Pattie Lovett-Reid: Why it’s a risky time for first-time investors
In recent weeks, the main North American indices have either hit or come close to all-time highs. Volumes have picked up and fear gauges reflect a ho-hum attitude toward risk. It is understandable if the belief is: there is money to be made, you need to get into the market. And that is where the herd mentality kicks in.
You often see the herd mentality after the bull market has been strong and the retail investor buys into the concept these markets have only one way to go – up. You also see it during a period of capitulation where that same retail investor believes the market has only one way to go – down, and then quickly decides to throw in the towel and move to the sidelines.
“My final conclusion would be that you want time in the market as opposed to timing the market,” Market Commentator Dennis Mitchell said in an interview Monday, when I asked him about whether it’s a good time to get into the market.
Somewhere between euphoria and fear is the investor who decides slow and steady wins the race.
Given the recent market performance, this could be a dangerous time for first-time investors if they allow emotions to dictate their investment decisions.
Before you decide to get into the well-performing markets, consider the following first:
1. Determine your goals, investing time horizon, and tolerance for risk. When it comes to risk, focus not only on what you are willing to lose but what can you afford to lose. Be reasonable with your time horizon. If you need the money within the next five years, the stock market isn't for you right now.
2. Go back to fundamentals. You may have purchased a stock that has done well, and have consequently started to believe in your own predictive powers. It is dangerous to think you shouldn't get back to fundamentals and do your homework. Researching before investing increases your odds of buying low and selling high.
3. Diversification matters. We have seen over the past year companies that have come under scrutiny with their stocks declining dramatically. It is risky to invest in one company, one currency, one sector or even one country.
4. If a tip sounds too good to be true, it likely is. Don't chase the daily news. By the time you hear a tip, the smart money has often come and gone.
5. Never invest money you don't have. I've seen some borrow to invest. Leveraging is a legitimate investment strategy with the upside potential great but the downside risk could be significant if the stock falls in price and catastrophic to your financial plan. Leave leveraging to the pros who may have more financial flexibility. I would also suggest short selling. Betting a stock is going to trend lower is best for the experienced investor.
If you are a first-time investor, think about buying good quality companies that build their balance sheet and continue to grow. Maybe they pay a dividend and maybe they don't. In a perfect investment world, as the company builds its balance sheet, you will too through price appreciation.
At the end of the day, don't be greedy. Rebalance your portfolio, lock in gains, and always remember: fundamentals are your friend.