Investing for the first time can be challenging because there are so many options to choose from and none of them is risk free.
Investing can be carried out via the money market where your money works for you when you buy debt instruments and in the end your principal is refunded to you plus interest or by investing in the capital market where you buy an asset and wait for it to appreciate.
Getting it right the first time will be a morale booster and encourage you to keep on investing so you need to avoid mistakes most new investors make.
Information is key when investing and as with everything, investing has its rules and an investor needs to know what to do and what not to do while investing for the first time.
What to do?
#1. Draw a plan
Investment is a long term journey that could last a life time and outlive you so before you embark on this journey it is only logical to count the cost. You need to know why you are investing as your why will determine your how. You could be investing for retirement, to buy your dream home or for your children school fees and investment strategies/ asset allocation for these goals will differ.
When drawing a plan, you need to determine how much time you have to achieve your investment goal. If you are in your 20’s & have more income, you can afford to buy more of risky assets as you have more time to recover from any losses than someone in his 50’s.
Your plan should also take into consideration your source of income. If you are a salary earner you could set up auto-debit standing orders to take money from your salary for investment and if you don’t have a steady income, you work out a way of funding your investments.
If you don’t have a plan you may end up modifying your portfolio every time and this costs money as every time you buy or sell an asset, your broker charges a fee. These fees though little, add up to a lot of money when they accumulate down the road. To avoid all this, you should draw a plan in the beginning.
#2. Pay off your debt
Credit cards encourage you to spend money you have not earned and interest charges are always enormous especially when you settle your debt late and you are charged late settlement fees.
Remember credit card interest repayment is linked to the LIBOR rate which is not fixed so this kind of debt stands in the way of budgeting your resources, because you don’t know how much interest you will be charged every month
The safest thing is to pay off all credit card and other forms of debt or at least pay part of it to reduce the debt. This will give you a clear view of how much you have left to invest.
By the time you commence your investment journey you need to be careful with credit cards and other forms of borrowing. Don’t spend more than you can afford repay in a timely manner so as not to accumulate interest charges and late repayment fees.
#3. Determine your Risk appetite
There is an element of risk in every investment though some are more risky than others but the higher the risk, the higher the reward. You need to be aware of what you are getting into and the chances of you losing your money.
You could choose to save your money in the Bank or invest in the capital market and both carry their own risk.
First, if you choose to save your money in the Bank, it will be safe and will earn you little but guaranteed interest. However, there is a risk of inflation which is a general increase in the price of goods and services and this means the money you save today may be worth even less when you want to use it tomorrow.
Second, if you choose to invest in the capital market there is market risk: the risk that stock prices could fall, Industry risk: the risk that a company may no longer be able to compete due to unfavorable government policies etc. Regulatory risk: the risk that industry regulators might stiffen regulations thus forcing companies to relocate or even close shop, and there is market risk: the risk a company may make a loss and not pay dividends.
All of these risks can affect return on investments.
Although investment in the capital market is more risky, it is also more rewarding in the long term because unlike the fixed interest investors get from saving money in the bank, fixed deposits and treasury bills, if a company does well there is no restriction on the amount of dividend it pays its shareholders. Some companies even offer bonus shares to shareholders after a good years outing.
Depending on your investment goals, you could choose to be an aggressive investor and allocate all of your portfolio to stocks, a moderate investor and have a balance of stock and money market instruments, or be a conservative investor and allocate your entire portfolio to safe but low interest yielding debt instruments like Bonds, fixed deposits, etc.
It is left for a new investor to determine how much risk he is willing to accommodate and allocate assets to his portfolio accordingly.
#4. Pick a good broker
There are various brokers to choose from so pick one that doesn’t charge exorbitant fees, has tight spreads and has a good mobile App that you can download to your device for easy investment.
Before you invest any money with the broker, you also need to check if the broker is regulated with the relevant regulator for the safety of your funds.
For stock trading & forex trading in the UK, you need to choose a broker that is regulated with FCA. But some online brokers may display fake license or regulation so you need to check & verify it from independent source.
Broker comparison website Safe Forex Brokers UK suggests, you can verify the registration/license number of the broker on FCA’s website and check their contact details including address, website, phone number, investment products approved, firm status to verify whether broker is allowed to operate in the UK. These details must be cross-checked on the broker’s website to ensure that you are not opening account with a clone or unlicensed brokerage.
If you invest all your money in one asset class and something goes wrong you can lose your entire investment. The silver bullet here is to invest in different stocks from different sectors such as technology, precious metals, Agriculture, etc. it may be challenging researching stock of companies in various sectors especially if you are a busy person, so investing in an exchange traded funds (ETFs) and mutual funds might just be the best option.
ETFs pool funds from different investors and invest the funds in a basket of assets, thereby allowing for diversification. ETFs are traded just like you would trade shares on an exchange and market forces determine their price. When you buy shares of an ETF, you own a slice of that basket of assets and your slice contains all the shares of the various companies in that basket.
ETFs can be configured in different ways, for example they track indices such as the S&P 500 index. When you buy shares of an ETF that tracks the S&P 500 index, you own shares of the 500 most capitalized companies listed on American stock exchanges like Apple, Microsoft, Facebook, Berkshire Hathaway etc. and this is good diversification.
Mutual funds are similar to ETFs as they also allow you buy into a basket of assets, some even track gold indices thus giving you exposure to companies that deal in Gold and other precious metals.
However, they are not traded on a stock exchange so you would have to approach the fund manager to buy units of a mutual fund. You could choose either mutual funds or ETFs to be part of your investment portfolio.
What to avoid?
#1 Complex financial products
As a first-time investor, stick to stocks, bonds and other simple financial instruments.
Do not go for complex products like derivatives. A derivative is a product that derives its existence from an underlying asset(s) such as a stock, commodity or currency. Examples of derivatives are futures, options, swaps, Contract for Difference etc.
#2 Not carrying out fundamental analysis
Buying into ETFs and mutual funds is ideal for new investors, but if you intend to handpick individual stock then you need to study the balance sheet, income statement and cash flow statement of the company(s) to know if their assets can cover their liability plus shareholders’ equity.
This is called carrying out a fundamental analysis and is better than investing based on online chatter, rumors, and online tips or out of the fear of missing out (FOMO).
#3 Buying penny stocks
Some companies may be new startups or small companies, so their share price may be very low, but it does not mean that all these companies will grow. Sometimes a low share price could mean a poorly managed company. Whichever the case may be, such stocks are considered penny stock.
If you invest in such a stock, you might wait a very long time before the stock begins to appreciate or the business pays you dividends. You may not be able to sell off the stock when you want because the demand for them is low, meaning they’re illiquid.
While it is true that some stock may be undervalued and an ailing company today might put its act together and become profitable in the future, you don’t want your first investing experience to be a bad one as the first impression matters.
If you don’t have money to buy blue chip stock, you could talk with your broker about buying cheaper fractional stock of bigger companies.
#4 Investing more than you can afford to lose
You should always invest only the money you are prepared to risk & hold some cash. There’s always a possibility of losing your capital when you invest.
Have an emergency fund of ready cash kept in a savings account. This will be a fall back if anything should go wrong. Investing more than you can risk losing will put you under too much pressure and can lead to health problems and a loss can discourage you from further investment and you end up leaving the capital market.