Jan 13 2010

6 Tips For the Beginning Investor.

Here’s a list of some investing insight I’ve learned over the years that I hope will help accelerate the beginning investor’s road to wealth.

1. Don’t go all in at once.

If you have a lump sum of money to invest and you are doing so when the market is going down, don’t just use it all at once to buy shares. Instead, split that lump sum into 3rds and buy at periodic intervals as the market goes down. The idea is that you simply cannot time the market effectively, so don’t bother.

Instead, you’re dollar cost averaging on the way down and spreading your money out like scatter shot instead of a single bullet. By doing so, you will improve the chances of hitting near the lows with at least some of your purchases.

2. Don’t be paralyzed by taxes.

Often times, individual investors hold on to a winning stock because they don’t want to pay the taxes on it, only to have waited too long and find they rode the stock back down to loser territory.

It’s an understandable course of action, after all when an activity is taxed, people do that activity less than when it is not taxed. But you have to get past that and realize that even at a 42% tax rate, you still have a 58% profit.

But let’s be clear – I’m not saying you could ignore taxes, only that you shouldn’t allow their implication to paralyze you into inaction.

Taxes should be an important part of your investment planning. For example, you want to be aware of the kinds of assets you hold so you don’t keep tax free, municipal bonds in a tax deferred account.

3. Broken stocks are OK, broken companies are not.

A stock’s price is a function of the quality and value of the underlying company, over the long term. This means that if you are looking to hold onto a stock for the long term, say 5-7 years, you should avoid stocks of broken companies and instead look for stocks of good quality companies that have suffered a temporary decline in stock price. Eventually the market will recognize the superior quality of the company and reward the stock price. Conversely, stocks of broken companies become broken stocks over time. An example of this might be Johnson & Johnson in the fall of 2008. The stock price suffered because the market as a whole crashed, not because the company was in poor shape. GM stock on the other hand suffered because the company was bankrupt and has no upside potential.

4. No one ever got rich panicking.

The key to success is simple to understand, difficult to practice – have a plan. You will never be a successful investor if you “just wing it”, “play by ear” or perform in a host of similar colloquial cliches.

Instead, you need to have a plan for when to buy and when to sell each and every stock you hold. Once you have your plan, use Stop Order and Limit Order to take the emotion out of your buying and selling.

5. Diversification is essential.

There have been a lot of pundits pointing out that diversification didn’t help in the 2008-2009 crash, but that while that is true, it’s not as important as it may at first seem .

Firstly, the 2008-2009 crash is not the norm and you’re far more likely to encounter situations where diversification would protect you than you are to experience another such crash.

Secondly, the only things safe in the 2008-2009 crash were cash and (maybe) commodities. If you want to prepare for a 2008-2009 style crash you should diversify some of your holdings into these asset types. But if you held most of your portfolio in them most of the time, you would lose in the long term.

6. Buy and hold is not “set it and forget it”.

Buy and hold investing is great for retirement savings, but even then you need to pay attention. Too many people mistake “Buy and Hold” for some similar sounding marketing gimmick from Ron Popiel.

“Set it and forget it” in the investing world is simply neglect, and it will catch up with you sooner or later.

Instead, you should periodically create a list of your holdings and rank them , that way you will have a course of action and always know where your holdings stand regarding buy, sell or hold.

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