First-time investors should invest in what they know, avoid making emotional decisions when investing, and invest for the long term.
This is advice from Chantal Marx, investment research head at FNB Wealth & Investments.
“Investing for the first time can be daunting – particularly when building your own portfolio by buying and selling company shares,” Marx said.
“Investing in the stock market is a ‘zero-sum’ game, meaning that for every winner, there is a loser.”
While it is inevitable that investors will pick the wrong stocks at some point in their investment journey, Marx said there are some strategies investors can use to minimise their losses.
She gave eight pieces of advice for investors at the beginning of their investment journeys to help them maximise their returns while minimising risk.
Invest in what you know
Considering that opportunities are available on the JSE and the opportunity to buy stocks internationally, it is important to limit your focus to countries, companies, and industries you know.
It is not to say that every company you know will be a good investment – but it is a good starting point to build your research.
You can also use ‘invest in what you know’ to eliminate certain stocks from your watchlist or perhaps sell them if you are already invested.
Beware of the “next big thing”
By the time the average investor gets tipped on a stock by their brother, dentist, or hairstylist, the smart money has already come and gone.
The “next big thing” has probably already been bid far beyond fair value and could even be in bubble territory if everyone is talking about it.
You may feel like you are missing out at first, but you will more often than not be very happy that you did not get swept up in the euphoria.
Price matters – it comes down to the fundamentals
Once you have identified stocks you would like to invest in, it is important to check if the company is in good financial standing and if the stock price is not too high.
While company analysis can get very complex – there are a few things you can check to find comfort in the investment:
Revenue: Is revenue growing, and will it grow in the future?
Profitability: Is the company profitable? Are the company’s margins improving or deteriorating?
Cash flow: Do profits translate into cash flow? A good measure here is to look at EBITDA compared to cash flow from operations – they should match up.
Debt: Does the company have a lot of debt relative to its size? Professional investors often look at the net debt to equity” and “net debt to EBITDA” ratios to determine the financial health of the company.
Valuation: While not a perfect science – a company’s price-to-earnings or price-to-book ratio can give you insight into how a company is currently being valued.
Try not to get emotionally involved
Humans are inevitably governed by their emotions, which becomes an even bigger issue when dealing with money.
Some emotional biases in investing include loss aversion, overconfidence bias, and regret aversion, which go hand-in-hand with FOMO.
Knowing that these biases exist and that you are more than likely to exhibit some of them is the first step in righting our mistakes and avoiding similar wrong turns in future.
Other tactics include ruthlessly sticking to your strategy and researching what you want to buy and what you hold.
Decide how long you want to stay invested
If you are investing for the long term, it is important not to look at short-term fluctuations.
Equities are volatile in nature, and by following the price of your stocks too closely – you could get overwhelmed and make an incorrect investment decision without conducting your due diligence.
Decide when and why you would sell
If you are investing for the long term, you still need an exit strategy. While you won’t necessarily have a “profit target” or “stop-loss” in place, you need to decide in what set of circumstances you would sell the investment.
It could be that during your regular review of your holdings, you find that the fundamentals have deteriorated, or you have identified other opportunities that potentially offer more upside.
Don’t hold the stock simply because it has done well for you in the past.
Contribute to your trading account regularly
Like what you would do for retirement savings or your TFSA, having a regular debit order run to your stockbroking account is a good way to ensure you consistently build your portfolio.
The opportunities may not be there immediately, but it is always good to have cash available in your trading account to deploy when they arrive.
Having cash in your trading account will also force you to reassess your holdings and allocate more funds where the prospects are solid or build up your cash balance further.
Diversify but do not overdo it
“Don’t put all your eggs in one basket” is one of the most important investment principles for professional and retail investors.
By diversifying your holdings across several companies, sectors, and geographies, you can reduce your portfolio risk dramatically.
However, the benefit of diversification begins to fade when you invest in too many stocks, and your portfolio begins behaving like a market ETF.
Most experts recommend that a portfolio has at least 20 stocks and no more than 30 to get a good balance of managing risk without sacrificing return unnecessarily.