Pound for pound, the most accessible way for beginner investors to build capital equity is the financial markets.
Unlike sports betting or casino gambling, buying stock in a company is an asset that grants privileges and rights. Even if the shares lose value, you still own a piece of that business.
And while real estate is considered the king of investments, the barrier to entry is steep.
One of the great selling points about financial investing is that there’s virtually no limit in terms of how you can apply your own interests. If you’re into sports, you can always pick up shares of Nike Inc (NYSE:NKE) or Under Armour Inc (NYSE:UA). You can even invest in world-famous soccer club Manchester United PLC (NYSE:MANU).
In fact, one of the most common investing mistakes among beginners is not expanding their horizons. There’s an entire world of opportunity out there waiting to be discovered!
At the same time, not all stocks are built the same. Rushing into a company without research and due diligence can be a recipe for disaster. Both excessive bullishness and crippling bearishness can be rookie investing mistakes. Deciding to start the investment journey is only half of the solution.
To complete the process will require time and effort. The path along the way can personally and monetarily be rich and rewarding, or utterly devastating. Avoid these seven investing mistakes to give yourself the best chance for success!
Tips for Beginner Investors: You Will Make Investing Mistakes!
So you want to be an investor? Congratulations on taking this first step! Now, the first lesson in investing … is not to invest.
While that sounds like a contradiction, you’ll want to hear me out.
In my physics class, my professor stated bluntly, “You will make mistakes.” As the class would evolve from kinematics to electromagnetism, there was virtually zero chance that the students would not commit an error.
This wasn’t meant as a discouragement. Rather, the professor was acknowledging facts, and that it’s better to make errors early than on a midterm or a final exam.
The same goes with investing mistakes. You’ll be thrust into a world of endless securities, economic charts and confusing jargon. Rookie errors will come fast and frequently. Frustration is a normal emotion not just for beginner investors, but even for hardened veterans. The dynamic nature of the markets doesn’t allow rest for the weary.
The problem of investing mistakes is compounded by losing real money. But good news — plenty of brokerages and financial websites offer practice accounts, where you can trade stocks without the pressure of losing your shirt. They offer a wonderful platform for beginner investors to become acclimated to the wild world of Wall Street.
Even with this precaution, you will still make errors! Nothing quite prepares you for the real deal. But with practice accounts, you can eliminate some of the dumb errors that veterans rarely commit.
Tips for Beginner Investors: The Price Is Not Right!
It’s human nature to look at price. The most immediate way in which we evaluate economic decisions comes down to what it will cost us personally. Consumers will often make a decision between two similar-looking products if one is offered at a lower price than the other.
But what price ignores in this context is value. Sometimes, buying cheap results in getting cheap.
This is never more true than in the financial markets. Beginner investors will want to avoid the trap of associating value with price. There are many companies that are priced to the moon, and others that on paper look dirt cheap. Price is really just an entry point in owning one share of the company. There’s absolutely no way that you can assess a company through that metric alone.
To get a better idea of what price means, it’s better to look at market capitalization, or the price per share multiplied by the number of outstanding shares. But even there, beginner investors will want to be careful. You’ll want to ask why an organization is selling its shares or why they are buying them back.
One of the most common rookie investing mistakes is focusing on numbers and not the story.
Of course, price is important. Just be sure to put it in its proper place.
Tips for Beginner Investors: Beware of Fuzzy Math
Fuzzy math is a big problem in America. Arguably, it cost a popular presidential candidate the White House. On a broader scale, American students produce middling results in international math exams.
For beginner investors, fuzzy math can lead to unmistakably clear losses.
Take for example a case where a trader loses 50% on his investment. How much profit will he have to make to break even again? Many will quickly say 50%, but that’s the wrong answer. A gain of 50% would still leave his position well short of break even. Think of it like this: if you have a $100 stock and it loses half of its value, it’s now worth $50 … and 50% of $50 is $25, so that large a gain would only get you to $75.
In other words, if you took a 50% loss, you would need a 100% return to reach equilibrium.
This also reaffirms why price isn’t the end-all, be-all of investing decisions. A $1 move wouldn’t even register for a stock like Berkshire Hathaway Inc. (NYSE:BRK.A). On the other hand, the same $1 move would be a stellar gain for J.C. Penney Company Inc (NYSE:JCP). There are a lot of distortions that can occur by not looking at the math properly.
Worse, it can result in regrettable investing mistakes.
You certainly don’t need to be a math wizard to be a successful investor. However, learning a few key concepts will go a long way.
Tips for Beginner Investors: Defense Wins Championships
In sports, there is no substitute for having a solid defense. Sometimes, weaknesses on offense can be papered over with different schemes, but a vulnerability on defense is exploited mercilessly by the opposing team.
Beginner investors will definitely want to adopt a defensive posture when starting out. This flies in the face of traditional investment advice, which states that younger people should take more risks than older people. But remember, volatility doesn’t give two cents about your age. Indeed, some commonly accepted advice should be thrown into the pit of investing mistakes.
The “certainty of zero” is a concept that beginner investors need to embrace early on in their market journey. You can come across the best investment idea in the world, but if your account is empty, you cannot take advantage of it.
And bear in mind that profitability increases with leverage. In other words, the more money you put into that great idea, the greater the potential reward.
But you just don’t give yourself an opportunity to win if you keep making reckless investing mistakes. There’s no need to constantly shoot the three-pointer. In investing, not getting creamed by the markets is sometimes just as good as making it big.
Tips for Beginner Investors: Whose Side Are You On?
Stock tips are a dime a dozen. There’s obviously no prerequisite for an analyst to render an opinion.
But in addition to the quality of work, beginner investors should consider to whom an analyst reports. Someone employed by JPMorgan Chase & Co. (NYSE:JPM) isn’t going to be employed much longer if he or she writes a scathing assessment of JPM stock.
Learning from independent analysts can help cut down on biased information. However, bias can never be fully eliminated. The most objective reports will still have a particular leaning. This isn’t necessarily a bad thing. After all, you do need to make a decision — fence-sitting isn’t an option.
But awareness of this issue is important. For beginner investors, rather than exclusively listening to one analyst or source, it’s often more helpful to look at the broad consensus. And by all means, review the arguments of the other side. If you’re bullish on a stock, a bearish analysis will provide you with the most threatening of risk factors to consider.
Ultimately, no analyst will have a perfect track record. But by acknowledging the natural and financial biases that can filter their way into their opinions, you can more effectively wield the information available.
Tips for Beginner Investors: Penny Stocks
Whenever beginner investors start talking about the financial markets, inevitably, the topic of penny stocks comes up.
Maybe it’s the proliferation of get-rich-quick advertisements on the internet and social media. Perhaps it’s the ultra-cheap price. Why get only one share of Apple Inc. (NASDAQ:AAPL) when you can own more than one million shares of Adaptive Medias Inc. (OTCMKTS:ADTM)?
Psychologically, it sounds like an awesome deal. But you have to get the loony tunes fantasy out of your head. Penny stocks are one of the most deadly among investing mistakes because they are so alluring. The cheap price implies less risk. Since many people drop pennies on the street without thinking twice about it, owning a stake in a company for that loose change seems like a much better proposition.
If an investment is limited to a penny, sure. But many beginner investors tend to go overboard emotionally. A dollar quickly turns into a hundred. And all the while, the “company” could really just be a paper filing.
That’s because penny stocks are, for the most part, unregulated by federal agencies. These companies end up in over-the-counter markets because they don’t meet the minimum requirements of listing on a national exchange.
True, some companies choose to be listed that way because of the expenses involved in the bigger exchanges. However, the vast majority of cheap penny stocks are listed in the OTC because they stink.
Tips for Beginner Investors: There’s No Magic Button
Regardless of experience, one of the most common investing mistakes is the heavy reliance on a particular analysis tool. Beginner investors are often told that price doesn’t matter, only value. This, however, is an example of telling the truth to sell the lie … and it brings us to a very misunderstood metric: the price-to-earnings ratio.
In a nutshell, beginner investors learn the misguided analysis that a “low” P/E ratio is “good,” and a “high” P/E ratio is “bad.” This is just crazy talk. We already discussed that price can be a deceiving barometer. Dividing price by the earnings per share — which is what the P/E ratio is — doesn’t really help matters.
It’s not that the P/E ratio is useless. It just has to be incorporated in the proper context, and in conjunction with other analyses. Otherwise, beginner investors risk missing out on opportunities simply by letting math compose the framework. A key example is Amazon.com, Inc. (NASDAQ:AMZN), which has a P/E ratio nearing 200, but has been a strong performer over the years.
Don’t think I’m picking on the P/E ratio. Every analysis tool has its pros and cons. But using just one barometer as the basis of your trading strategy will almost always lead to more than a few investing mistakes.
As of this writing, Josh Enomoto did not hold a position in any of the aforementioned securities.