If you are new to the stock market, there’s a high chance of making a mistake that could cost you dearly. Prudent investment is a combination of three P's — Patience, Practice and Practical hands-on application. Before you get going, here are a few important words about how novice or first-time investors can increase the likelihood of making their investment work for them.
1) Waiting to make a large initial investment
Why it’s a mistake: A lot of people have this misconception that they need to build up a lot of money before they are ready to invest. People who think that way are ultimately losing in the long run. Waiting to get hold of a large capital sum before starting to invest is just delaying getting on the investment bandwagon.
What to do about it: Start with smaller but consistent amounts. It will add up to a tidy sum over a period of time without putting any additional strain on your budget. It will also lead you to a more diverse portfolio. Remember that a lot of companies can help you get started by investing as little as £5000.
2) Putting all your eggs in one basket
Why it’s a mistake: It is never a good idea to put all your eggs in one basket. Ideally you should build a portfolio consisting of seven to ten investments that have low correlation with each other.
“Allocating your money across different industries and categories reduces the risk to a considerable extent as different industries are more likely to react differently to the same event” - says Ilayda Taze, CEO of London-based TrendScout, which specialises in guidance and information related to Enterprise Investment Scheme (EIS).
"A good diversification strategy can maximise your returns because if one investment performs poorly over a certain period, there could be a high probability of other stocks performing well during the same time. Compare this with having a very limited investment portfolio, wherein the risks of bearing the brunt of market volatility are much higher”,
What to do about it: Diversify your portfolio with a mix of stocks and bonds. It is always prudent to invest in two or more companies operating in different sectors. For example, let's assume that you have £50,000 to invest. You can either invest all your money in a company X or divide your investment between two companies — X and Y.
Suppose you invest your entire £50,000 in Company X, and the value of the shares goes down from £4 to £2 per share, and you end up with a loss of £25,000.
Now let's assume that you invested £25,000 in the stock of Company X and £25,000 in the shares of company Y. The price of the stock of Company Y increases from £4 to £6. The £25,000 of your investment in Company X is now worth only £12,500, a sharp drop in the value of your investment. But the other £25,000 is now worth £37,500 (this is the part invested in the Company Y stock). Overall, the present value of your portfolio is £50,000. No profit or loss but much better than having all your money invested in the Company X stock.
3) Trying to do the job of professional advisers
Why it’s a mistake: Individual investors often turn out to be their own worst enemies. The internet contains so much conflicting advice and a deep analysis of stocks when it is not required can often cloud your judgement and coax you into making costly investment mistakes.
“What to do instead: Picking a good due diligence firm is important as they can guide you in the right direction. Also, keep your expectations rational and invest with a medium- or long-term mind-set”, says Taze.
Choosing the right company to invest in is paramount, which is only possible if you let professionals who are legally obligated to work in your best interest do the job. They do diligent research to obtain current data and information about a company, it's leadership, its growth prospects and the industry it operates in.
Investing can never be 100% risk-free but you can greatly increase your odds of generating a good return on your investment by talking to qualified professionals.
Investing in equity markets means that you have to develop a certain level of immunity towards bad news of stock under performance and stock market volatility. Your ability to stay put and manage your own emotions regardless of news cycles and market volatility bodes well for your investment.
4) Failure to take into account tax implications
When you start investing in the stock market, you do have to consider tax implications. Please remember that you may be taxed differently on the same amount depending upon how you choose to invest it. Download our guide to the Enterprise Investment Scheme to learn more about some of the potential tax breaks available to you.
First-timers often indulge in quick buying and selling, hoping to make quick profit on their deals, but these short-term gains are taxed at regular rates, whereas long-term investments are often taxed at a lower rate.
“You’d have to be an investing genius to understand the difference, and first-time investors lack the expertise as well as the insight to do prudent tax planning”, says Taze.
It is always a good idea to speak to someone who has knowledge and expertise about the industry you are interested in. Get in touch with us today to gain more insights and learn how to make better decisions.
Apart from helping you with your investment, we will also arm you with questions that you were not even aware you should ask.
Mo Rassolli is a senior consultant at TrendScout. The London-based firm acts as a conduit for investors who wish to invest in high potential EIS-qualifying start-ups.