If you are new to investing, the process can seem daunting. To complicate matters further, there are many pundits writing books or making media appearances, and they have no shortage of advice. Some of it is valid, but it can seem overwhelming.
Before you get to that point, there are certain steps you can take to set yourself up for success. While investing is a personal experience, it is not merely taking positive action. There are certain things you should avoid doing to ensure that you meet your financial goals.
1. Not building a safety net
If the past year has taught us anything, it is that you should prepare for the unexpected. While very few of us could have anticipated a global pandemic that would wreak havoc on people’s health and finances, there are steps you can take to financially to prepare for adverse events, such as a layoff.
Namely, you can build up sufficient savings before making investments. Many experts recommend setting aside three to six months’ worth of expenses in a safe place, such as a savings account.
If you don’t have adequate savings for an emergency, you could find yourself in a bind or forced to sell your investments at an inopportune time.
2. Not understanding your risk tolerance
Missing out on large gains in stocks such as Tesla, whose price has gained nearly 990% over just the last three years, is hard to take. But while some still have bullish views on the company, it’s important to remember this is a high-risk and high-reward company, and the price is volatile.
If you are willing to take those risks at the onset, that’s fine. However, you should know if you’re ready to lose a lot of money, too. Fortunately, there are investments for people whose risk tolerance runs the gamut. You can choose dividend-paying blue chip stocks or fairly new companies that offer the promise of high growth. Or you can invest in something whose risk and reward is somewhere in between.
Understanding how much risk you are willing to bear is important. A good way to judge is by asking yourself how you would feel if you lost your entire investment. While no one would feel happy, would you lose sleep and make yourself ill?
3. Jumping on the bandwagon
Once you are comfortable with the risks, you should do your own homework to determine the best path forward. Perhaps you want a mutual fund, or you’d like to mix in individual stocks.
You can certainly adjust your path as you get more comfortable investing or your financial situation changes. What you should refrain from doing is buying a stock or other asset class merely because it is gaining a lot of attention. It is difficult, but you should judge an investment on its own merits.
For instance, you would have lost a lot about 60% if you bought GameStop when the share price was over $480 earlier this year. Remember, do your own homework and don’t get overly swayed by short-term price movements.
The earlier you start the investment process, the better. You don’t need to start with a large sum, either. Armed with this knowledge, you can avoid costly mistakes and end up with more money, which is the goal.
This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.