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A new investor should take the following factors into account before investing in the stock market:

1. His risk profile and investment style
2. Things he should know and do
3. Things he should not do

Think of the stock market as an ocean that runs deep, one that is infested by sharks, big whales, and other predators. Now think of a beginner as a new hatchling that needs to survive and thrive in such dangerous waters.

I’m sure you get the picture.

Based on my experience in the stock market, I have created the following guide that I believe will help newbie investors. Here we go:

1. Determining Risk Profile and Investment Style

How much risk can you afford to take?

A new investor in his 20s or 30s can afford to take more risks than a 50-year-old newbie investor. Before investing, you need to budget for your monthly expenses, contributions to your retirement fund, an education fund for your children, and more. Only after setting aside enough money for your family’s security can you then plan to invest the surplus into equities or fixed-income securities.

How much time can you afford to spare?

If you are in a job, then you may not have enough time to spend on researching stocks. Perhaps, you may not even have the required skills to pick stocks. In any case, know that investing is not just about buying stocks and forgetting about them – investing involves following the macroeconomic and company-specific developments regularly and acting on information, as required. So, if you do not have the time, skills, or inclination to get financial knowledge, consider hiring an experienced financial advisor.

Can you exercise self-restraint?

The stock market is a heady rollercoaster ride and you need to keep your emotions in check during the investment process. Overconfidence in your abilities, or overestimating them, can lead to losses or underperformance. Excessive trading also can lead to underperformance. Fear of losses can motivate you to work without applying a stop loss, which can turn out to be a huge mistake. Falling in love with a stock can stop you from booking profits at the right time. Investing based on emotions instead of relying on macro- or micro-economic conditions too is a mistake. Panicking at the prospects of notional losses or celebrating notional profits are also mistakes that many new investors make – remember, a profit or loss is not real until it is realized.

2. Things a New Investor Should Know and Do

Setting Investment Goals

Every new investor should determine his investment goals. For example, a risk-averse investor typically invests in large caps, value stocks, or utilities, which pay a reasonable dividend every year, for the long term. An investor who likes to take risks is more likely to park his funds in small- and mid-caps across different periods (short to long term) depending upon how powerful his or his advisor’s research or recommendation is. Define your investment goals based on your risk profile, capital, loss-bearing capacity, and trading style.

Expecting A Reasonable Rate of Return

New investors are often tempted to invest because they have heard of how legendary investors like Warren Buffet, Carl Icahn, George Soros, etc., raked in millions in the stock market. They may also be tempted by stories about how penny stocks zoomed 1000x or more over the long term. While the stock market can help wise investors generate money, one should have realistic expectations because the market is volatile and both bull and bear phases can last for years, giving rise to unrealistic expectations or an aversion to investment, respectively. Therefore, a new investor must have reasonable expectations from the market. For example, the Fed has projected interest rates at 5.1% in 2023 – so, if an investor gets 10% or more from the market, he should be satisfied – anything above that can be considered a bonus.

Diversifying Portfolio 

A well-diversified portfolio made up of growth, income-generating, and value stocks spread over several sectors is preferable to chasing one or two sectors or stocks.

Diversifying your portfolio involves spreading your investment across several stocks. Check any ETF’s or mutual fund’s portfolio. These funds usually invest in multiple stocks across one or several sectors (depending upon the fund’s theme), so that even if some stocks underperform, the other stocks can make up for their underperformance. Plus, the funds also review their portfolio once a quarter or so, which is something you should emulate.

Gaining Knowledge

Most of the experienced traders and investors know how technical or fundamental (or both) analysis works and many of them have probably been active in the stock market for years. A new investor cannot just jump in and try and compete with such traders/operators, because, in simple terms, one man’s loss is another man’s profit in the market. Therefore, it makes sense to sign up for a course and understand how to read annual reports or how to trade before jumping into the fray. Learning technical analysis too is desirable. However, if the investor does not have the time or inclination, he should hire an experienced financial advisor.

Understanding His Trading/Investment Style

An aggressive investor is impatient and is likely to act on impulse. He is likely to take risks and invest for the short term. Such investors need to learn self-discipline.

A cautious investor is more likely to invest in blue chips and bonds, while giving a miss to mid- and small-caps with a lot of potential. Such investors should develop a healthy risk appetite.

A nervous investor may panic even at a small notional loss. Moreover, in most cases he may book profits very early on without riding the trend.

Such investors should learn how to be more flexible and pragmatic.

3. Things a New Investor Must Avoid

Chasing Fads

There are all sorts of fads that keep cropping up and new investors tend to latch on to fads only to find out they were running behind a theme that destroys capital. Some prominent examples are dotcom stocks (early 2000s), the recent SPAC fad, overpriced IPOs, pharmaceutical start-ups during the COVID-19 period, meme stocks, low-earning highly hyped stocks, and so on. Fad stocks are typically feasted on by big whale investors while the small retail investor is left gnawing the bones.

Following The Herd

Following the herd means investing in stocks that the crowd is investing in. Usually, this herd mentality results in losses and heartbreak, especially for newbies. That is because herd investing is based on hearsay rather than on research. The wrong stock (usually most herd-backed stocks are turkeys) can substantially erode your capital.

Revenge Trading

A revenge trade is a trade or trades that an investor takes so that he can recover losses incurred on a previous trade/trades. Such emotions can make the investor act in an irrational manner and lead to more losses.

Investing Based On Media Commentary

They say that the news is always in the price. Savvy investors track their investments like a hawk and deploy capital in anticipation of news or corporate developments. New investors, on the other hand, react to what the media says and rush in to invest or short stocks based on any positive or negative commentary – only to find that they have been shortchanged.

I believe that this guide will help new investors take their first steps on a sound footing and avoid falling into the twin cesspools of greed and fear. If you think my post has helped, please comment, give your suggestions, and share the article. Happy investing!

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