It is best to start young when you are learning any skill. It is no different to saving. Missteps are common when learning something new, but can have severe consequences when dealing with money. Investors starting young usually have the versatility and ability to take risks and recover from their money-losing mistakes, and avoiding the following common mistakes will help increase chances of success.
Procrastination can be harmful to investment. The stock market has grown in the long term, at a rate of around 10 per cent a year. While there are years (and periods of years) in which the market is going down, it is wise to start saving as early and as often as possible to take advantage of the potential for stock prices to increase. It may be as simple as purchasing a monthly index fund or ETF with the money set aside for investment.
Compounding is efficient, and the better off the investor will be down the road the faster capital starts working to make more money. If a person starts investing at 25, then at 60 they can be a millionaire investing half as much (every year) as someone who starts at 35.
#2 Speculating instead of Investing
A young investor has an advantage. The age of an investor determines how much risk they will take upon themselves. By taking bigger risks, a young investor can look for greater returns. This is because if a young investor loses money, they have time through revenue generation to recover the losses. This may seem like an argument for gambling on big payoffs for a young investor but it’s not.
Instead of betting or taking up extremely dangerous trades, a young investor will look to invest in companies with higher risk but greater long-term upside potential. Small-cap stocks are a wide segment of the stock market which has higher risk but also higher yield potential. These are smaller, less well-established firms, but many of them go on to become household names with stock prices increasing over the long term. Many disappear into silence. Young investors could invest in small-cap stocks through a diversified portfolio or index fund. But for older investors who are nearing retirement, this should not be recommended.
One final danger of gambling or extremely volatile trades is that a big loss will scare a young investor and affect his or her potential investment choices. This will lead to a propensity to shun all investment or transfer to lower or risk-free assets at an age when it may not be necessary.
#3 Utilizing too much Leverage
Leverage has benefits and pitfalls to it. If investors can ever add value to their portfolios, it is when they are young. As stated earlier, young investors are more likely to recover from losses by generating future profits. However, the leverage can shatter even a good portfolio, similar to highly speculative trades.
Whether a young investor can tolerate a 20 to 25 per cent decline in his or her portfolio without being discouraged, the decline from 40 to 50 per cent which would result in twice the leverage might be too much to manage. Not only is the loss part of the consequences, but the investor may become discouraged and too risk-averse to move ahead.
One alternative is to use moderate leverage, likely only with a portion of the funds in the portfolio. For example, if a young investor accumulates a portfolio of $100,000, they may start using a margin/leverage of 2:1 on 10 per cent of the portfolio, or another percentage they are comfortable with. This also raises risk on certain particular trades, and potential returns, but the overall risk to the portfolio remains very small.
#4 Not asking enough question
When a stock drops a lot, a young investor might expect it to bounce back straight away. Perhaps it will, and it may not. Stock prices continue to rise and fall.
Some of the most important considerations in making investment decisions is to think, “Why?” If an asset sells at half the expected value of an investor, then there is a reason and it is the duty of the investor to discover out. Young investors who have not experienced investment pitfalls may be particularly susceptible to decision-making without locating all relevant information.
What kind of details an investor is looking for will depend on their goals? A young investor may decide that they don’t have enough time to learn how to invest for themselves, and so they get a financial consultant to help them out. The consultant will answer their questions and will handle the investments.
Another type of young investor may not want to ask a lot of questions or do analysis, and instead, they invest in index funds. They do it alone but keep it easy.
The third type of young investor wants to know everything, so they are asking themselves questions and then set off on their own to research for the answers.
These three are feasible methods of investing, but each needs a different strategy, such as high dependency on others with the advisor, to be completely self-reliant with the investor who does it himself.
#5 Not Investing
As mentioned earlier, when they have a long-term horizon, an investor has the best ability to seek a higher return and take on greater risk. Young people seem to have less experience of getting capital, too. As a result, they are often tempted to concentrate right now on spending their money without concentrating on long-term goals like retirement.
Although retirement may seem like a long way off, it is not just about retirement that we need to invest. Investing some capital instead of investing it will also, in the short term, increase income and quality of life. If a young person wants to have more money, then investing is one way to get there.
Conclusion: Young investors should capitalize on their age and improved risk-taking potential. Applying fundamental investments early can help lead to a larger portfolio later in life. Evite gambling, and concentrate on strong long-term upside companies instead. This could be as easy as buying index funds. Leverage is a double-edged sword, so using it in moderation or not at all if the added danger is unpleasant. Consider what type of investor you want to be, so you know what questions your adviser or yourself should be asking. Finally, start saving to continue creating more money for now, and later in life, as soon as possible.
By Wayne Pisent via Investopedia.com