There is no such thing as the “perfect investor”, but getting the fundamentals right is a good starting point
TAKEAWAYS
Ah, the pandemic years. Many people started their investing journey then, thanks to their spare cash – some of which was likely given by the government as part of the COVID-19 relief packages. As they poured their money into the stock market in 2020–2021, it felt like the bull market would never end; asset values went up, up and up!
Until they didn’t.
As the market went into freefall in 2022, many newbie investors were given a rude shock, particularly those who had started investing just the year before.
What went wrong? Well, apart from rising inflation rates and world events such as the Russia-Ukraine war, it is also undeniable that sheer inexperience was also a factor.
But as the saying goes, hindsight is 20/20. It’s pointless crying over spilt milk, but we can face the future with the knowledge gained from battle scars. That said, here are five timeless mistakes we think every investor new or old should avoid.
“Investing” and “trading” are often used interchangeably by people starting their investing journey. Yes, both of them involve the buying and selling of assets, but there’s a clear difference.
> Trading tends to be more short-term. Traders trade with the intention of earning income across a certain period, such as daily (hence, the term “day trader”), weekly, monthly, or even quarterly.
> Investing is more long-term. When you invest in something, you’re typically putting your money there for at least five years. When we (The Woke Salaryman) discuss investing, we’re looking at 10, 20 or even 30 years.
The next question you might be asking is, “Does the time frame matter?” To that, we answer, “Of course it does.” In the short term, financial markets are volatile and irrational.
Trading is like sprinting. Investing is running a marathon. Neither is superior to the other, but one should be clear about which activity one is involved in.
This brings us to the second point.
If you’re expecting stock or crypto tips that will multiply your capital by five times, 10 times or even 100 times, then it’s extremely unlikely you have an investor mindset.
Many young people are obsessed with the idea of quitting their full-time jobs to be full-time investors. The expectation is that they will earn their riches quickly. This is wishful thinking.
Why? Because how much you earn from investing depends on two things – your return, and your capital.
> Higher returns of more than 8% are impossible without taking on high risk. You need vast amounts of skill, luck and holding power to earn impressive returns consistently over the long term.
> Low capital means low returns. If you’re a young adult, it’s unlikely you have a lot of money. A 20% return on a capital of $10,000 is a mere $2,000. That is good investment performance, yes, but it doesn’t translate into money that can compare to a full-time salary.
For that reason, we believe in working on your earning power first, which in turn will translate into more capital for investment.
Investing doesn’t have to mean buying stocks of individual companies, or analysing financial reports to look out for financial ratios such as EBIDTA margins, ROIC, P/E, EPS, etc.
Yes, this is what professionals do. But the layperson does not necessarily need to do that. One can also invest via funds such as unit trusts and exchange-traded funds. These funds can either be professionally managed “active” funds, or “passive” index funds, which typically have lower fees.
The “index” in index funds usually refers to a stock market (for example, the NASDAQ), or a subsection of the stock market (the S&P500 – the 500 largest companies listed in the US market).
> Some popular passive index funds include:
For those who are looking for lower risk, there’s also this category of investments known as fixed income. As you might have guessed, the goal is to provide stable and predictable returns to investors.
> Some fixed income investments include:
For most people, we suggest looking into building a simple portfolio consisting of a local index, an international index fund and other fixed income instruments. Further reading:
Of course, both fixed income and equity investments also have drawbacks. This brings us to the next point.
Risk is an integral part of investing. The tricky thing about risk is that you need to find your own sweet spot; you can’t gravitate towards the extremes.
If you take on too much risk, you approach “gambling” territory. Borrowing money you don’t have to invest, also known as “leverage”; not having a diversified portfolio, and being overly speculative – these are all signs of taking too much risk.
The danger? Suffering losses you may not recover from.
On the flip side, being overly conservative isn’t much better either. If you avoid investing entirely, the value of your cash will be eroded by inflation over the years.
That said, in situations where inflation is particularly serious, the returns offered by fixed income instruments alone might not be enough to generate enough cash flow for your retirement. This is the reason why most financial advisors advocate a combination of equities and fixed income as part of your portfolio!
Last but not least, new investors are particularly susceptible to panic selling – the unfortunate practice of dumping their assets the moment their values drop.
There’s nothing wrong with selling, but with panic selling, the motivations are fear-induced – it’s an emotional reaction. That’s never good news when it comes to investing.
Of course, there’s nothing wrong with selling your investments if there are good reasons to. These include:
a) your financial situation has changed and you now need your invested funds;
b) the fundamentals of your chosen company have deteriorated;
c) you are rebalancing your portfolio;
d) you have found better opportunities for your money;
e) your investments have become overvalued and do not match their prices.
Currently sitting on a portfolio of red? You’d probably feel discouraged. You might even be considering swearing off the stock market altogether. But here’s the thing: If you’re in your 20s or even 40s and reading this, there’s still plenty of time to grow your wealth through investing.
Successful investors know that volatility is part of the journey when it comes to investing. Ups and downs are normal, but in the long term, most major indices trend upwards.
Is it easy to watch your hard-earned money fall in value? Of course not. It’s far easier to give up – which is why most people don’t make good investors.
As the saying goes: If you want sunshine, sometimes you just gotta deal with the rain.
Stay woke, salaryman.
© 2024 Institute of Singapore Chartered Accountants