If you're new to investing, I have three crucial suggestions for you. Every investor makes these mistakes, but the quicker you can identify them and learn from them, the less likely you are to make them again. Your investing will have greater purpose, and the outcomes you achieve from your investments will be more likely to match the goals you – perhaps subconsciously – had in mind when you started. Here's what you need to do:
- Identify what you want (what are your goals?)
Essentially, consider your financial position, how long you would like to invest for, and what you are looking to achieve with your investments. Broadly speaking, are you looking for growth or income, and lower risk or higher risk?
Take it one step further than that, however, and consider what types of company you would like to own. Generally speaking, I would say that there might not be much point in a growth-seeking investor owning Woolworths Limited (ASX: WOW). Woolies might go to $40, but it's not going to $100. I would submit that Woolworths is a mediocre idea for investors looking to multiply their capital over time – but it has more appeal as a dividend share.
If you don't know what you want, you will be roped into buying a business that is not suitable for you because some fund manager thinks it's undervalued, or because you read a media article suggesting it's a buy.
- Think about how you are going to reach your goals
What is your approach going to be, and does it match your investment goals? Short-term trading is not an approach that would suit many investors looking for lower risk. Will you look for companies with competitive advantages and room to grow, like a2 Milk Company Ltd (Australia) (ASX: A2M)? That's the Foolish way. There are other ways – just as effective – like 'value' investing, where you buy a company that's fallen on hard times because you think it's undervalued and that the market will eventually realise that. You might even choose to own exchange-traded fund that tracks the index, for example the Vanguard Australian Share ETF, or V300AEQ ETF UNITS (ASX: VAS) that tracks the Australian market. Will you stay local, or do you want international share exposure too?
For the same reasons as the above, if you don't think about the process you'll use to reach your goals, you're vulnerable to being led astray by methods that are unsuitable for you. Index-tracking ETFs can be a great set-and-forget investment – but are hardly ideal if you want to play a more active role in selecting your portfolio (and since you're reading this article, I'm assuming that you do!).
- Learn to seek advice (from people that know more than you do)
There is a seminal paper in psychology with the charming title: "Unskilled and Unaware of It: How Difficulties in Recognizing One's Own Incompetence Lead to Inflated Self-Assessments." Known as the Dunning-Kruger effect, research has found that not only do people not know things, but also they aren't aware of how much they don't know. This leads them to overrate their abilities. Less experienced individuals repeatedly and significantly overrate their abilities, while those with more experience can accurately rate themselves.
You'll find this mentioned directly in investing, with some commentators saying that the worst thing that can happen to an inexperienced investor is having their first stock pick become a huge winner. The investor is thus presented with tangible evidence of their competence (they made a lot of money), despite perhaps not having any real idea why they picked that company. Many investors are usually pretty open to sharing their methodology and ideas – just check out Warren Buffett's annual letter to shareholders.
