A beginners guide to… Investment perils and how to avoid them
Avoiding investment pitfalls (the newbie guide):
Whether it’s the latest hot tech stock or the new cryptocurrency on the block, it is easy to fall prey to over excitement about the latest darlings of the stock market, and before you know it you end up ‘losing your shirt’ (an investment-world term used to denote someone losing everything on a bad investment).
In this blog we will attempt to briefly outline how beginners to investing can avoid common pitfalls, as well as putting forward some suggestions for staying on top of your investments. This way, you will spend more time making money, as opposed to burning it!
Let us begin with the obvious points: –
- Do your research
Investing is fun and exciting, but it comes with plenty of risks. At the core, the concept is simple, you want to buy something (an instrument) and see its value increase over time, or you want to profit from a short term change in its value. You may also want to profit from a decrease in its value over time (known as ‘shorting’ an instrument). Either way, it’s best to make an informed call, so do some homework first! This means evaluating a stock’s ability to make you money.
It sounds like a no-brainer, but what points have you considered for your latest investment? Have you looked at the firms performance over the last few years? Have you assessed where it stands in comparison to its competitors in the marketplace? How vital are its products and will consumers always consider them useful? Where does the company seem to be heading? Are there issues with the management? What sort of macroeconomic (wider) factors might hurt or help the company? Are they at the forefront of innovation or are they lagging behind their rivals? Are they willing to adapt to changing environments? How consistently do they perform well in earnings reports? How popular are they with other investors and the public as a whole? Or is it just based on your own ‘gut feel’? We created a handy diagram to summarise these points:
You can ask hundreds of these questions. Research is one of the keys to making wise decisions and hopefully seeing your investment come to fruition and make you consistent returns, instead of jumping in too quickly without enough knowledge and getting burned. Research and knowledge also helps you become an expert in one field or many, thus knowing your investments inside out and being able to more accurately forecast how a company is going to perform into the future. Other things to factor here include watching for company events, such as financial results (which often affect share prices dramatically) and general / shareholder meetings. You should look at any major announcements from a firm and what they say about their futures too. Talking to other investors is also vital. Sometimes we become so wrapped up in our ‘perfect’ investment idea that we forget blind spots which others can help us identify.
- Keep an eye on your portfolio
We are not saying you need to watch it like a hawk, ready for any small gain or loss. Even newbies to the stock markets can see for themselves that stock prices fluctuate constantly and often seemingly randomly. These ups and downs need not be cause for concern. As the world-renowned investor George Soros said, “There is an urgent need to recognize that financial markets, far from trending towards equilibrium, are inherently unstable.”
However you do need to check in sometimes. Being laid-back is no virtue in financial markets. It pays (literally) to conduct thorough research into your investments and keep track of the movement of your portfolio. As we have explained in previous blogs, financial markets are all interconnected, which means that sectors and the companies within them can all affect each other. The price of oil is tied to energy company stock prices, for example.
A glut of oil (an oversupply) thanks to the actions of big oil-producing countries can cause the price of oil to slip due to oversupply and too little demand. This in turn affects the ability of energy companies to make money. This can then drag down energy firm share prices, (which if you invested in them can cause some concern). On occasion, this downward pressure continues for some time before rebounding, perhaps even for months, as we saw with commodity prices over the last few years. At one point, commodity prices had fallen to their lowest level since the financial crisis and — by at least one measure — to the lowest this century. Amidst China’s growth slowdown (and therefore the lower demand for metals and other materials), many investors were worried about a continuing spiral downward. Before you know it, your investments may have slumped due to factors out of your control, which is why keeping track of them is vital to minimise losses.
- Be aware of the risks
This ties into knowledge and research. Do you feel fully informed about the instrument(s) you are buying into? For example, Bitcoin is the hot investment at the moment. It has indeed given some investors huge profits, but are you aware of the volatility it can experience on a daily basis, where it can lose hundreds of Dollars off its price in a single afternoon?
Speaking of cryptocurrencies, investors have been routinely caught in scams involving ICOs (or initial coin offerings). An initial coin offering is similar in concept to an initial public offering (or IPO). Both are a process in which companies raise capital, while an ICO is an investment that gives the investor a cryptocoin, more commonly known as a coin or a token in return for investment. Cryptocurrency trading is essentially based on speculation. There is no inherent value in Bitcoin except for what other investors ascribe to it. When you invest in an ICO, it’s not like an IPO where a company is using the capital to develop new products and initiatives. Speculating on the rise and fall of a price is different to investing and it is more risky overall. Regular equity prices do not tend to have such regular drastic swings in their value in comparison to cryptocurrencies, which is why we would suggest that beginners to the markets should stick to regular equities at first, (though you can just as easily lose everything on ‘regular’ stock market investments too if you don’t make a wise and well reasoned decision on your investment).
Many of these cryptocurrency ventures had investors flocking to them due to the explosive surge in popularity that these coins experienced throughout 2017, but a significant proportion turned out to be scams, prompting investors to part with their money for no return. This is not a warning concerning investment strategies, but it is something to be aware of so that you don’t get caught in the hype surrounding shiny new investment opportunities, which sometimes make promises of getting you rich quickly.
The same kind of situation is exemplified most clearly in the ‘dot-com bubble’ of the 1990’s, which saw a huge amount of investor enthusiasm for tech stocks, many of which turned out to be bogus investments.
The rising uptake of the internet at the time, meant many investors and speculators were over confident about many of these companies and their ability to make profits. They bought stocks with less care and concern than usual, with the expectation that these companies were bound to make good money because the sector as a whole was growing so rapidly. This led to a bubble, that is, a huge amount of trades that involved buying stocks for way more than they were actually worth. People all over the place were paying over the odds for stock in companies that weren’t solid investments. This was so pervasive that it became a sector wide phenomenon, and many investors sadly did ‘lose their shirts’.
Trends and fads in markets come and go, and that is why it’s important to stick to the fundamentals.
- Keep it simple to start with
There are many different asset classes that investors can choose to put money into to generate returns, but some are more complex and less intuitive than others. Forex trading (foreign exchange) for example can come with a higher level of risk and volatility than investing in equities, as a rule of thumb. Currency trading requires a higher level of knowledge about macro, geopolitical and socio-economic issues because these are the factors that make the value of a country’s currency move up and down. Not only this, but it is about how countries relate to each other too. Currency values are measured in comparison to other currencies, which is why currency ‘pairs’ are often traded, i.e. the GPB/USD (the strength of the British Pound against the strength of the American Dollar).
If we were to make a recommendation, it would be to start first with equities as your first investment, though there are many options available each with their pro’s and cons. Funds, including ETFs (Exchange Traded Funds) which operate similarly to a stock are a popular option for many investors, as are mutual funds. You can also go the old fashioned route and buy stock in one or a set of particular companies. The great benefit of this is that you have the most control over your money as you decide the precise amount you would like to invest in each instrument, and as such you are effectively your own ‘portfolio manager’. It’s also generally easier to follow individual stock performance as opposed to tracking a fund, many of which contain a broad range of asset classes and instruments, making things a little more confusing especially for beginner investors.
Investors should focus on companies which are likely to perform well into the future, so while trends come and go, they stay relevant and produce good returns. Often these companies are consumer defensive. What does this mean? Investment firm Morningstar describe this as: “Companies engaged in the manufacturing of food, beverages, household and personal products, packaging, or tobacco. Also includes companies that provide services such as education & training services. Companies in this sector include Philip Morris International, Procter & Gamble and Wal-Mart Stores.” These businesses make things that people always need, regardless of the overall economic conditions. These are often also called ‘consumer staples’ meaning they are a fixture of a consumers life – goods people tend to buy out of necessity.
4. To sum up
- Past performance of an investment is no guide to its performance in the future.
- Investments, or income from them, can go down as well as up.
- Risk can be brought about by the performance of world markets, interest rates, taxes on income and capital, and foreign exchange rates.
- You may not necessarily get back any of the amount you invested.
- Smaller company shares can be relatively illiquid, meaning they could be harder to trade, which makes them higher risk.
- Content and information about potential investments are designed for general use, and so cannot be considered personal to your circumstances or your financial position.
- Don’t Drink and Invest at the same time!