Investing for the first time can be both scary and exciting. There’s the prospect of making a serious profit, but it’s often coupled with the fear of losing it all. If you’re a first time investor, it’s best to avoid this kind of thinking. You need to learn the lingo, come up with a strategy, and make sure you invest astutely. For first time investors, this starts with avoiding these 5 common mistakes.
1. Working with a financial advisor who is not a fiduciary
This is the first case where learning the basic terminology and principles is absolutely vital. It may not sound interesting, but not understanding precisely what a fiduciary is can cost you big in the long run. In short, if a financial advisor is also a fiduciary, they are bound by law to act in your interest.
“But wait, of course financial advisors act in your interest!”
Well, not necessarily. A financial advisor who isn’t a fiduciary can legally give you financial advice that maximises their own commission but isn’t actually in your best interest. In fact, in 2015, the Obama administration required financial advisors to work under these standards. Today, there’s a possibility this will be repealed, so it’s still best to ask and make sure anyone you hire for financial advice is really working for you.
2. Not paying attention to fees
Maybe you’re going to hire a financial advisor, or perhaps you’re going to simply use a management service. Whatever tools you’re going to use to invest, one thing you need to watch closely is the fees involved. In short, you want to find the lowest possible fees for any investments you’re making. Even a 1% increase in annual fees can leave you with a substantially smaller amount of money at the end of a few decades.
Perhaps you’re thinking that those extra fees are worth it, because your investment service is top notch, and they may be great. In most cases, however, the benefits of one service over another won’t outweigh the lost money from fees over the lifetime of your investments. Of course, individual results will vary, but always keep this in mind. For an entertaining and elucidating breakdown of this issue, check out John Oliver’s take on it.
3. Not carefully taking risk into account
Do you want your investments to be high risk, high reward, or low risk and lower reward? To begin answering that question, ask yourself why you’re investing. If it’s for retirement, then you can probably take on a little bit of risk, but gradually transition into lower risk investments as you get closer to retirement age.
If you’re investing to generate some money in the short term (and the money you’re investing is money you can afford to lose), then you might want to try a riskier investment strategy. For most people though, a balanced portfolio where the risk matches financial goals is best. In particular, this often means investments that aren’t likely to all go bad at once. Investopedia has a great article on doing this right.
4. Trying to “play” the stock market
When most of us hear about investors, we either think of venture capitalists in Silicon Valley, searching for the next Facebook or Google, or we think of someone who trades stocks all day. Well, if you imagine yourself as the latter, then you want to make sure you know what you’re doing. This isn’t your parents’ stock market anymore. Today, men and women known as “quants” use advanced algorithms to buy and sell stocks within fractions of a second.
So how can you compete? Fortunately, there are products out there that allow you to easily build your own algorithmic trading strategy, meaning you can automate when stocks are bought and sold. This allows you to buy and sell without having to constantly check the market or pay someone else to do the hard work.
5. Paying for active fund management
First, what is active fund management? In short, it’s when you’re paying someone to actively manage your investments. That may sound great, but what it actually means in most cases is higher fees and returns that simply don’t justify them.
In fact, studies have found that active funds not only cost more, but actually perform worse than passive funds. Why is this the case? While it’s true that the average person isn’t very good at playing the stock market, the secret is that many professionals aren’t either.
Overall, your best bet is to create a balanced investment strategy which minimizes fees and doesn’t take up too much of your time. This could mean buying indexed mutual funds once every few months, or it might mean building an algorithmic trading strategy to buy and sell stocks for you. Just remember, the sooner you start saving and investing, the better off you’ll be down the road. Why not start now?