It is easy to get overwhelmed or make big mistakes when you start investing. We asked three of our writers for their best advice for beginning investors. Read on for more.
The piece of advice I always give to beginning investors is to learn the basics of index investing and the impact that fees have on your returns over the long term. If you are looking for a book on the topic, a great primer is John Bogle's "Little Book of Common Sense Investing."
As a whole, investors can only earn the return of the market, minus any fees that advisors and other helpers charge. For this reason, it behooves you to try and pay the lowest fees possible. One note: Many fees in investing are not hidden, but they are certainly not obvious to the beginner. If you are investing in funds or ETFs, or working with an advisor or broker, it is important to find out how fees are being charged and how high they are.
In general, the lowest fee funds are index funds. These funds track the broader market rather than trying to earn more than the market. Because of their simplified mission and large size they also have some of the lowest fees possible. For example, the popular SPDR S&P 500 ETFcharges 0.09% a year, and the Vanguard S&P 500 ETFcharges an even lower 0.05% a year. That's $9 or $5 for every $10,000 you invest per year.
With the average mutual fund charging 0.75% a year, that means that to earn the same return as an index the fund must earn at least 0.75% more to get the same return. Those fees add up. On a $10,000 investment, if you earned the market return of 8% a year over 40 years you would have $217,000. If you earned just 1% less over those 30 years your return would be just $149,000. That's a $68,000 difference!
Overall, learn the basics before you commit real money to investing in the stock market.
One common mistake I see new investors make is focusing on making short-term gains. For example, a friend of mine bought shares of Apple for the sole purpose of capitalizing on the iPhone 6 announcement.
While this works out sometimes, it is a losing strategy over the long run for a few reasons. For starters, if you trade for the short-term, you'll end up paying much more in the way of commissions. With commissions around $10, making a trade every two weeks adds up to $260 per year.
Also, even if you make a profit, short-term capital gains are taxed at a significantly higher rate than investments held for longer than a year. Just as a quick example, if you are in the 28% tax bracket and make a $5,000 profit on an investment, the difference between short- and long-term capital gains tax would be more than $250.
Finally, trying to time the market and jumping in and out of different stocks almost never works out in your favor. In fact,the data indicates that investors who trade in and out of different investments significantly underperform the market. Buying stocks for the long-term is a much more certain way to create wealth, so my best advice to newcomers would be to approach investing with a long-term mentality.
Dan Caplinger: The one thing I'd recommend to every beginning investor is not to be afraid of taking risk. Most people who are just starting out with their investing have a long time horizon ahead of them, and the best way to put time on your side is to embrace riskier investments that have the best potential for outsized long-term returns. That can be a big challenge for many new investors, as they want to start out on the right foot rather than beginning with what proves to be a catastrophic mistake. Yet if there's a time when you can afford to make mistakes, it's with the first money you invest -- and in fact, making mistakes with small amounts of money early on can save you from costly errors at a more critical time.
Later in your investing career, you won't have the time or the risk tolerance to take as many home-run swings at potential blockbuster stocks, as you'll need to make sure you preserve at least some of your assets to protect against unforeseen financial problems. Then you'll have an opportunity to put more of your money into less volatile investments like bonds and bank CDs. At current rates, though, beginning investors shouldn't hesitate to jump into aggressive investments like stocks and stock ETFs and mutual funds as a good way of putting their money to work for them.
The article 3 Pieces of Advice for Beginning Investors originally appeared on Fool.com.
Dan Caplinger has no position in any stocks mentioned. Dan Dzombak has no position in any stocks mentioned. Matthew Frankel has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.
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