Earn, save, and invest. This is the triad of financial success and wealth generation.
Investing is what makes wealthy individuals different than people who remain financially constrained since saving money is not enough to achieve financial freedom unless you have a plan to increase the size of your bag.
That said, if anyone tells you that investing is easy they are either trying to sell a course or they just don’t know what they are talking about.
In this article, we share five tips that could be useful if you are getting started in the investing world.
1. Pick a low-cost brokerage firm
Where you invest is perhaps as important as what you invest in. Nowadays, there are hundreds of brokerage firms around the world willing to offer you their services. However, investors need to identify the best in the business as they will be entrusted with something valuable – your money.
Websites like BrokerReviews.com offer investors curated assessments of a large number of brokerage firms so they can choose the provider that offers the best terms and conditions.
Some of the things an investor should expect from a broker include competitive trading fees and commissions, appropriate regulatory oversight, fast execution speeds, top-notch research materials, and an easy-to-use trading platform.
2. Invest in businesses you understand
Investing in the financial world is quite similar to investing in the real world. You’ll rarely find someone willing to start a business they don’t know anything about and this same principle should be applied to financial investments.
If you don’t understand the business you are investing in, it will be difficult to predict how it will look like in the future and that complicates the process of determining its intrinsic value.
3. Diversify, but not too much
Most financial advisors agree that diversification is positive for lay investors. However, diversifying comes at a cost.
Since diversification nowadays involves holding hundreds of instruments within your portfolio – either directly or indirectly through an investment fund – the large number of losers you will be holding will probably offset a large portion of your winners.
Therefore, diversification is good but an overly diversified portfolio can end up delivering mediocre returns. With this in mind, investors should spread their money into a decent number of businesses that offer promising upside potential rather than buying a large number of stocks – both good and not that good – just for the sake of diversifying.
4. Look for asymmetric opportunities
Asymmetric opportunities in the financial markets are those that offer a higher potential reward compared to the risk assumed.
Imagine that you have analyzed a stock that currently trades at $10 per share and your analysis states that it can jump to as much as $50 per share in the next five years. This results in potential gains of 400%.
To compare those expected returns with the risk assumed, an investor could analyze the maximum drawdown that the stock has experienced during a 12-month period.
If the maximum percentage that the stock has declined in the past turns out to be 75%, this opportunity could be considered an asymmetric one as the reward far exceeds the risk assumed.
That said, investors should be fully comfortable with the possibility of losing that 75% before opening a position in this particular asset. Additionally, this scenario assumes that the calculations are correct for both the potential returns and risks.
5. Be patient
The financial markets are a complex animal. Not even those who have years of experience and are considered by the community as seasoned professionals in this particular field can typically foretell what is going to happen in the next couple of months – whether that is for the market as a whole or a particular security.
That said, financial assets are valued based on their underlying fundamentals – i.e. expected cash flows, interest rates, macroeconomic conditions. Focusing on those variables will typically yield good results for investors in the long run rather than trying to anticipate what the market as a whole will do in the short term.
As John Maynard Keynes said: “The market can stay irrational longer than you can stay solvent”. For those who invest for the long-term, an elevated degree of patience will be needed as the market may not fully agree with your particular view about something for a long time – until it does.
In this regard, there will be periods in which an asset’s fundamentals will not shape its price. However, in the long run, fundamentals will typically prevail.
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