New investors should approach investing like the purchase of a new car: like the multitude of cars available in the marketplace, there is a multitude of ways to invest money. You can buy small and straightforward or cutting edge and complicated, you can follow the trend or you can go against the trend, you can stay with domestic products or you can go with something different and foreign.
Irrelevant of your choice, however, there are certain things that need to be kept in mind. The following 5 points should be followed before investing your hard earned money in the markets.
1) The funds for investing should be money that you saved up for this particular purpose. You should have an emergency fund in case you run into troubles and you should have money to cover bills and any other obligations. You should strongly consider how your life would be affected if you lost 75% or even all of this money.
2) The time horizon for your investment, will affect your investing decisions. If you intend to pull this money out within 5 years in order to buy a new home, then this should be a consideration when investing. If you know you can invest this money for the long haul, then you may be able to handle the volatility of the markets more than someone that has a shorter time frame. Warren Buffett invests with, essentially, no time frame. He has billions of dollars at his disposal and loyal shareholders that will not question his investing decisions. This allows him to invest in companies for very long periods of time and only sell when he feels to time is ripe. This type of strategy will differ to the person who has a limited amount of money to invest and is constantly in and out of investments.
3) Past performance does not equal future performance. Before the housing bubble crashed, everyone believed the mantra that real estate was the safest investment and would always appreciate. There is no such thing as definite appreciation of an investment. Even the gold standard of safety, United States Treasuries, have become riskier due poor decision making by government officials. In the 1990’s, there would be no hesitancy in purchasing Treasuries as a safe investment since there was no past precedent to believe the country would not repay its obligations.
4) Understand your investment. What’s the difference between a bond and a stock? What’s the difference between a bond investment and a bond fund? How about the difference between a Global Bond ETF and a Municipal Bond ETF? You should be able to understand what comprises the investment, how it is managed and/or if it is managed and what affects the volatility and value of the investment.
5) Diversification decreases your risk. Buying multiple investments or a fund which has a diversified portfolio, is a safe beginning to investing. Take into consideration what type of investment you are interested in and then research other investments which are not highly correlated to this investment. Since all the investments are not moving in the same direction, you have a more balanced approach in your portfolio. This is an important attribute as you get accustomed to having your money go up and down with the markets and you increase your understanding and experience in the markets.