Common Errors of new Investors

An investor is a person who makes money by buying specific items for re-sale at a much later stage for a profit. While the term “investor” most often refers to a person who buys financial products such as company stock or bonds, the product could indeed be stamps, gold bullion, art works, a classic car, a house or similar item.

An investor differs from a trader who buys and sells as an ongoing business (e.g. a storekeeper) or even a speculator, who buys and sells on hunches essentially gambling for a ‘quick win’.

A few simple definitions are important to understand the concept. A person investing in a bank savings account is in principle buying a bond (the bank has to ‘buy back’ the bond when you want your savings back), while an investor in mutual funds is buying a collection of equities or bonds specified by the seller.

The purpose of an investment is to make money. The most fundamental error that many new investors make is to forget this and to become emotionally attached to the investment. They do not sell it (cash it in) when the price is right, or do not get rid of it the investment proves to be a failure. There is always the hope that things will get better. After all, even investing in banks can lose you money as evident since the crash in 2008.

Investments are generally long-term, not short-term. The second error that many new investors make is to be too concerned over short term or daily fluctuations in the market. Over any one day an individual stock on the NYSE can fluctuate by a couple of percent. Over the longer term however, the trend tends to remain constant. An investor who is too concerned over short term effects will soon panic and lose everything.

An investor requires knowledge. The third error many investors make is to invest on promise or rumor, without understanding the possible return or the risks involved., All investments need to balance risk and return and unless the investor understands this proposition the investment is likely to be suboptimal. An investment with high risk (e.g. equity derivatives) has the possibility of high returns but also has the potential for large losses. An investment with low risk (e.g. savings account in the bank) will only generate a low return but has small potential of losing money. An investment in a specialized item such as antique car or rare coin requires knowledge of the value of these items in various states of repair. It also has a special risk – the sale is not a certainty as it requires a serious buyer. Any investor (other than in a regulated environment such as a savings account) has to understand that every investment requires two parties: – if you buy there has to be a willing seller, and when you want to sell it does not help you if there is no buyer prepared to pay your price.

Finally any reasonable investment takes time to mature. The long term benefits of investing are indicative of the power of compound interest. A stock price that increases at 10% per year will double in value in about 7 years, not 10. As an example consider a stock with a value of $100. In one year it will grow 10% or $10, to $110. In the second year it will grow 10% of the new value of $110 or $11 to $121. Compound interest gives you interest on interest. Even growth of 1% will double the price in 70 years.

 Your investment is your way of committing to the future. In what way do you think your investment capital will grow?

 * The writer of this article is not a financial advisor, and is in no way advising any investment in any particular product. He does however invest on his own behalf.*