Now you know our thoughts on how you should get started investing (see 7 Ways To Get Started Investing), but what are some ways that you should avoid investing when you're just starting out?
Don’t invest before you have an emergency reserve in place
This is part of building a solid financial foundation. Your emergency reserve should be held in a savings account. Having an emergency reserve allows you to worry less about what is happening in the markets if an emergency suddenly occurs. You don’t want to be in a position where your investment portfolio is down and you need cash due to an emergency. The keys to investing are to invest over the long term and not try to time the markets. Markets go up AND down. You don’t want to take a loss on your investment portfolios because you didn’t adequately plan.
Don’t invest in businesses you don’t understand
The likes of Warren Buffett and Peter Lynch (two of my favorites) have lived by this investing philosophy forever, and it has worked quite nicely for them. Too many people read about different companies or hear financial media talking about company "XYZ" on television and decide to invest in that stock. All without completely understanding how the company makes money.
Coca-Cola and Home Depot are companies that we all can understand. When we buy a Coke at the store, that goes to Coca-Cola making money. The more of those red cans they sell the better off the company is (and thus my investment). On the other hand, you have companies like Ensco (nothing against it) which financial talking heads seem to always praise, but which most people have never heard of before, don't know what they do, or how they make money. This all adds up to mean that despite what the financial talking heads say, it probably shouldn’t be your first investment ever.
Don’t invest based on your neighbor's hot stock tip (unless your advisor is your neighbor)
These stock tips sound intriguing but tend to not fare well. Well actually, any hot stock tip, doesn’t tend to be so hot. Remember, your neighbor doesn’t know your financial situation. He won’t know what your goals are, how much you are trying to save for retirement in order to generate a comfortable income stream for you. And he doesn’t know what your allocation already is. Make sure that you take advice from someone that has a complete picture of your current financial situation and what your financial goals are. And, do you think your neighbor will care if you lose money in the hot stock? Probably not. So why take advice from someone who doesn’t care about your outcome?
Don’t invest in just a single stock or bond
A key to successful investing is to have a diversified portfolio. Having an individual stock or bond isn’t deemed a diversified portfolio. Owning a single ETF or low-cost index mutual fund would be considered a more diversified portfolio. When investors try to invest in just one or two individual stocks or bonds, we call that putting all your eggs in one basket.
The problem with putting all your eggs in one basket is that if that basket falls and your eggs crack, you are left with no eggs. If you have multiple baskets, though, you may still be able to make an omelet or some scrambled eggs with the eggs from the other baskets. The same holds true for your investments. You could be left with nothing if you invest in just one security. You are at least giving yourself a chance of making some money by diversifying within multiple securities.
Don’t invest when your goals aren’t aligned with your advisor's interest
This goes more towards the individual who wants an advisor to help with them with their investment allocation. You will want to make sure you understand how your advisor makes money.
One option: They can make money via commissions, buying and selling investments… this may not be in your best interest.
Another option: They could charge a fee for the investments they manage (i.e. if you invest $50,000 and the advisor helps manage that money, they would receive a fee based on that amount). If the amount grows the amount the advisor makes goes up, if the amount falls the amount the advisor makes goes down. This is called fee-only, and Clark Howard is a fan.
Finally, advisors may charge a fee on the investments they manage, along with earning a commission on the investments they buy and sell for you. This is called fee-based.
Make sure to utilize an advisor that you believe has your investing goals ahead of their own.
Now that you know how Not to Invest, and 7 ways to get started invested, check out our blog on how to invest with limited funds.