How to Begin Investing
If you are trying to figure out how to start investing you have come to the right place. I will explain what the pros do to set up a basic portfolio, and tell you a few things to keep in mind when you start building your own portfolio.
What you will need to do is decide what type of person you are. Managing a portfolio is not meant for everyone, there are plenty who would prefer the benefits of having not to think about their portfolio all the time, and there is nothing wrong with this. For others, picking individuals stocks may be intimidating and choosing an already selected portfolio of stocks may be more comforting. There are investment products meant for all people and all comfort levels, one popular example, an Exchange Traded Fund (ETF), has become so common now that they can be customized for everything and everyone. These products offer the benefits of diversification, while also cutting down on Front-Loaded and Back-Loaded fees. In many mutual funds run by money managers, you can expect to find substantial fees that they charge for managing your money. These fees are one of the primary reasons it is hard to obtain returns greater than that of any of the major indices. While many in academia recite from text books all too often that the market can not be beaten, I am telling you that it can be beaten when done right. Think about it, if the market could not be beaten, why are thousands of traders on Wall Street being paid so much to do what they do? There is clearly money to be made where you can outsmart the masses and take advantage of their herd mentality. If you have the will to put in the time and effort examining companies down to the most granular details, and carefully managing your portfolio on a regular basis, then you are ready to begin building your portfolio.
Creating an Account
The first step if you have not done so already is to set up an account with a broker – I prefer the online brokers such as Scottrade, TD Ameritrade, or E*Trade to name a few – and fund your account. Investing in stocks involves risk, and because of this risk you should only invest what you can afford to be without for a long period of time (think 15 -20 yrs). Once you have determined how much you can comfortably work with, you can put this into your account and begin thinking about building your portfolio.
To begin building a portfolio like a value investor, you will want to learn how to select companies that fall into this category. To learn more about what characteristics are common of this type of company you will want to refer to “How to Pick Value Stocks,” which explains some of the fundamentals that are common in most of the winners, and conversely, what you should be cautious of.
Diversifying
One of the most important aspects of investing your money, which can NOT be stressed enough, is Diversify..Diversify..Diversify! This is the biggest key to successful investing, and while we all want to make money, by diversifying we are less likely to lose money as well, and this is even more important than making money. So how does a beginner diversify? Well, if you gave your money to a professional they would most likely spread your money into 20 or so different stocks, but this is not necessary. Did you know that if you put a list of all the publicly traded companies on a board, and then threw darts at the list to create a portfolio, it would take roughly 15 companies to be maximally diversified (Maybe that’s why the pros pick so many)? Well, luckily we aren’t picking at random, because trying to keep track of 15 companies would literally be a full time job.
Creating a well diversified portfolio is possible with 5-6 companies, and this is a portfolio a beginner can sufficiently manage. The idea to diversifying a portfolio is to pick companies and their stocks that have no relationship with each other. That means each company should be in a different industry from the rest, and its revenue should not rely on similar sources (i.e. Insurance companies and Car Manufacturers both rely on consumers spending on related purchases - with a new car comes auto insurance).
Apt Investing
Using the amount of money you allocated towards creating a portfolio, take that amount and multiply it by 90%. Set the other 10% percent of the cash aside mentally and make sure you keep this as cash in your portfolio – there will be times when you may need this cash and it will come in handy. Using the 90% you now have to invest, split this amount evenly for each company you plan on adding to your portfolio. This is just a guideline; however, moving too far away from this allocation will cause your portfolio to become unevenly weighted and will expose you to company specific risks – thus defeating the purpose of diversifying.
Now, here is a mistake I made, which, I hope you will not. “Dollar Cost Averaging” (DCA) or “Averaging Down,” is a technique that is commonly applied in a typical 401k. It is the act of contributing a fixed dollar amount on a regular schedule (monthly in most 401k accounts) into your account regardless of where the market is at. What happens by doing this is that you will never invest all of your money at the peak of a market and you will more likely purchase shares at a fair value.
Example:
Buy Company XYZ first of every month:
Oct 1 – $1000, shares at $23.1
Nov 3 – $1000, shares at $9.9
Dec 1 – $1000, shares at $7.09
Average = 285, shares at $10.53
Trading Fees = .9%
2*Trading Fees = over 1.6%
If we had invested all of our money into this one stock on October 1st at $23.1, then we would have been down over 57%!! However, we are going to Dollar Cost Average by investing the same amount of money at three regular intervals, and by doing so, we have brought the average price of each share we purchased down to $10.53. If the stock turns around, we will be much closer to making a profit and have insured that we did not make a large investment error. Here’s where I made a mistake; you have to make sure you don’t invest such a small amount or invest too frequently, because the more times you invest the more your trading fees add up. Many of these online brokerage sites charge a commission for each trade, and you can see from the example above that it has cost us .9% of the money we invested so far. But imagine if we had invested the money twice as frequently (bi-monthly), we would have racked up almost 2% in fees. It is important to keep this in mind, and in my opinion one of the biggest reasons most investors don’t continually outperform the market.
Keeping A Careful Eye
After creating a portfolio it is important to monitor these companies frequently, and to keep an eye on the general state of the economy. It is very easy to assemble a portfolio and forget about it; however, managing your portfolio is just as important to ensure successful investing. Buy and Hold is a popular misconception, it rarely works out well. As Jim Cramer Says “Buy and Homework” is what we should be doing, and he recommends about an hour of homework each week for each company you own. If you own 5 companies in your portfolio, his guideline states you should commit about 5 hours of homework on your holdings per week. It is important to know what is going on specific to your company as well as its industry – don’t forget about its competitors too.
Creating a portfolio should be fun and exciting, but it does require a bit of work, and may not be for everyone. If this doesn’t seem to be for you, don’t sweat it, there are plenty of other ways to get into the market such as by investing in an ETF (Exchange Traded Fund), and many of these funds provide easy ways to get into the action while being diversified at the same time. Now you have a little insight into investing, you should be able to get started like a pro, and avoid some of the amateur mistakes that I made myself