9 Investing Rules for Beginners
The world of investing; stocks, real estate, currencies, precious metals can seem intimidating or confusing to the uninitiated. It needn’t be though — anyone can invest in today’s day and age, and all it takes to begin is understanding some simple principles.
1. Invest in Yourself First
Money is not your biggest asset and nor will it ever be. Your biggest assets are your time and your mind.
Use your time to improve your mind. Money comes and goes, but with knowledge — and more importantly, the practical application of knowledge —you’ll gain valuable experience and money will come far more often than it’ll go.
A sharper mind leads to better decisions and better investments, which in turn will lead to more money. Never stop learning and never stop bettering yourself; investing in yourself is your greatest and longest investment position.
2. Understand the Meaning of ‘Investment’
The monetary meaning of investing simply means to make money from money.
To invest is to buy things (assets) which will make you more money than what you initially paid for them.
3. Understand the Difference between an Asset and a Liability
An asset is anything you buy which puts money into your pocket. A liability is anything you buy which takes money out of your pocket.
It’s pretty much as simple as that, but it’s very important to note that any potential asset could also be a liability.
Say you buy a house, for example, and you want to rent it to a tenant. If you find a tenant, the house is an asset because the rental income is putting money into your pocket.
If you don’t find a tenant and the house sits empty, you’ll still need to pay the mortgage and bills regardless. The house is then a liability because it’s taking money out of your pocket.
Almost any investment can be an asset or a liability, it’s very difficult to say with 100% certainty that any investment will always be an asset.
A house, share in a company, savings account or government bond are all potential assets, because they could all be worth more money than what you initially paid for them. Designer clothes, alcohol, cars (as just some examples) will almost always be liabilities because their value won’t appreciate to more than what you paid for them.
At its core, successful investing is simply about purchasing things which turn out to be assets more often than they turn out to be liabilities. Choosing what to buy is where knowledge, experience and prudent decision-making come in.
4. Never Invest more than Half of your Liquid Capital
Liquid capital simply means how much cash you have to hand, and how many assets you own which can be readily converted into cash.
Life has many expenses — mortgage, rent, bills, food, travel etc — you need enough cash available to cover all these costs and any other unexpected expenses life may have in store.
If you invest most of your available money, especially in assets which aren’t easily or readily convertible back into cash (like real estate or certain types of funds), you’ll struggle if life throws unexpected expenses at you. Never invest more than 50% of your total available capital and always ensure you have enough money to live on.
5. Understand Risk is a Core Part of Investing
Risk isn’t just a part of investment, it’s a part of life. Everything has risk attached; driving a car, cutting vegetables, even going for a walk.
Risk is managed with knowledge and experience. The more knowledge you possess, the more experience you gain, the lower the risk factor drops.
You wouldn’t drive a car without learning how first; if you did your chances of causing an accident would be very high. You minimise your risk if you learn how to drive first, and then it drops further the more you drive and the more experienced you become.
Investments are the same. Investing carries a real risk of losing most or all of your money, and with some you can lose even more money than you initially invested (if you use leverage — borrowing money to invest — which is quite common in forex).
Minimise risk with knowledge. Learn all you can about the investment area you’re interested in. Follow market news, expert advice and become familiar with the ins and outs of the field and the economy.
If you want to invest in company shares, for example, research the company first. Do they have a good amount of cash flow? How prominent are they in their industry? What’s their competition like? Is their market up and coming?
Generally speaking, the more return you hope to gain, the more risk you’ll have to accept.
6. Diversify, to Begin with
“Diversification is protection against ignorance. It makes little sense if you know what you are doing.”
- Warren Buffett
Diversification means to spread the amount of money you invest over more than one different investment. This is to minimise risk; if one investment fails, all of your money wasn’t tied up in it and you have other investments to fall back on.
Whether you should diversify first depends on how much money you’re investing. Recalling the ‘never invest more than 50% of your total capital’ rule. If you’re investing only 1% of your total wealth, for example, perhaps you can afford to invest it all into one asset. If it fails totally, you’ve only lost 1% of your wealth.
If you’re investing 50% of your total capital though, it would be wise not to invest it all into one asset, and to diversify it into multiple assets instead. If you invest it all into one and it fails, you’ve lost half of all your money.
The second factor is your level of knowledge.
Remember, the lower your knowledge, the higher the risk, and as a general rule beginners should diversify to minimise risk. More knowledgeable or experienced investors, however, may be able to afford placing more of their capital in a less diversified number of assets. If they know the asset and the market, they can make a better informed decision on what they think will do well.
This is why Buffett said diversification is protection against ignorance; diversification indeed does make little sense if you know what you’re doing.
7. Invest Before you Spend, not After
When you get your paycheck, take out money for your rent, bills, food and other costs first. Then put money aside to invest, then do what you will with the rest (socialising, clothes, frivolities etc).
As a loose rule, after you’ve covered all your expenses in a month you can put aside 10–15% of what’s left for investment, 10–15% for savings (if you like, but that’s another discussion which I won’t go into here) and the rest as disposable income if you wish.
Take money out to invest before you spend on unnecessary things, not after. Investing is all about making money from money, so the money you invest now, if you manage to make it a success, will bring you more in the future.
8. Start as Early as You can in Life
Investment is most successful as a long game; the earlier you start, the better.
The reasons for this are fairly obvious. When you start early in life you start with less money. You’ll make more mistakes but you can learn from those mistakes and the money you lose will be small.
The earlier you start, the more knowledge you’ll accumulate, along with experience and this will make you a better investor at a younger age. You’ll have more to accumulate returns on your investments which you can then reinvest which will bring you even more returns.
Warren Buffett started investing when he was 11 years old. Now he’s a billionaire.
9. Understand the Power of Compound Interest
One of the best examples of why it’s so important to start investing as early in life as you can.
First of all, interest means the cost of borrowing money. For the purposes of investment, interest is paid to you, the investor. Compound interest means when interest is paid on the total amount of a principle sum, plus the interest already accumulated on it. Simply put, interest on interest.
I know this can sound complex, but it really isn’t. Let’s compare with simple interest.
Simple interest is when money is paid out on the principle sum of a loan and nothing else. This means if you put $10,000 into a savings account which pays 5% simple interest, it means every year you’ll be paid $500 on that $10,000. After the first year you’ll have $10,500 in the account, the second year $11,000, the third year $11,500 and so on.
If you invest the same $10,000 at 5% compound interest, it means the interest will be paid on your initial investment plus the amount of interest already accumulated. In the first year you’ll have $10,500 ($10000 x 5%), the second year $11,025 ($10050 x 5%), the third year $11,576.25 and so on.
Your $10,000 initial investment with simple interest, after 50 years you would have a total of $35,000. With compound interest your total on the same initial investment would be $114,674. This is the power of compound interest and why investing as early as possible is key.
How to get Started in Investing
Firstly, ascertain your level of knowledge. Do you know much or little about investment and the financial markets? If it’s little, or nothing, go and learn. Read and absorb as much knowledge as you can. Read into what the stock market is, how currencies work, the history of finance, what’s currently going in the global business world etc.
Secondly, ascertain how much you can afford to invest. look at your personal finances and money you have access to. Remember, don’t invest more than 50% of your total wealth, but even as a beginner 50% is a huge chunk. If you’re just starting out, try 5, 10 or 20% of your total wealth.
Thirdly, ascertain your appetite for risk. Remember, knowledge mitigates risk — your risk will decrease based on how much practical knowledge you possess about what you’re investing in, but your level of risk will never be zero. When starting out, it’s common wisdom to begin with lower risk investments, like savings accounts or government bonds. As you gain more experience, you can begin trying out slightly higher risk positions, like certain stocks, commodities or currencies.
Fourthly, ascertain how much effort you want to put into your investing. In the old days it used to be only that the very rich needn’t lift a finger and could have other people invest for them. Those days are gone. Now even the most modest of investors can put aside small amounts of money to invest in their instrument of choice. This is done today mainly using robo-advisors — mobile apps and other automated services which ask you a few questions and then invest your money for you, like Betterment or Wealthfront. If you want to go classic and do all your own investing, however, there are plenty of platforms like Etoro or Interactive Brokers which’ll let you do just that.
Fifthly, choose an investment to get started in. I’ve mentioned a few already. At the low risk, low effort end, you can start putting money in savings account with fixed interest returns, buy government bonds or use a robo-advisor. At the mid risk, mid effort level, you could begin trading popular stocks, like global and Fortune500 companies or put money into mutual funds or ETF’s, and at the high risk, high effort end, one could invest in emerging companies or markets, certain commodities or forex. There are a whole load of other invesment types other than what I’ve mentioned here, google any of the terms above for more information.
Generally speaking, investment is a long game and the best returns are made over the course of years, not months. Remember, the higher the risk, the higher the reward, but the higher the chance of losing your money. The lower the risk, the more stable the return. Never stop investing in yourself. Follow experts in your chosen market but learn as much as you possibly can about it as well. This is how you’ll develop a gut feeling.
Start small and slow; build up your confidence, knowledge and experience and you’ll be surprised how much you’ll learn and how much better your investments become, along with your returns.
This article is NOT meant for advisory purposes. It is meant only for the purposes of information. Investing carries a real risk of losing most or all of your money, or more money than initially invested. Consult a financial professional before making any financial decisions.