The app Robinhood has helped many new investors to monetize stocks. Previously stock investment was only for the rich and the wealthy because most brokerage firms required a minimum assets to open an account. Additionally, there is a fee for each transaction. Unless the transaction would generate a positive spread there is no reason for anyone to buy and sell stocks.
Recently Robinhood was put on the spotlight because there were a number of news how some investors took too much risk and lost a lot of money. The worst news was a 20 year old committed suicide because he thought he lost $730 thousands from betting on options. Investing in stocks are risky. Anyone who want to invest in stock needs to understand the risk and each investor needs to know his/her risk tolerance.
There are a number of experts who continue to point out that to minimize losses in stock market is to diverse their holdings. For new investors, they need to at least have a basic understanding how stock market works and what are some of the investment vehicles that are available to them in the open market. The question is what is the right mix of investments for a new investor?
How Much Risk
There is no clear answer on what is the right mix of investments because everyone is different. There are some who has a lot of liquid assets and willing to bet all. On the other hand, there are some investors who want to dip their toes in the water and would not take any risks. I have been investing in the open stock markets for over 3 years and majority of my assets are in the traditional retirement income of which I have no control over what to invest in. I learned to understand how much risk I am willing to take and that in turn helps me to understand what mix of investments that works for me. Below are some guidelines that I hope you find helpful.
Understand Your Financial Standing Before Investing
Although investing in stock has become easier for the mass, it is still not for everyone. The type of people who should be discouraged from investing are those who are having difficulties in earning enough to make ends meet and those who have high debt. Investing involves taking a large sum of funds and put it in a basket that could lose value.
Before an investor start investing, the person should take stock of his financial status and determine if he has the means to invest the money otherwise meant for sustenance. In 2018, the Federal Reserve Board did a study and found that 40% of Americans do not have $400 in the bank for emergency. The rate today could be higher due to the pandemic. A lot of Americans borrow from their credit cards to meet daily needs, including investing in stocks. There was an article in July 2020 of how an investor started investing by borrowing from credit card and with devastating results. Investing in stocks is risky and there is a likelihood that you could lose value. No only you could not recoup your investment you are now liable for the money that you borrow.
Separate Asset into Categories
Investing in stock market is similar to gambling, but legally. Like all gambling, you could win all and you could lose all. To minimize the risk of losing all, it is advisable not to put everything in one bucket; experts call it diversification. As noted earlier, majority of my assets are in retirement account. I only have 10% of my asset invested in open market. Additionally I further diversify my investment to further minimize the risk and maximize the return. To achieve this I categorize my holdings into 3 categories and I also put in how much percentage I own.
- Long Term Investment (15%) – These are the bonds and index funds that are stable. While the returns are minimal, the likelihood of them losing value is reduced due to the fact that they are consolidation of multiple stocks.
- Capital Generates Passive Income (60%) – These are stocks of companies that are reputable and in good financial conditions. These companies remain to be profitable and are not likely to be at risk of default. The stock prices continue to be in the upward trend. Additionally, these stocks pay dividends, which is a type of passive income.
- Play Money (25%) – I consider these stocks that are volatile and likely to lose value easily. However, volatility is also positive because to generate the spread is by buying low and sell high. These are the stocks that I will trade. These stocks to not pay dividend.
How Much Are You Willing to Lose
In an ideal world, we want to make money from stocks. However, stock markets go up and down. Hence, there are chances that one could lose money from stocks. Before anyone starts investing, he should set a limit of how much money he is willing to lose. Knowing the limit will minimize the risk of losing it all. The important question to ask is what sacrifice will you be making if you lose the money you invested.
Learn When to Quit
One of the important things I learned for the past year is know when to “sell” the stock. A profit is only realized when the stock is sold. On the other hand when the stock price falls below at a certain level, it makes sens to sell it before it goes any further. I learned the hard way when the Luckin Coffee stock that I owned continued in a downward spiral that there was no way for it to recover. I was holding to the hope that it would go up. Unfortunately that did not happen and the stock was subsequently delisted from Nasdaq. I lost over $900 when I finally sold the stock before its value dropped to $0.
One of the biggest challenge that I face is what happens when the stock prices of the company continues to go up? The premise in a stock market is buy low and sell high. However, I tend to hold on to these stocks especially if they are from reputable companies and they pay dividend.
Is there a right mix when it comes to investing in stocks? Yes, and it depends on one’s preference and how much risk is he willing to take. Before taking a big step in investing, it is also really important for the investor to understand his current financial status.