The pandemic has led to more Americans buying stocks. That could be a good thing, since long-term investing in solid companies can help you accumulate wealth. But some of these new investors getting into the market are taking a short-term day-trading approach, and that could prove problematic in a major way.
Day trading -- or trying to flip stocks quickly for a profit -- can be tempting. But today's new investors are often buying shares in bankrupt companies or businesses that have little in the way of proven financial results.
These people are playing a dangerous game that they're likely to lose. Predicting stock market moves on a short-term basis is difficult, if not impossible. It's like playing roulette: exciting when you win, but a money loser in the long run because the house has a huge edge.
It's always a good time to enter the stock market if you have a long-term horizon and plan to be an investor (someone who buys and holds great companies) and not a trader. Buying stocks during the current pandemic does present some special challenges, but you should be in good shape if you follow these three rules.
1. Don't invest money you may need
Before you buy stocks, it's important to have an emergency fund to cover at least six months in case your finances take a downturn. And in the current volatile economy, you may want to extend that reserve to nine months or even a year.
You also want to account for any likely upcoming expenses and set that money aside before you consider buying stocks. Basically, you want to have enough cash on hand so a short-term need doesn't force you to sell stocks that you would otherwise want to hold on to.
2. Avoid the pandemic hype
It's tempting to chase big winners, and that temptation has increased during the current global health crisis. Which company will create a successful vaccine? Airlines and cruise lines have to recover at some point, right?
The reality is that a vaccine is unlikely to be a major revenue driver for whatever company or companies create one. Cruise lines and airlines may not disappear or go out of business, but they may go bankrupt, wiping out shareholder equity.
3. Boring can be better
People love speculating about early-stage companies that have a promising idea. Turning ideas into a viable business, however, can be very difficult.
Social media sites tend to hype very speculative stocks. The reality is that long-term investors make money from buying shares in proven winners. It's not sexy to buy Amazon, Costco, Microsoft, Walmart, or any other proven winner. But in the stock market, winners tend to continue winning.
Do the work
It's a good idea to know a fair amount about the companies you invest in. How do they make money? Is the CEO a good leader? What new areas are they working on?
You don't need to know everything, but it's important to understand the basics of what the company does, how it operates, and what it's leadership looks like. You should also look at whether it's consistently profitable and, if it isn't, understand why.
The overall rules for investing did not change because of the coronavirus pandemic: Buy good companies and hold them for the long term. That requires patience and risk tolerance (great companies sometimes see big price drops), but it's a long-term winning strategy.