The journey of a new investor takes many twists and turns. From my own personal experience, I hope to shed some light on how even a beginner can invest profitably in the stock market. In this post, I’ll take you through step by step about what you should do.
This week’s article is a guest post from Tony at A Young Investor. Tony writes about how to invest in the financial markets and he shares his investment experiences.
Read As Much As You Can – Don’t Jump Right into the Market
Many new investors make the mistake of knowing nothing and buying the first stock that looks good. On the contrary, a good investor should learn as much and read as much as he can before investing. While I can’t tell you what books to read, I can tell you what to avoid. This is because my introduction to Investing 101 was a little different (and something that no one can replicate) – my parents were investors, so I was taught more than self-taught. By the time I started reading books about investing, I was already pretty advanced, so my books definitely did not constitute beginner-level information. Here’s a couple of things to avoid:
My foremost rule is to never buy a stock just because some “expert” is recommending it. Most of the time, the “experts” aren’t correct – if their tips were correct, they’d be making money from investing in those tips as opposed to making money by telling others how to make money! That being said, Jim Cramer’s Mad Money and other financial market shows are generally just full of BS.
A lot of people sign up for investment newsletters that cost hundreds of dollars a year. 99% of the time, the market predictions in these newsletters are wrong – if they were right, the newsletter writer wouldn’t be writing and instead would act on his own advice!
How to Choose a Broker
In the past, brokerage fees would take out a decent chunk of your portfolio’s value. But not anymore. With online brokerages nowadays, brokerage fees are virtually non-existent. That is why I use an online broker (IB) as opposed to a retail broker, which charges fat fees that will cut into your profits.
How to Select a Stock
When it comes to stock selection, I have my own criteria. While most people pay attention to tangible numbers such as earnings-per-share (EPS), I pay attention to the non-tangible factors. These include:
- The industry that the company’s in. Is it an industry that really has a solid, fundamental need, or is it a “fashion” industry? I use the classic Microsoft vs. Apple example for this case. On paper, Apple seems far better than Microsoft: bigger profits, wider consumer appeal, etc. However, the problem with Apple’s business is that it’s technically in the “fashion” industry. Apple’s products are products that we can live without, so once Apple loses it’s “bling”, there’s nothing that will prevent consumers from switching to an Apple competitor (this is happening already). On the other hand, Microsoft, the old, musty company that most investors shun, is far better (in my opinion) than Apple. Microsoft’s business has a fundamental need in the market – peoples’ lives would be much less convenient with PC’s. In addition, Microsoft’s consumer lock-in (platform incompatibility) prevents consumers from easily switching to a competitor’s software. As such, Apple is a fly-by-night company while Microsoft has consistent, steady earnings. In other words, you never know when the manna will stop flowing at Apple, while Microsoft is a huge cash-flow generating cow.
- Is it a company that can be run by a ham sandwich? Many companies depend too much on their leaders – when the brilliant visionary leaves the company or dies, the company’s competitive advantage is immediately gone. Let me give you 2 examples. When Walt Disney, the founder of Disney died, his company failed to create any significant for almost 30 years. After Frank Wells died in 1994 in a helicopter crash, Disney churned out failure after failure after failure (that’s why if you search for Disney songs on Youtube, you’ll see that all the comments are like “Disney just doesn’t create movies like this anymore”). Now that Steve Jobs is dead, where is Apple’s fountain of creativity going to come from? Tim Cook, an operations and supply chain guy? No. On the other hand, companies like Coca-Cola can literally be run by a ham sandwich – Coca-Cola’s structure is written in stone so that all you have to do is do 1, 2, 3 and Coca-Cola’s making money!
A Few Tips For New Investors
- Don’t short stocks. Shorting is the betting that stock prices will go down. Theoretically, the maximum amount of money you can make from shorting is 100%, while the losses are infinite. That is why shorting should not be attempted by new investors – the risk/reward ration is too high.
- Stay away from financial products you don’t understand. A lot of new investors who plunge into options, futures, etc get killed because they don’t understand what’s going on. Like my mother used to say “if you don’t understand it, stay away from it. The money may flow in fast, but it will flow out faster”.