Things to Remember Before You Buy Your First Investment
A letter to someone who has never invested before
The process of investing can be overwhelming. Throughout this site, you’ll find hundreds of articles to help you understand everything from what stocks are to how you can reduce your risk through techniques such as dollar cost averaging. Before we get into the details about investing, it’s important to understand some general concepts that will help along the way.
Your Money Can Do More For You Than Your Labor
The first thing you need to understand before beginning an investing plan is this: Your money can do more for you than your labor.
You wouldn’t know that by listening to the average lower or middle-class family, who constantly extol the virtues of getting a good job.
Sometimes the process of investing is going to be difficult. You’ll be tempted to pull out when the market falls, to switch investments when things aren’t moving quickly enough, or to invest in something you don’t understand: DON’T!
You Can Tailor Your Investment Plan to Your Personality
There is no “right” answer when it comes to investing. Once you understand the basics, you can put together a portfolio that represents who you are as a person. There is a famous story of a man who worked for a water company and became fascinated with water stocks. He spent his whole life trading nothing but shares of water companies, amassing a substantial fortune to the point that he knew precisely, to the penny, the profit one of his “companies” made when someone flushed a toilet.
Others, who are passionate about real estate, may never own a stock in their life. Instead, they may buy rental properties, growing their collection of houses over time (it’s even possible to buy real estate through something known as a self-directed IRA but that’s beyond the scope of this article).
The point is that you can’t listen to every investment commentator on television. You don’t see dentists running off to become a singer every time they hear about a pop star earning royalties so why would you think about cashing in your investments, the ones that you’ve spent time choosing and understand, for some exotic new thing you heard about on CNBC? If you know beauty companies, or restaurants, or real estate, it doesn’t make any sense for you to trade them in for oil futures just because a billionaire says that’s the place to be.
Control Your Costs
Regardless of if you choose to invest in stocks, bonds, mutual funds, commodities, real estate – it doesn’t matter – you must focus on controlling your costs. What seems trivial can make the difference between having enough, and scraping by, in retirement. Buying an index fund from a wealth management company may come with what is known as a “sales load” of 5%. That means that when you first invest, $5 of every $100 you put to work is going to get taken as a fee by your bank or financial institution. For a $10,000 investment, that means that over 40 years, you’re going to end up with $22,600+ less money assuming a 10% return than you would have had!
A lot of this has been solved by the age of the Internet. A generation ago, you may pay $200 in commissions on a $10,000 stock trade. Today, you don’t have to pay more than $10. This should have resulted in more wealth in the hands of new investors. Instead, it led to people hyper-trading, buying and selling at such a frequent pace that they forget stocks represent ownership of a business, not just pieces of paper.
Don’t Invest Money You Can’t Afford to Lose
Don’t ever invest money that you cannot afford to lose. That’s why we have FDIC insured bank accounts. Investing should only be done with your “capital” – that is the money you’ve set aside to grow your wealth long-term. You should never use the money you need to buy stocks, real estate, or anything else. The dangers simply aren’t worth the risk.
A Few Other Thoughts
In many cases, the old clichés exist because they have wisdom. You know the ones. Don’t put all of your eggs in one basket. Bulls make money, bears make money, but pigs get slaughtered. Stocks climb a wall of worry. These sayings have been around for more than a century and they still hold true.
If I could add one thing to the list, it would be this: Never do anything that makes you uncomfortable. If it doesn’t make sense, if you get a feeling in your gut, or if you just don’t understand what someone is asking you to do, just pass on the investment. Your first objective is to avoid major losses. If you protect your capital, you can always find ways to make money.