Any young investor should have a basic understanding of the simplest concepts first, such as savings, the power of compounding (interest or gains), how returns correlate to risk, the importance of principles like dollar cost averaging, diversification and asset allocation, an finally the basics on typical investing options like mutual funds, stocks, bonds, and ETFs. Understanding the difference between personal and qualified account is useful too. Qualified accounts would be any that “qualify” for preferential tax treatment (deductions or tax deferral) such as IRAs, ROTH IRAs, and typical employer plans like 401(k) and 403(b) plans.
This can be best done with some online learning or a good primer text. These days there are many great online resources – just rely on well-known resources such as Barrons, Morningstar, Lipper, Bankrate, Kiplinger, Yahoo Finance and MSN Money. Do not chase down Google results that point to newsletter websites – if you see “start your free trial now” at any point go elsewhere.
Beginning investors should consider mutual funds or Exchange Traded Funds(ETFs) or both.
A mutual fund is a pool of stocks or bonds, or both, run by fund managers who state investment objectives and a chosen market bias.Mutual funds with track records of 10 years or more improve an investors chances that fund shows long term performance, not just the luck of some shorter term gains.
Exchange Traded Funds(ETFs) trade like stocks, but represent largely a passive investment in underlying stocks reflecting the ETF focus on a specific part of the domestic or world markets, or both.
None of the Above
None of the above educates a young investor on the definition of a “good stock” and that deserves an answer. Picking a stock or stocks to invest in isn’t easy, because even stocks with good “fundamentals” or a solid underlying reason to believe in a company’s financials and earnings, doesn’t mean you can buy the wrong stock at the right time and make money, or buy the right stock at the wrong time.
Below are 7 useful tips you can use:
1.Learn what drives the stock market.
Some say learn how to evaluate a company’s balance sheet and operating statements. Fair enough, but that is a very complicated process and unfortunately the stock markets are driven largely by simple human psychology, technical trading programs or external considerations like politics, current events and even weather or natural calamities.
2.Learn from a great investor
Buffet has always said “buy a stock of a company that you understand” – maybe not the details of a business model, but any investor should have a basic understanding of the business the company is in. If you’re a fan of that company and a big consumer – all the better. Go through Warren Buffett’s annual letters and read them from start to finish. They are written in plain language, contain a treasure trove of investment advice from the world’s best investor and you can download them for free here: Berkshire Hathaway Shareholder Letter (1977 to 2016)
Four decades worth of letters is quite a bit of reading so if you are looking for a shortcut, I would also highly recommend Larry Cunningham’s The Essays of Warren Buffett: Lessons for Corporate America which does a great job of summarizing them. In fact I would recommend reading this book alongside reading all of the letters anyway. There are countless other influential books that I have read over the years but this is where I started.
3.Invest in large companies
Focus on well-established and larger firms at the start. They are more likely to continue to run profitably and weather challenges from adverse economic conditions, competition, or other factors.
4.Ratings of a company
Don’t discount the value of online “ratings” assigned by the reputable online financial sites. They do give stocks ratings based on long term price growth, accumulation, earnings and dividends and price changes against their peer group or the overall market. The comment concerning the price / earnings ratio is a good one. It tells an investor when a stock may be “cheap” or better yet, whether its price is higher or lower than it should be if compared to its peers.
5.Companies that are growing
If an investor does decide they want to buy individual stocks alongside the other more diversified options such as funds or ETFs, it’s very easy to first decide whether you want to buy a company whose growth prospects are good (they are growing earnings and profits over time) or find a company whose stock is considered a “value” or cheap at the time and take advantage of that short term opportunity.
6.Mutual funds top 10 holdings
Once an investor does that – it’s very easy to go the best performing mutual funds in either of the above categories or whatever sector an investor has interest in, and review a fund’s top 10 holdings. After all, if professional money managers like those stocks, don’t they deserve consideration by a novice?
7.Buy high and sell low
Learn the discipline of knowing when to buy but more importantly when to sell to take profits when it’s appropriate, or to avoid losses. Typical investors usually do a poor job on both counts. The behavior attached to investors by experts is that they “buy high and sell low” – behavior that is well documented.
The sooner you start and the more you know is the best start, but always – always – learn from both your successes and mistakes to improve results and avoid losses
There are no shortcuts to become a good investor. And by the way, you should probably learn how to love reading — you will be doing a lot of it. It is a lifelong process and the earlier you start the better.
So what are you waiting for?