Investing Essentials
Important Investing Tips
You need this chapter for two essential
reasons. First, we want you to be very careful with your capital. We strongly recommend you put only 18-20 percent of your capital
into short-term trading and the other 80 percent into sound, long-term investments. Second, before investing whatever part of your
money you decide to put into long-term investing, you should be aware of some of the various strategies for that kind of portfolio.
You will find some of those various styles and strategies here, in a shortened form.
As you will see, many investment principles can be used or modified so you can use them in your short-term trading strategies as
well.
As you probably know, when it comes to stock investing, there's no shortage of methods, strategies, plans, and theories to make
money. Some strategies are untested; some are proven. None of them are absolute or work all of the time. What you will find here are
many of the best known and most effective stock investment theories. These are the fundamentals you need to know before you go any
further. This is just the beginning.
The following are some basic concepts that you should know and keep in mind at all times.
Diversification
Your portfolio can be severely damaged if you put all your eggs in one basket. It is a cliché, but it is true. If your money is all in
one sector, or heavily concentrated in only one or two stocks, and that part of the market collapses, then so does your money. Make
sure you invest in a mix of different kinds of companies. Even in the best of markets, not all stocks go up at the same time, and
some can even head downward while most stocks are skyrocketing. If you have too many stocks in one or two sectors, such as banking,
raw materials or energy - or if you have your money in only one or two stocks - and that sector or those few stocks nosedive, your
portfolio will, too. Sure, if that sector skyrockets, your portfolio looks great. The best offense, however, is a good defense. Make
sure you are diversified so you don't lose too much when, not if but when, the market or some of its sectors take a nasty downturn.
You must have a plan when to sell. Nothing goes up forever. Determine under what circumstances you will sell and stick to your plan.
Be disciplined. For most investors, selling is a lot harder than buying, and for a lot of reasons. If you've lost a lot of money,
the temptation is to stay with the stock and hope
it comes back. If the stock has gone up a lot, the temptation is
to stay with it and hope it will go up even more. Sometimes you will sell the stock and it
will continue to go up a little, then anxiously you will buy it back just in time for it to fall and take all the profits you just
made. Obviously, these actions are classic signs of Fear and Greed. If you plan ahead and know when you will sell and ruthlessly
apply that discipline, you will save yourself a lot of pain – and will make
yourself more money by getting out of a stock when the time is right for you.
Understand Fundamental Analysis and specifically know about a stock’s beta coefficient. The beta coefficient is a measure of how
volatile a stock is compared to the market. Usually, the stock is compared to the Standard & Poor's 500 index (S&P 500). If a stock
has a beta of 1.0, then it rises and falls exactly as much as the market does. If the beta is higher than 1.0, then it has wider swings,
up and down, than the general market. If a stock's beta is lower than 1.0, its ups and downs are less than the market's general rise and
fall. A high or low beta is neither good nor bad. It is simply a way of measuring how risky an investment the stock is. When you buy a stock,
you have to factor in your ability to handle risk, and beta helps you determine whether a stock is too risky, too conservative, or
about right for your own risk tolerance level.
In the following Screen, this stock's beta coefficient is 2.35.
Therefore, we can see that this stock's price has more volatility than the S&P 500 index. It does not determine whether
the stock is a "good" investment or a "bad" investment. It simply states that it can move more violently than the overall market.
Higher volatility, however, is a higher risk.
Personal Goals
What is investing? It is getting your money to work for you. To do this, you need to ask yourself:
- What is the money for?
- What do I want to achieve?
- When do I want it to occur?
- How much will it cost?
Be realistic in setting personal goals. What do you want to accomplish, and what can you reasonably expect
from an investing program? Over the long term, the stock market returns an average 12% per year. Therefore, a
goal of 100% a year would be unrealistic.
How long before you plan on using the money? Are you planning for retirement, a child’s education, or world
travel in 10 years? These are the types of questions you need to answer before you can develop a strategy and
plan to attain your goals.
Setting measurable and realistic investment targets requires practice and discipline. The importance of starting
to invest early and adding to your investments regularly cannot be repeated enough. In this topic, you will practice
estimating future value for your goals.
Goals should be specific and measurable. For example:
"I need $150,000 to pay for my child's college tuition in 15 years."
Goals that are vague or not measurable are more difficult to achieve. After all, how will you know you have
arrived if you didn't know where you were going? To illustrate, consider the following comments stated as goals:
"My goal is to be successful."
"My goal is to live a good life."
These goals do not meet the criteria of specific and measurable. Until these personal goals meet these
criteria, setting financial goals is not possible.
Setting such qualified goals will drive your future investment decisions. For example, you may know that you need
$150,000 in 15 years for a major expenditure, such as college tuition. How much you need in the future to meet a
specific goal, $150,000 as in this case, is known as future value. Knowing future value enables you to
estimate what you need to reach your goal.
Let's look at how investment decisions can affect future value. Suppose you have $10,000 today to either invest
or spend. You are 25 years old and interested in investing. You are curious about the potential benefits if you were
to begin to save now for your retirement. Your goal is to retire when you reach 60.
The importance of starting to invest early and adding to your investments regularly is shown here.
Financial goals are highly individualized. As an investor, you will want to know how future value applies to your goals.
Once your goals are set, a professional financial advisor can offer you intelligent and targeted suggestions to meet those goals.