For first-time investors who are a long way from reaching the list of the world’s top billionaires, understanding just what they’re getting into can be intimidating. With the wrong moves, new investors could actually lose their precious capital, rather than grow it.
As Adriel Tam, CEO of AdvisorCheck, a company that helps individuals find and compare financial advisor profiles explains, however, first-time investors can have much greater confidence — and a greater likelihood for success — when they follow processes that will protect their capital.
- Understand Your Risk Tolerance
“There is risk involved with any investment, but some investments are undeniably riskier than others,” Tam says. “It’s important that first-time investors understand the differing levels of risk inherent with stocks, bonds, or funds. They also need to consider how much money they could potentially lose through their investments. The future is uncertain, so you must try to understand what you’re investing in, what your timeframe is, and how it compares to your actual risk tolerance. Research the background fundamentals of the companies you want to invest in to see how they fit.”
Weighing the risk-reward proposition of different investment opportunities is key for helping first-time investors make informed decisions. And understanding that risk is a personal decision that varies from individual to individual – don’t feel pressured to conform to what others say, especially in your own peer group – risk tolerance is uniquely your own.
- Focus On the Long-Term
Another common mishap that puts first-time investors’ capital at risk is when they focus on short-term gains and losses. They constantly monitor market conditions in an attempt to buy low and sell high. Unfortunately, with limited experience and knowledge, this is just as likely to backfire and result in significant losses.
For example, in an analysis of investor returns from 1996 to 2015, the S&P 500 had an average annual return of 8.2%. On the other hand, investors who tried to time the market had a much lower average annual return of just 2.1%. Focusing on long-term investments rather than trying to time the market reduces the risk of making emotionally charged decisions that don’t pay off.
- Diversify Your Investments
Diversifying one’s investments is another tried and true solution for protecting capital.
“Having an appropriate mix of stocks that aren’t tied to the same industry or market trends will make it much easier to weather the ups and downs of the market,” Tam notes. “Stocks should be diversified in terms of market sectors, size, geographic region and investment style to ensure a single event or trend doesn’t cause major losses. There’s no guarantee you won’t ever have losses, but a diversified portfolio can definitely help mitigate losses if one stock you own has problems.”
Diversification of one’s portfolio can also be adapted with age, focusing on more aggressive or conservative investments depending on time to retirement or other life goals.
- Work With a Qualified Financial Advisor
“The importance of an experienced, skilled, and trustworthy financial advisor cannot be stressed enough,” Tam says. “Not all advisors are created equal, and the wrong advisor can have just as much negative impact as a high-quality advisor can have on the positive side. There are legitimate horror stories of advisors who defrauded their clients – or worse, advisors with poor service and competency that can significantly damage your financial plan. You must do your due diligence to ensure an advisor doesn’t have major infractions on their record so you can have confidence in the guidance they offer.”
Researching whether a financial advisor has disclosures on their record for bankruptcy, fraud, arbitration or other potential issues is an absolute must when new investors consider who they should work with. Investors should never rely solely on information on an advisor’s or firm’s website.
- Utilize Dividend-Paying Stocks
Dividend-paying stocks are not commonly understood by new investors, but they can be a powerful option for increasing gains and reducing investment risk.
“Stable companies that pay dividends to their shareholders typically deliver above-average returns,” Tam says. “Your gains aren’t just tied to the stock price going up or down. You receive an additional payment — the dividend — as a distribution of the company’s earnings. This can be especially beneficial when stock prices are going down, as the dividends provide a financial buffer that reduces your portfolio’s overall volatility.” In fact, dividends have accounted for 41% of all market returns in the S&P 500 since the 1930s.
- Be Aware of Investment Red Flags
Finally, Tam advises first-time investors to be aware of red flags of investment fraud.
“Whether you’re vetting a financial advisor or getting advice on the internet, there are common red flags to watch out for when evaluating an investment opportunity. Watch out for ‘too good to be true opportunities’ that claim to be completely risk-free or offer unbelievable returns. Be especially wary of aggressive sellers who try to pressure you to invest immediately or into a specific product. These can be pump and dump schemes where scammers will try to artificially inflate a stock’s price, sell high and then leave you to deal with the loss in value or just inflated products where the issuer benefits disproportionately by forcing you to hold an investment for an extended period of time. Always dig deeper and consult with a trusted, licensed professional before making any major investing decisions.”
Protect Your Capital
By implementing these practices, first-time investors can have greater confidence and focus with their investments. With sound financial guidance and a diversified portfolio that focuses on long-term gains rather than short-term trends, investors can put themselves on track to reach their financial goals.
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