With the seemingly infinite lists of acronyms and abbreviations, complicated jargon, and complex topics, the early steps in one's investing journey can certainly feel overwhelming -- like trying to order a meal in Paris when the only French word you know is "merci."
While inexperienced investors might be itching to make their first stock purchases on the road to building wealth, their zeal can quickly wane if they find that they've made choices that lost significant amounts of their initial investments.
What to do if you're a young investor? First, congratulate yourself. You've taken your first steps to building wealth and gaining financial independence. Next, take heed: There are some common pitfalls that novice investors often fall victim to. So let's look at some of the things to keep in mind as you embark on your investing journey.
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1. Read, reflect, repeat
In one of the most famous scenes from Hamlet, Polonius encourages his son to, more than anything, be true to himself. While inexperienced investors should also follow this sage advice, I think it comes second to another pearl of wisdom: Be careful about what you read.
Learning about an innovative technology, a business merger, or any number of other items may lead inexperienced investors to conclude that there's a lucrative investment opportunity related to the news. While this might be true, it's far from a guarantee. Instead, investors should use it as the starting point for further research, digging into the company's fundamentals and assessing how the news fits into the larger picture of the company's business prospects.
This is a lesson I know all too well. One of the first stocks I ever bought was Inovio Pharmaceuticals. I had read an article about how the company reported encouraging results about one of its vaccines and the game-changing nature of its innovative delivery system. Thinking I had discovered an under-the-radar stock that would soon explode, I started a position. I knew nothing about the biotech industry -- nothing about clinical trials, nothing about the company's financials, and nothing about how the news fit into the company's bigger picture. After waiting several years for the stock to rise, I decided to cut my losses and turn elsewhere.
While I still get the urge to buy shares when I read about a company's auspicious news, I never give in. Instead, I start researching, then research some more, and then a little more before I click the buy button.
2. When you're ready to sell, don't
Moving from the Bard to some poets of the 20th century, Simon and Garfunkel, we find a line that provides some investing insight: "Slow down, you move too fast."
While it can also apply to investors who are anxious to buy a stock after reading a news story, it also is relevant to investors who deem it's time to sell. It can be very tempting for investors who have seen their stocks rise to decide to sell and take profits. In actuality, this can be one of the greatest ways to sabotage their own successes, preventing themselves from generating even more impressive returns.
Let's consider one of the most obvious examples of this, Amazon. Imagine investors who invested $1,000 in late May 2005. It's easy to imagine that the same investors, two years later, thought that it would be a good idea to lock in profits and sell; after all, a 93% return is nothing to sneeze at.
AMZN data by YCharts.
But if those same investors had decided not to sell, they'd be a lot happier. Instead of a 93% return, they'd be looking at (on paper) a return of about 9,000% -- that initial $1,000 investment would be worth about $90,000 now.
AMZN data by YCharts.
Of course, not every stock is going to provide the extraordinary returns that Amazon has provided, but the lesson is valid nonetheless. Unless you need the money, have found a better opportunity, or have another comparable reason to leave the position, it's important to recognize the value of being patient and take one of our favorite investing precepts to heart: Let your winners run.
3. Don't let this anchor weigh you down
Setting your anchor might help when you're on the water and ready to start fishing, but when it comes to investing, anchoring can be disastrous -- one of the greatest challenges for young investors to overcome. A cognitive bias that applies outside of the world of investing as well, price anchoring is the overvaluing of a figure while disregarding other important data. In other words, it means becoming fixated on a certain price and not paying heed to other important information.
How does this affect investors? Let's say you're interested in a stock, check the price, and decide you're ready to buy. Before you execute the transaction, though, you find the stock has risen. "Darn, I'll wait for it to come back down before I buy," you think. But there's no guarantee it will come back down; it may rise and rise, never returning to the price you've become set on. This flawed way of thinking is part of being human; we're all susceptible to it. The important thing is to recognize the cognitive bias and guard against it in the future.
It's essential to recognize that you'll never time things perfectly. If a stock was a little lower yesterday than it is today, that's not a sign you should wait to buy. Doing so may lead you to wait forever and miss a wealth-building opportunity.
Boiling things down for beginner investors
Spend enough time investing and reflecting on your experiences, and you'll learn a lot. But one of the most valuable things to remember is the importance of patience: patience in deciding when to buy a stock, and in considering when to sell a stock. Investing is not a sprint; we're looking to build wealth over the long term. So take your time and pay close attention to what you're thinking along the way.
