In life, making mistakes is an important learning mechanism. After doing so, you identify where you went wrong to avoid the same mistake again. Among other things, it will often cost you time, pride, or money. While making your own mistakes is a useful process, understanding someone else’s mishaps can provide a similar learning experience without the associated costs. I hope that sharing my early investing mistake allows you to avoid a similar trap.
My Initial “Investment Strategy”
My investment journey began when I was younger than most. I opened my first brokerage account with TradeKing (which has since been purchased by Ally Invest) when I was 18 years old. I funded my account with savings from years of birthdays, holidays, and odd jobs. The amount of my initial deposit was about $2,000. I will be the first to admit that I had no clue what I was doing. My “investment strategy” (if you can even call it that) was to purchase a company’s stock just before the company reported earnings. I would browse a few websites until I found a company that was anticipated to report “better-than-expected” earnings. After I found a company that met my criteria, I would make my investment a few days before the earnings announcement. Looking back, this technique was incredibly foolish. I was risking my own money based on the biased predictions of a faceless stranger.
My Investing Mistake
Thinking I had figured out the art of investing, I made another deposit a year later with some of the money I had received from my high school graduation party. As I began college, I stuck to my same basic “investment strategy” with the hopes of multiplying my money. Little did I know, that would not be the case. During my freshman year, I bought a semiconductor company the week before they reported earnings. What I figured was a solid pick, ended up being an absolute disaster. I remember walking out of class in the morning and seeing that my account value had dropped by over $1,000! I physically felt sick. As quickly as my fingers would let me, I entered an order to sell all my shares of that semiconductor company. The sell order had executed seconds later, but the damage had been done.
To my freshman-self, $1,000 was a huge amount of money (and still isn’t a negligible amount by any means). It was about the cost of textbooks for the entire school year. The loss was deflating. I was upset that I had been irresponsible enough to let myself invest in a company I knew nothing about. More than anything, I was determined. Going forward, I completely revamped my investment strategy. I would only invest my money in companies, products, and services that I understood. Prior to investing a nickel, I would review the balance sheet, historical earnings, and dividend history of each company I was contemplating (all of this information can be found on a company’s Investor Relations page). After making this adjustment, my investing results changed drastically. I felt like I was no longer leaving my fate in the hands of chance. By making more informed decisions, I felt like I had more control over the outcomes of my investments. To this day, that $1,000 has been the most valuable bit of education I have ever paid for.
Learn from My Investing Mistake
Please learn from my mistake. Most people probably wouldn’t buy a house without completing an inspection. The same should be true when it comes to stocks. Don’t invest in a company that you know nothing about. If you aren’t willing to put in the time and effort to do the appropriate amount of research, I strongly recommend against investing in individual stocks. Thankfully, if you are confused or intimidated by the thought of researching stocks (like my wife), alternative options exist.
One popular hands-off approach to investing is using an index fund. In simplified terms, an index fund is a type of investment that allows someone to purchase one share and receive exposure to a large number of companies. For example, one of the most popular indices in the U.S. is the S&P 500. The S&P 500 index is designed to track the performance of the 500 largest U.S. companies. To invest in the S&P 500, my preferred index fund is the SPDR S&P 500 ETF Trust (symbol: SPY). When I buy one share of SPY, I am essentially purchasing a tiny sliver of each of the 500 largest U.S. companies all wrapped together in that single share (I’ll save you the technicalities). For offering me this type of diversification, SPY charges me $0.945 a year for each $1,000 invested (an expense ratio of 0.0945%), which is quite reasonable for the service being provided.
After my investment fiasco, I only purchased index funds for a while. Until I was comfortable with my abilities to research individual companies, I used index funds to take a passive investment approach. Index funds are a solid option for beginning investors or investors that don’t want/know how to appropriately research individual stocks. It’s a way for an investor to achieve diversification across many companies, sectors, or even regions. Before purchasing an index fund, be sure to understand what particular index that fund is attempting to track. I also highly recommend reviewing a fund’s prospectus before putting any money at risk.
Develop an Understanding of Investing
If you take away nothing else from my early investing mistake, don’t invest in something you don’t understand. If you aren’t comfortable investing in individual companies, that’s okay. It will take time. If you don’t feel comfortable with the concept of an index fund, don’t risk your money in one. Before risking any of your hard-earned cash, educate yourself. Make time in your life to develop an understanding of investment principles. Listen to podcasts about investing, watch YouTube videos about investing, read books about investing, and talk to friends about investing. If you’re looking for a place to start, check out one of my previous posts to learn a thing or two about stocks. Understanding the concept of investing will take dedication. Ultimately, putting in the effort will most likely pay dividends (literally and figuratively).
Please use the Your Thoughts page to submit your investment questions. I’ll gladly answer your questions as best as I can.
Your thoughts are worth more than a penny.