Taking Off? Five Things Every New Investor Needs to Know

Get out of Debt Guy recently wrote an article, “New To Investing? Follow These 5 Guidelines.” The article takes a look at the five things that Millennials and all others — whether they are new to investing or not — really need to know.

1. Pick A Custodian With Low Trading Costs

I couldn’t agree more. If you are going to invest your money, there’s no need to spend a lot of money on fees and commissions. There are numerous index funds with minuscule fees. There is no reason to buy a managed fund that has high fees. Further since 4 out of 5 professional money managers under-perform their respective index, why pay more (in fees) to get less (fund performance).

Secondly, if you are going to buy individual stocks, bonds, and ETFs, there’s no reason to pay high commissions. The commissions that are offered by many brokerage houses today are about $10. There no reason to spend more than that.

2. Passive Management Beats Active Management

As I touched on in the prior section, most fund managers under-perform their associated indices. If roughly 80% of fund managers running actively managed funds can’t get the returns that a passively managed index fund can, what incentive is there to invest in an actively managed fund? Granted, there are fund managers who do better than their indices, but unless you are will to do the research necessary, it’s a wonder why anyone would choose to try to beat the market when most people fail to.

People who are trying to beat the market averages operate as though average is a bad return.  If you can beat the market averages, great, but average isn’t bad at all. What’s wrong with average. The S&P 500 has returned 9.61% over the past 50 years. That means that if you invested $1,000 every year for the past 50 years, you would have $1.11 million. Not bad at all.

Most fund managers can’t match that. In fact, As of 2011, only 8 funds out performed the S&P 500 every year for 10 years.

How many funds have beaten the S&P 500 on average over the past 40 years? One. The Nicholas fund. And they have beaten it handily. Over the past 40 years, this fund has average beating the S&P 500 by an average of 2% a year over that time frame. If you think that’s immaterial, this might change your mind. That 2% difference over that time span means that a one-time $10,000 investment in the Nicholas Fund in September 1974 was worth about $2 million in September 2014, that’s roughly twice the value of the same investment in the S&P 500 index. It’s really tough to beat average. An average is a pretty good goal to aim for.

3. Global Diversification Is A Necessity

Many people believe that it is important to invest globally, and not just invest in American-based companies. It allows you to hedge against a decline in the USA. While this is reasonable, and in my book, Investing For The Rest of Us, I do present various portfolio models which include an International Index fund, but you probably could just get away with an S&P 500 fund. Many of these 500 largest companies in the USA are multinational companies, doing business all over the globe. Think Coke, Pepsi, McDonalds, Apple, and Microsoft, just to name a few. All of these companies do business around the world. All of these companies are affected — both positively and negatively — by economies around the world.

4. Invest Consistently

Dollar cost averaging allows you to invest money on a regular basis. For instance, you could invest $100 every month. Some months the stock market increase, other months it declines in value. When the market is up you get to buy fewer shares, conversely when the market is declining, you get to buy more shares. If you believe that eventually the market will appreciate, buying when share prices are depressed allows you to buy a greater number of shares.

For many of us, it’s difficult to keep investing when the market is declining. Many people do just the opposite, they sell when the market drops out of fear and anxiety. In the first two months of the year, 93% of the people investing lost money. The market averages declines precipitously. The NASDAQ declined by 4.00%, the Dow lost 3.55% of its value, and the S&P 500 was down 7.04%. There were numerous articles, like this one from CNBC, and cartoons, trying to allay investors’ fears, showing how selling in 2008 would have been a mistake as the markets have rebounded and erased all of those losses. No matter, many people sold.

Source: Stock Twits

Over the next three months — March 1st through May 31st — three indices turned around, Overall, after the first five months of 2016, the Dow is up 2.08%, the S&P 500 gained 2.59%, but the NASDAQ is still down for the year, down 1.19%. Think about that; the S&P 500 was down 7% after two months, and is now up over 2.5% for the year. If you had sold in February, you would have missed out on these gains. Alternatively, had you continually invested, you would have been able to buy additional shares while prices were depressed.

Most of us shouldn’t try to time the market. Stay the course, keep dollar cost averaging. Try to ignore all the noise in the stock market. In the long run, you will probably be very happy.

5. When Everyone Else is Screaming, Stay Calm

This is the key. It’s easy to say, but in practice, it’s difficult to keep buying. I can some this up with one quote from Warren Buffett:

“Be Fearful When Others Are Greedy and Greedy When Others Are Fearful”

 

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