”

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

John Mackey, former CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool’s board of directors. C Ruane has no position in any of the shares mentioned. The Motley Fool UK has recommended Amazon.com and Tesla. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

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