Need to Learn How to Invest in Stocks Cannot be Over-emphasised.
There are many sides to investing in stocks. I will like to start by saying that investing in stocks involves some elements of risk. This is not to scare anybody anyway. It is important you know this truth. As I usually advise anybody that wants to start a business about the need for proper and adequate planning, the same way I will advise anybody that likes to consider investing in stocks to do his homework properly. While it is acknowledged that you don’t need to know it all, you should not invest in shares blindly. These days, you don’t need to be a professional stockbroker to become an expert in investing in stocks. The truth of the matter is that, some of the professional stockbrokers do learn about strategies being employed by successful investors who did not have any educational background in stocks trading. For instance, I don’t think there is any stockbroker who will not acknowledge Warren Buffet when talking about investing in shares. Warren Buffet is one of the big time successful stocks investors not because he had large amount of money to invest. He became successful by giving himself time to understand the rule of the game. If you want to achieve success in stocks investing, you may need to follow suit. Therefore, before you starting pumping your money into buying stocks no matter how appealing the deal may look, you need to first invest in yourself. In this article, I highlight some salient points you may need to consider before you start your journey into investing in shares.
The starting point is for you to sit down and understand the kind of person you are. In the world of stocks investing, we have three categories of investors namely; the risk takers, the risk averse and the in-between which is known as risk neutral. This aspect is very important in stock investing. Each stock in the market comes with its own risk but the level of risks involved in investing in stocks differ from one share to the other. The level of risk you are ready to take will determine the type of stocks you should buy. The basic principle guiding investment whether you are investing in stocks or in any other instrument is; the higher the risk, the higher the likely return on such investment. If you are risk averse, it means that you are not willing to take much risk. Being a risk averse does not mean you are not taking any risk at all. It simply means that you want to reduce your risk to the barest minimum. People in this category are more concerned about the security of their capital. They are contented with whatever little returns they have on their investment. Instead of investing in stocks, risk averse individuals may prefer investing in bonds or mutual funds. The returns on bonds may not be that high but it promises guaranteed returns while your capital is also secure. People who have attained a retirement age are usually risk averse. They can’t afford to gamble with their money. Therefore, they prefer to play it safe as they may not be able to go back to work if they lose their money.
The opposite of risk averse are the risk takers. If you have a gut for taking risks, investing in stocks will be your delight. Being a risk taker does not mean you should invest with your eyes closed. Risk takers take calculated risks. However, no matter how calculated they may appear in risk taking, they still have the understanding that things can go in the opposite direction. It is a game of probability. But a wise investor will like to have odds to his favour. That is, the probability for success should be higher than the probability of recording failure or loss. Risk takers are usually aggressive stock investors. They are ready to venture into investing in stocks as long as such stocks promise high rate of returns. Their focus is more on returns rather than the risks. Of course, if the old turns to their advantage, the returns on their investment is like hitting a jackpot.
In addition to the two categories of investors described above, there are people who are neither risk takers nor risk averse. They are seemed not to be bothered about risk. Please, don’t confuse this with being a risk taker. Risk takers are known for investing in shares that people consider too risky. They do this with the aim of achieving high returns. It is a conscious decision on their part. On the other hand, risk neutral investors’ decision to invest in stocks is not motivated by any risk factor. Their own is that they invest in any stock they like whether risky or not.
So, if you are a beginner learning how to invest in stocks, your attitude to risk will play a very important role in the type of stocks to invest in and the likely return you will enjoy.
Determine your investment goal
To a novice, the motivation behind their investing in stocks is to make money. The best approach to investing in stocks is to have a clear investment goal. Your investment goal will determine which stocks to invest in. Your investment goal can be either of the following:
- To save for retirement
- To save for home down payment
- To raise capital in order to start a business
- To save for children’s school fees
Those are examples of investment goal. The goals are specific and well defined as against saying that you want to make money. When you have a clear investment goal, it now becomes a driving force guiding every investment decision that you will make. It will be like a road map telling you the type of stocks to invest in. You also need to match your investment goal with your attitude to risk. For instance, a person that is investing in stocks for the purpose of securing his retirement income may not want to invest in shares that are considered risky no matter the rate of returns the shares may offer. On the other hand, a young person that is investing in shares in order to save for his children’s future school expenses can afford to invest in such stocks. Therefore, if you are looking for top stocks to invest in, your investment goal will play an important role in determining whether a particular stock is good for you or not. In essence, what is considered as best stocks to invest in for somebody that is saving for the payment of his children’s school fees in the future may be bad stocks to invest in for a person that is investing his retirement income.
Understand different types of stocks
Apart for the risks involved in investing in stocks, stocks can be classified based on the types of returns they offer. Principally, stocks offer three types of returns namely income, growth and stability. The stocks of companies that usually pay dividends on a regular basis whether bi-annually or annually can be termed as income stocks. They provide a source of income for investors. For people that need such income on their investment, it will be a nice investment decision to invest in stocks that pay dividends. This type of stocks is good for retirees who may need income to support themselves since they are not actively engaged in any productive activity. Income stocks are also good stocks to invest in for people looking for passive income to supplement his earnings.
There are also growth stocks. Growth stocks may not pay dividends at all or it may be that the dividends pay out of the companies is damn low. The growth in this type of stocks may come in two forms such as script issue and capital appreciation. In place of dividends, the company may offer script issues to its shareholders. In this case, the company will not pay physical cash to its shareholders. Instead, it will convert its reserves into shares and distribute them to the existing shareholders in proportion to the shares they already held. This is also called bonus issue because the shareholders are not paying any money for these new additional shares. For instance, a company may declare bonus share of one for five. This means that for every five shares you held in the company, you will get additional bonus share. For somebody having 5,000 shares, he will get additional 1,000 shares thereby making his shares to increase to 6,000 shares. The second way shareholders enjoy growth is by way of share appreciation. If you bought a growth stock say at $5 per share, it can grow to $15 within a period of time. By calculation, that is three hundred per cent growth. These type of stocks can be best stocks to invest in for someone saving for school children fees or planning to save in order to start a business in a future time. Because of the lack of physical cash flow coming to shareholders, growth stocks may not be the best stocks to invest in for retirees. Notwithstanding, if a retiree invest in growth stocks, he can decide to sell off part of his shares. This is like declaring and paying dividends from his investment as he desires per time. But one thing with growth stocks is that the growth may not be as predictable as that of dividends. Therefore, anyone planning to invest in such stocks should have a long range perspective. Nevertheless, with growth stocks, you don’t need to wait till the company declares dividends before you can enjoy cash flow. You can sell part of your shares at any time to cash in part of the profits which might have arisen either by way of bonus shares or capital appreciation.
The third return a stock can offer is stability. The motivation for investing in stocks like this is not because of any capital appreciation but the assurance that the invested capital is preserved. If you can’t afford to lose a penny from your capital or may be you know that any loss in the capital may disrupt your investment goal, it might be safe to keep this type of stocks. If you are looking for this class of stocks to invest in, you can consider companies that have been around for decades and have passed the test of time. They are companies that you should be able to describe as strong and reliable. If there is likelihood that the stocks might outperform the interest in savings or fixed deposit account, it may make sense investing in stocks like this. Otherwise it would be better to keep the money in fixed interest yielding investment such as Treasury Bills or Bonds. Besides the returns on investment, some people like the status of being a shareholder of a company.
Know your available time range
Your age or the number of years you still have to achieve your investment goal will also influence your investment decision. This factor will keep changing your approach to investing. For instance, your investment goal may be to save a minimum of $200,000 as a start-up capital for your business in a ten year time. Initially, you can be an aggressive investor ready to buy any stock that guarantees capital appreciation. But as you are approaching the date you set for you to start the business, your investment priority may change from investing in growth shares to investing in shares that guarantee stability. The more time horizon you have available to achieve your investment goals, the more risk you will be able to take. You age will also influence your attitude to risks. If you are a young individual earning a very good
Do your research
If you want to make appreciable returns from your investment in shares, you should not be a lazy or passive investor. Those people that usually make most returns investing in stocks are the active investors. What is the difference between active and passive investors? Active investors usually take time to research stock market before making investment decision. They don’t just buy any stocks that their stockbroker throws at them neither do they invest based on mere hearsay. They usually have a list of top stocks to invest in. They study the companies and then wait patiently for the right time to invest in such stocks. They usually study the trend of the stock market to determine when to buy or sell a particular stock. Although they may not hold stocks for a long time, they only sell based on the facts they have gathered rather than the panics caused by uninformed investors. Passive investors on the other hands may not spend time to study the trend in the market. Passive investors will rather choose to invest for a long period instead of being an active trader in the market. They may have money but there is tendency that they don’t even have a clue about the stocks to invest in. I am not saying that you cannot make money investing in stocks as a passive investor. But because passive investors are not conversant with the happenings in the stock market, they usually lose most of their gains back to the market due to stock price fluctuation. If you ask an expert about how to invest in stocks profitably, he will probably advise you on the need to be an active investor. Let’s take a look at two investors below:
Mr A and Mr B. bought 5,000 shares at $2 per share each. The cost to each of them was $10,000. At a time, the stock appreciated to $5 per share. At this point, Mr. A who was an active investor that usually monitored the market trend decided to sell his all his 5,000 shares at $5 each. He then realised $25,000. Though the price of the stock later increase to $5.25, within a short period of time, the price of the stock peaked and later came down to $2.50. Mr A later bought new 5,000 shares of the same company at $3 per share. This brought the cost of the shares to $15,000. At present, the share price is $3.50. Let’s assume that the two of them decide to sell all their shares at this point; below is the analysis of their profit:
|Proceeds from sales 5,000 shares @ $3.50||
|Cost of 5,000 shares||
|Profit from 1st sales ($25,000 – $10,000)||
Note: It is assumed that the transaction costs are all inclusive in the calculation.
From the above analysis, you can see that both passive and active investors actually recorded gains. But the gain accrued to Mr A. can be described as super profit when compared to that of Mr. B. The difference was that, Mr. A was very active in the market and understood the market trend. This helped him to know when to sell his stocks and the time to buy again. This singular practice resulted in $10,000 gain difference between the two investors. However, I need to say that I am not recommending that you take the same approach. There is no guarantee that you will achieve the same result if you do the same thing. It is just a practical demonstration on how many investors lose money into the market by not monitoring their investment in order to take advantage of the fluctuation of the market trend.
Don’t focus on the price alone
When it comes to investing in stocks, there are many factors you need to consider before making a buying decision. Some people usually confuse penny stock to be cheap stock, Some penny stock can be very expensive if you take into consideration other fundamental issues. Also, the fact that a stock is low does not mean that it is actually cheap. For instance, if a stock that used to sell for $10 suddenly drops to $1, a novice investor may consider the share as a good stock to invest in because of the price. An avid investor will probably see it differently. When you see such a stock, the first question you may need to ask is, “what is responsible for the fall in the price?” If you take time to carry our some background checks about the company, you may realise that the factory of the company has just been raze down by fire. If that is the case, would you still consider such as good stock to invest in? Price is relative. Seemingly cheap stock can be the most expensive stock to buy while the seemingly expensive shares may be the cheapest stocks to invest in at that particular time. Beside price, it is important that you consider other factors such as the performance of the company, its management, competition, market shares, introduction of new products, effects of new technology on its products, likely merger or takeover etc. One of the ways through which you can obtain vital information about a company is by studying its financial statements and directors reports.
What of Diversification?
Opinions differ when it comes to diversification of investment in stocks. It is generally believed that a good way to minimize risks involved in stock investing is to diversify. Diversification can mean investing in shares in different industry. It can also mean investing in shares in different companies within the same industry. But investing all your money in companies within the same industry is not a true diversification. For instance, if you invest all your money in companies within banking industry, a change in government policy may have adverse effects on your entire investment. The main objective of diversification is for you to spread your investment in such a way that any change of events or policy will not affect all the companies the same way at the same time. This in essence is to help you minimize the impact a loss may have on your entire portfolio. That is why some expert belief that you should not put all your eggs in one basket. If one stock is not performing, the other should be able to help you weather the storm.
The second opinion on diversification is that, you can put all your eggs in one basket and ensure you watch over it. This saying may only apply to the risk takers type of investors. Before you put all your eggs in one basket, you must have carried out enough due diligence and you are convinced that the risk is worthwhile.If you are risk averse, it is better and safer to diversify.
Invest your Idle Funds
As a beginner who is just learning how to invest in stocks, I advise that you start with your idle funds. Don’t invest the money you can’t afford to lose. The reason is that, at the very beginning, there is a tendency for you to make some mistakes. Each mistake you make is part of your learning process but it may cost you some bucks. Supposing you invest just $1,000 in stocks and it happens that you lose 20% of your investment. This loss in absolute figure will amount to $200 only. I think it will be easy for you to manage the loss and forge ahead. On the contrary, if you had invested $10,000 of your hard earned income and you lose 20%, the loss would have been a whopping $2,000. Can you bear such a loss considering your present position? As mentioned before, the earlier you admit that investing in stocks entails risk, the better. When you invest in stocks, there is always a probability of losing your money. Certain events can happen which may adversely affect the price of the stocks you invest in. For instance, if the financial performance of the company you invest in is below expectation, the market will react to this thereby leading to the fall of its share price. Also, a change in government policy may be unfavourable to the company. For instance, if government prohibit the importation of a particular item which is a vital raw material being used in the manufacturing of the company’s product, this can create crisis for the company. If not properly managed, it can even lead to the liquidation of such company. This will in turn lead to loss of investment to the company’s shareholders.
Don’t borrow to invest
At times, the performance in the stock market may be very attractive to the point that one can be tempted to borrow money to invest in shares. This is very dangerous for beginners. I remember how many people went deep into debts in 2007 when stock market suddenly crashed. Before then, stock market has been on the bullish trend. Prices were rising and everybody was taking position without even carrying out any due diligence. Almost all stocks were performing as the law of demand and supply set in. So people didn’t see any reason for either technical or fundamental analysis. People started borrowing in order to invest in stocks. If you were not investing in stocks then, it was like you were not smart enough. But the boom did not last forever. Suddenly the stock market peaked and the prices started tumbling. Still, people were holding to their stocks hoping that the trend will soon reverse itself. People were afraid of taking losses until most stock prices fell by more than fifty per cent. It was a great loss that even affected some of the stockbroking firms and other financial institutions. So, if you want to invest in stocks, it is safer to start with your own money. Personally, I still believe that investing in shares should not be that risky if only you learn how to invest in stocks by taking one step at a time.
Invest for a medium or long term
If you want to invest in stock market, don’t expect a quick return. Investing in stocks should not be seen as a get rich quick scheme. That is not to say that one cannot make money by speculation. But speculation is not for beginners. Speculators are experts who have good understanding about the market trends. They know the stocks that have behaved and performed consistently in a particular manner over time. It may be difficult for beginners to speculate without getting their fingers burnt. Even, experienced speculators don’t get it right every time. So, the best approach for people who are relatively new in stock investing will be to invest for a medium or long term. The reason is that, no matter how quality the stock you are investing in may be, it will always experience fluctuation in prices. If you invest in stocks today and you suddenly realise that you need the money to pay a particular bill the following month, there is a tendency that you might sell the stock at a loss. So, you should not invest the money you know you will need in a very near future. Don’t carry the money you want to use to buy your car to the stock market except you are willing to wait as long as the performance of the market may dictate.
Additional tips in stock investing
Before closing this article on how to invest in stocks, I feel that I need to give this additional tips here. I wish I knew these when I started investing in stocks newly. However, I have learnt my lesson. What the lessons I learnt? This is what I will cover in this section.
Avoid buying stocks on the way down in price
I read a book as part of my training on how to invest in stocks to always buy low and sell high; that most of the profits are made at the entry point. That is, if you are able to buy a stock when the price is low, that is when you can make most profit. Of course, the saying is true. But the question is that, “how do you low whether the price is already low enough for you to buy?” I was busy looking for stocks that their prices are trending downward. With my research, I finally settle for one that has reached its lowest price for the year. I considered this a good buy and quickly placed my order. Unfortunately, what I thought would be the lowest price of the share turned to be incorrect. After I bought the share, the price still went further down far below the price at which I bought my own. So, the point I am trying to make here is that, it is not advisable to buy stocks when prices are going downward. You may not know if the company is heading for its grave. Some stocks prices have gone down that way and never bounced back. In your attempt to buy at a low price, you should not make this mistake. Instead, wait until the price of the price start rising before you buy.
Don’t depend too much on your stockbroker
There is nothing bad in seeking information and advice from your stockbroker. Of course, they are trained in that line. But the truth is that some of them are so occupied with trading activities to the extent that they don’t have time to carry out any research. Instead of depending entirely on your stockbroker, I suggest that you do your own study and research. Thereafter, you can then seek for further information from your stockbroker to corroborate the one you have gathered. I have had instances where I would tell my stockbrokers something and he would later tell me at the end of the trading session that what I mentioned to him earlier was true.
Greed and fear are your two enemies when it comes to investing in stocks. Some people will not invest in stocks because of the fear that the market will crash or that they may lose their money. I don’t want to talk much on fear because those people that are plagued with such fear will not even bother to read this article. If you are reading this article, I want to believe that you are interested in stock investing. One of the ways one can easily lose money in stock market is when you are too greedy. Greediness will not allow someone to sell his shares when he has made appreciable gains on the stock. If you bought a stock and the price has gone up enough that you have made gain, there is nothing bad in selling the stocks and then look for another opportunity. If you have time to do research, you will always discover new opportunities in the market. If you hold to a stock for too long period, you may lose the money back to the market when the price reverses itself. Please, this does not contradict the point I mentioned that you should have a long term perspective when investing in stocks. Having a long time range will allow you to wait enough till the time the price will appreciate before considering selling the stocks. You will not be forced to sell at loss when you need the money.
Cut short your loss
In stock investing, it is not every time you will get it right. What should you do when you realise that you have made a wrong investment decision? What you need to do is to quickly sell the stocks instead of holding on to it. If you hold on to bad stocks, two things will happen. One, you will lose money. Second, you will not have money to invest in other good opportunities that may arise in the market.
I will like to conclude here by saying that learning how to invest in stocks is a lifelong adventure. If you want to achieve higher rate of returns investing in stock market, you may need to be an active investor. This will require that you be at alert regarding the market news and change in market trends. Though investing in stocks has element of risks, it can become fun if you master the rule of the game.