Investing for Beginners (Yes, I Mean You…)

Posted on August 16, 2012 at 12:24 PM PDT by

In my travels, I talk to a lot of people. Many of the folks I meet are brilliant at what they do. They share fascinating insights into their lives and professions, really interesting stuff. Just as often, they admit to me that what they need to understand most about money is the basics: investing for beginners.

Not because they aren’t smart enough to grasp complexities. I’m talking about engineers, lawyers, and doctors, top managers and sales leaders. No, they need investing for beginners because, in my world, they are beginners, as much as I would be in trouble behind a drafting table or holding a scalpel.

Investing for beginners meets the bull

Maybe they already jumped into investing with both feet and lost money — perhaps an embarrassing sum. Television shows about investing tend to make us all feel like instant experts. (Strangely, I don’t feel qualified to practice medicine after watching “House,” but I understand…) Or they have paid a few advisors ungodly sums and gotten disappointing results. Markets are humbling to all of us, eventually.

So I try to help. In these conversations, I find myself breaking investing down into the simplest ideas first, then building up to the more elaborate concepts, if time permits. I don’t “own” these ideas. They were researched and tested and codified by other, far more brilliant folks, some of whom I count as colleagues. But I do understand how to use them in real market conditions, and you can too.

There’s just three rules to investing for beginners, and together they form a decent starting point for learning more deeply:

Rule No. 1: Know what you don’t know. Investing is ridiculously hard to do. You can do all the legwork to check out a company, avail yourself of every morsel of data, pick apart the balance sheet, heck, you can invite the CEO over for the weekend if you want. You will buy that stock on a Monday and on Tuesday everyone in the market will dump it in droves. For no reason at all.

Sure, the financial TV shows and pundits will come up with reasons. Slumping foreign sales. Product pipeline glitch. Early snow in the Rockies. Some reason out there will fit, some fact pattern will appear that, in retrospect, seems to prove the folly of buying too soon or too late. The truth is, a bunch of people got up Tuesday morning and decided they needed cash more than your stock, and they sold. Sorry.

Rule No. 2: Stick to a plan. Short-term traders love trends. They love when masses of lemming-like small investors latch on to what feels like a new idea in investing, a hot sector, a flavor-of-the-month, some macro play that makes perfect sense to the investing for beginners crowd and cannot fail.

They love trends because beginners, flush with cash, chase them higher. “The trend is your friend till the end,” is how they put it. They don’t intend to hold that stock forever, or even for weeks. Maybe not even a day. Once they see that the investing for beginners crowd has burned out on a theme, they will bail out of their positions fast and leave you holding the bag. Chasing returns and trend trading is certifiably crazy. You are far better off with a solid, repeatable investment plan that you stay with regardless of what might be in fashion.

Rule No. 3: Time is on your side. Active traders have to be right time and time again to win. And they cannot lose even once. It’s a bit like watching gambling addicts, setting up for one more hand, one more roll of the dice to get back to even and quit for good. Yet it never happens.

You can safely ignore trends and avoid risky bets because you will build your wealth using the single greatest force in investing: compounding. When you protect your downside by using a carefully designed portfolio, your money grows and grows, absorbing temporary declines in one asset or another and then snapping back to solid, reliable growth. Money begets money, simple as that. Just avoid losing it.

Beyond investing for beginners

Are there more rules you need to know? Of course. Costs matter, a lot… Most financial advisors don’t really work for you, legally speaking. They work for themselves… You are extremely unlikely to beat the market. In fact, most investors earn far, far less… The list goes on.

The important point, in terms of investing for beginners, is to accept these three basic rules, then take active steps to overcome the limitations you face.