If you are a current subscriber, welcome back to another article! If you are not currently subscribed, feel free to do so! It’s great to have you here!
When I started investing I really didn’t know much about the stock market and I feel that many people that are starting to invest might feel the same way. It’s hard going through your first selloff or stock market crash but it will help you improve as an investor. Sometimes you earn and others you learn.
I decided to write this article with some tips that I think might be helpful for newer investors. It should also help more experienced investors remain long term oriented during drops such as the one that growth stocks are under currently.
Without further a do, let’s dive in!
Start investing in index funds to get a sense of the market
If your objective is building your own portfolio of individual stocks, starting with index funds may help you get a sense of the broader market without exposing yourself directly to a high “risk”.
I bought my first individual stock almost two years after I started to invest. I kept it really simple at the beginning and I simply bought a fixed amount of an S&P500 ETF once every month. Even though this might seem boring (it is!) it’s a profitable strategy over the long run and it helped me get a sense of the broader market.
Up to this date I still regularly buy this same ETF monthly. Individual stock investing and index ETF investing are complementary, not substitutes.
Never invest money you may need in the short term
I think that many people underestimate this tip as they might think this is something obvious. Truth is that not many people end up applying it!
Begin building your emergency fund (this is somewhat personal but I would say that you need your emergency fund to cover 6 months of expenses minimum) and invest a portion of your income once you are done building it. You should never invest proceeds from the emergency fund, even if you see that the opportunity is obvious just like in March 2020.
If you invest money that you may need in the short term (the next 5 years) you may be forced to sell your holdings in the worst possible moment, severely impacting your long term returns. If you are still in the early days of building your emergency fund you can spend this time learning about the stock market which is also a great investment for long term outperformance.
Do your homework beforehand
I know the feeling of deep diving a company for a long time just to find out that I will never start a position or at least at those prices. It’s very frustrating but it’s part of the process, as the great Warren Buffett says:
“The trick in investing is just to sit there and watch pitch after pitch go by and wait for the one right in your sweet spot. And if people are yelling, ‘Swing, you bum!,’ ignore them.”
Although this might appear to be wasted time, it isn’t. If you do your homework beforehand you will be well prepared to take advantage of any future opportunity that Mr. Market provides.
In my particular case this has happened with $ABNB as I deep dived the company and just started a very small position recently after taking advantage of the price drop the stock suffered with the expiry of the lockup period. I never though of starting a position at those prices after finishing the deep dive.
Chasing stocks on the way down might be a bad a idea and chasing stocks on the way up may be a good idea
Buying the dip is a very attractive strategy if you are long term oriented. It’s a strategy that I usually pursue but I try to average down exclusively on my highest conviction companies. Always bear in mind that stocks sometimes go down for other reasons that are not related to market irrationality so don’t chase them blindly.
You could also face the undesirable situation where you averaged down so much in any particular company so that it now is one of your biggest positions without being your highest conviction company, something you don’t want.
On the other hand, you shouldn’t be afraid of averaging up if fundamentals are improving and management is executing flawlessly. I am really happy to average up if these conditions are fulfilled.
Build your positions very slowly
I know that sometimes any particular company might be trading at what appears to be a very attractive price which may push you to buy your whole position in one go. This is a terrible idea and I learned this the hard way, losing money. I think that there are two main reasons why this is a terrible idea:
Buying your positions in one go is some sort of market timing. You are assuming that you are buying at the bottom because the opportunity is obvious but the truth is that stocks can always go lower. Lump sum investing is statistically more profitable but when you are wrong it will hurt and, let’s face it, you could be totally wrong.
Companies in their early stages carry a significant amount of execution risk. When you buy companies that are just getting started, they carry a considerable amount of execution risk so I think that the most intelligent thing to do is to build your position as management executes.
If there is a place where rushing costs money, that place is the stock market. As much as lump sum investing might seem preferable, you are better off building your positions slowly in a controlled way. Mr. Market always ends up providing great opportunities if you remain patient.
Build your portfolio (on a cost basis) so that it mirrors your conviction
This is very important as it will protect you against panic selling your positions. Price changes sentiment faster than you can imagine and if you are not well prepared for this it will inevitably affect you. Having your portfolio on a cost basis mirror your conviction will enable you to sit tight through severe market pullbacks. The key here is “Cost Basis”.
Don’t hesitate to adjust your portfolio, even at a loss, with the objective of complying with this “rule”.
Know yourself before investing
Before even starting to invest you should know yourself, investing is not made for everyone although it can be adapted to fit almost everyone’s preferences.
If you don’t have a stomach for volatility, invest in widely diversified index funds (those that cover global stocks).
If you do have a stomach for volatility you should know to what extent you can cope with it. Based on your stomach you can choose between many options: small, medium, large, mega cap, SPACs…
You will never know yourself perfectly before investing but investing will surely help you know yourself better.
Don’t hold more stocks that those that you can follow closely
Diversification is important because the game of investing is about being right 6/10 times and you will inevitably be wrong many times. This said, diversification may also be counterproductive if you end up giving quality (research and follow) just for the sake of diversifying your portfolio.
As I have said many times, diversification is a very personal topic and everyone should hold a number of stocks that they are comfortable with. Just bear in mind that you should never sacrifice quality.
Never invest based solely on third party information
Many people will trust a third party’s analysis without digging further or analyzing in depth the information provided by this third party. Although there are many great equity analysts out there that provide a great service you should always do your own due diligence. You should do this because if you don’t then you will have a hard time holding your positions during market drops.
I am not saying that you should not use these services, I use them myself! What I am trying to say is that these services should be a source for your own due diligence, not something you should trade blindly with. Exceptions apply if the research is really detailed and from a very trusted source, in this case you should read everything thoroughly.
Remember that you own companies, not stocks
This is a really obvious tip but it is very helpful if you force yourself to apply it. When you invest in individual companies you are buying a part of that company and a price drop will not change this, you will still own that same part of the company regardless. If the company is expected to grow then so will your ownership.
As a business owner you should be more concerned with stock dilution than short term price drops if you hold quality companies with a long term horizon.
Avoid the noise
When the market corrects, noise will increase dramatically as many investors will panic and bears will come out of their cave but the truth is that fundamentals of quality companies usually remain unchanged during these periods. I think that many investors are aware that they should ignore this noise but if you are exposed to negativity 24/7 you may end up making investment decisions based on noise even without being aware of it. Choose who you follow and who you listen to during down periods.
Be aware that bears predict two or three bubble pops during the course of a year and they are only right once every 5-10 years. Stay long run optimistic and tune off the noise!
Be cautious when investing in companies that recently became public
I have a “golden” rule which is to avoid investing in companies that came public not long ago, specially if the lockup period has not expired yet. I do this for three main reasons:
I want to see how the company performs as a public company for at least two quarters. Becoming public carries significant additional costs and will divert management attention.
Lockup periods. Typically, companies that become public have lockup periods ranging from 3 to 9 months during which certain shareholders are not allowed to sell their shares. When the lockup period expires some of these shareholders might sell, putting downward pressure on the stock and providing a better entry point. Recent example: Airbnb.
History shows that when a company skyrockets after IPO it will most probably end up coming back to a better buying point. There is no need to rush.
Be aware that some stocks don’t climb back to ATHs
I commonly see newer investors buying any particular stock just because they are way off its All Time Highs (ATH). As much as this may make sense when you combine it with solid fundamentals and great future ahead, it makes no sense at all if you look at it on itself.
Spoiler: some stocks never come back
Follow the company daily, not the stock
You are doing yourself and your investment returns a great favor if you force yourself to follow the company daily (company specific news, events, earnings…) rather than its stock price. Most people end up going daily into their brokerage to check prices but they will not go to other sources to check company specific news. Forcing yourself to do this will help you remain long term oriented. It helps me at least!
If you are humble, you’ll avoid getting humbled by the market
The stock market has one great or bad thing, depends on how you want to see it: it treats every investor the same way. This creates an opportunity for those investors who are humble and supposes a terrible risks for those investors who think that they control the market at their will.
Nobody controls the market short term although the market can be controlled over the long term. Always stay cautious and be aware that the market is much stronger than you in the short run and it can remain irrational for longer that you can even imagine!
As I always like to say, I am just a regular guy writing my thoughts during my investment journey so I don’t expect readers to agree with everything that is written here!
Of course you can imagine that I have made many mistakes in my short (but intense) investing career and I have learned the hard way. Investing normally requires pain to learn.
If you liked the writing please share so that others can also have access to it!
Stay well and keep holding!
IQ