3 things I wish I had known before I started investing
Timothy is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
A few weeks ago, my younger brother texted me and asked “Is AIG (NYSE: AIG) a good company to invest in?” I wasn’t sure, so I told him I would call him the next day after looking into it. When we were on the phone, I asked him two questions:
1. What does AIG do?
2. Why do you want to invest in AIG?
His answer to the first question was “something to do with mortgages”, and his answer to the second was “because the stock has fallen a lot in the past few years”. These answers told me two things: He had no clue about investing, and if he didn’t learn more, he could have a lot of money problems in his life. I described to him AIG’s current business and some of its recent history, and then recommended some things for him to do, starting with reading Ben Graham’s “The Intelligent Investor”, and of course mentioning Fool.com. After we got off the phone, I realized that there were a lot of other things that I thought he should know even before reading Graham. A few days later I sent him an email with a few ideas that I wish I had known when I had started blindly investing in 2007, just before the recession (perfect timing, right?). They are as follows:
1. Any money that you invest should be money that you won't need for at least three years. This means that you should have a fairly large savings account before investing anything in the stock market. Most advisers would recommend having enough money set aside for 3 to 6 months of living expenses in case of some sort of disaster. Before investing in the stock market, you need to be sure that you could handle possibly losing your job at the same time that the stock market drops 50 percent. I myself only have 3 months of living expenses set aside, but I am comfortable investing the rest of my savings because the companies I generally invest are household names that have already survived many business cycles. Also, I've found investing to be something I truly enjoy, and I think of it as good experience for when my accounts are much larger (hopefully, at some point, this WILL happen). I've already learned quite a bit from my mistakes, the type of mistakes that if I had made with an account in the hundreds of thousands, would probably have left me crying.
2. As with anything else, to be good (or at least not awful) at investing, you will have to either be incredibly lucky or be willing to put in a lot of time. Malcolm Gladwell has mentioned that to be aphenom at something, you must put in about 10,000 hours. Granted, you don't need to be a phenom, but you should know what you are doing, to the point that if someone asked a question about your investing style, or a company you've invested in, you should be able to answer the question without hesitation. In the case of company specific questions, you should be able to come fairly close to the numbers since they are constantly changing.
I had what I thought was a great idea to invest in natural gas via UNG (NYSEMKT: UNG), an ETF that invested in futures contracts. After losing 50% of my investment, I happened to read a blog post on UNG that asked what contango was. Being curious, I looked it up. Contango is when a futures fund has to roll over their existing futures contracts from one month to the next, and traders had been taking advantage of UNG by selling current month contracts (driving down the price of UNG’s assets) and buying the next month contracts (driving up the price of UNG’s next purchases). Obviously, the fund lost money every month, and me along with it. If I had done a little more homework, I might have caught that. On the other hand, you can’t win them all.
If you don't have the time or willingness to learn (which is completely understandable), then it might be better to follow the ideas of index investing and dollar cost averaging. Index investing is when one invests in an entire index of stocks, instead of individual stocks. This diversifies away company specific risks, and is often done using exchange traded funds (ETFs). Dollar cost averaging is where one invests the same dollar amount on a regular schedule, and has been found to be greatly effective. Warren Buffett, among others, believes that most individuals should probably be doing those two things exclusively because they won't have the time to put into really learning the markets. I think you are a intelligent, and you seem excited to read about investing, but it WILL take time, and you should start with relatively small amounts and with very safe companies.
3. One of the biggest advantages you have is that once you start investing, you have tons of time before you will need that money. In The Black Swan, Nassim Taleb recommends not paying attention to the daily moves of the market. You can still read daily articles, as it will help you stay informed, but remember that you have 40 some years (well, my brother does, anyway) for the prices (and dividends!) to go the way you want. That is the best possible advantage, because of the way compound interest works. Time is on your side, and in the long run what happens on a single day is relatively insignificant.
Even though my brother has seen most of this already in my email, I still plan on sending him a link to this article. Does anyone else have any tips on things they wish they knew earlier? Let me (and him) know in the comments.
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Fool blogger Tim Noffsinger does not own shares in any of the companies mentioned in this entry.