Don’t Start Investing Until You Know What You’re Doing

Since early 2009, the stock market and the U.S. economy have been slowly but surely recovering from the mortgage crisis. In fact, in recent years, the market has been expanding to new territory with relatively few bumps in the road along the way. Now the Dow Jones industrial average is knocking on the door of 20,000 – roughly 40 percent higher than it ever was before the crisis.

Regular headlines about the stock market making new highs make stock investing seem like easy money to people that have never invested before. In addition, President-elect Donald Trump has repeatedly stressed that lowering corporate taxes and removing market regulations will be priorities for his administration.

Historically, the Dow has generated an average annual return of 7.27 percent for investors. With the U.S. economy firing on all cylinders and the prospect of the next president clearing the path for U.S. corporations, why not try investing in stocks for the first time?

The historical numbers don’t lie, and stocks have always been a great long-term investment. But for people considering dipping their toes into the market for the first time, investing is not something to learn about through trial and error.

Intelligence, corporate experience, confidence and drive are certainly common traits of successful people. Unfortunately, these characteristics are simply not enough when it comes to investing. Put plainly, “learning on the fly” is a recipe for disaster in the stock market.

According to Nicholas Colas, chief market strategist for Convergex Group, investing is like driving a car on a dangerous freeway. “You wouldn’t get into a car with an unlicensed driver,” he says. “Investing is full of risk, and the more you understand those risks, the better you will do over time.”

Jamie Cox, managing director for Harris Financial Group, says that the amount of homework people need to do before investing depends on the type of investing they plan to do.

“Making contributions to a 401(k) every pay period is smart, even if the participant doesn’t fully understand financial markets. Such investments have pre-selected options that either have established histories of investment results or employ options, like target date series, that assist participants in making educated selections,” Cox says.

Unfortunately, many investors that charge into the market without first educating themselves fall victim to a number of mistakes that are common to new investors.

Chris Zaccarelli, chief investment officer of Cornerstone Wealth, says that new investors often don’t understand the difference between a good company and a good investment.

“The most common mistake I see new investors make is to buy a stock just because they like the company’s product – without any regard for the price they are paying for the stock,” Zaccarelli says.

In addition, he says new investors pay too much attention to share price. “The other mistake they make is to assume that a $50 stock costs more than a $25 stock,” he says. “You need to have a basic understanding of market capitalization and price-to-earnings ratio before investing in a single company’s stock.”

David Blake, director of the pension institute at the Cass Business School in London, says that new investors often fall into the trap of herd mentality. “New investors often follow fads, which typically results in them buying near the top of the market. When markets crash, they panic and sell near the bottom of the market,” Blake says.

Once new investors understand the danger of investing without educating themselves about financial markets, the next step in the process is figuring out what exactly they need to learn.

Owen Murray, director of investments for Horizon Advisors, says new investors need to start by determining exactly why they are investing and setting some realistic goals.

“A young professional who is interested in building their retirement nest egg should remember that the money in their portfolios is meant for the future, which may be 30-plus years from now,” Murray says. “Short-term swings in the market should not influence your willingness to continue saving or maintaining the appropriate amount of portfolio risk.”

Zaccarelli says it’s important for new investors to put time and effort into reading books, visiting reputable websites and/or talking to a friend or financial advisor with years of investing experience. Nobody likes homework, but students that do the most studying prior to the test tend to get the highest grades.

“They need to have realistic expectations about their potential returns – and potential losses – as well as a basic understanding of what diversification, time horizon and liquidity mean,” Zaccarelli says.

Fortunately, unlike college students, new investors have full control about how much their education might cost.

“It’s extremely important to understand the basics before handing off the management of that money to someone else so that you are knowledgeable enough to ask good questions. If you are going to handle investing on your own, you need to learn much more than the basics – always remember to experiment with small amounts in the beginning so that your ‘education’ is less expensive,” Zaccarelli says.

Investing may seem easy when the stock market has been rising on a month-to-month basis for eight-plus years. However, stock market investing is…

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