Idiot’s guide to investing

Picking a stock to invest in requires more than just a quick google search so either invest passively or get someone else to do it for you.

Some people just pick a stock to invest in because it’s fashionable at the time or all their friends are doing it so they jump on the bandwagon too, however, this should not be your approach.

Stock picking

To really grasp the fundamentals of a company and see if it is a profitable business or at least has the potential to be then you need to take a deep dive into their books.

You need to study the news, know the CEO’s intentions with the company, their balance sheet and profit and loss statistics.

Then there is the price to earnings ratio to consider and since I cannot even explain that to you, as I have no interest in picking stocks, you need to go and learn this stuff for yourself if you have any hope of picking lucrative shares in a company or companies.

I mentioned in last week’s blog – trading vs investing – a book that is definitely worth reading if you want to take this seriously is: “The Intelligent Investor” by Benjamin Graham, as it outlines the approach one should adopt when analysing a company.

Gold dust apparently but went way over my head.

For those that, like me, recognise picking stocks is not for them then don’t worry, all hope is not lost.

You can still invest even if you are an amateur and this is how.

Passive Investing

In very simple terms, passive investing is choosing a large index fund that tracks a certain basket of underlying investments and tends to favour a “buy-and-hold” strategy.

An index fund will hold a small amount of stocks in many different companies so your money is diversified across different sectors, assets and even countries.

The upside here is that if you own shares in 500 companies, for example, if your index fund tracks the financial index Standard & Poor 500, and 1 company goes bust, it will hardly affect your portfolio because you have 499 other companies still afloat.

The downside with diversification is that if a particular company (e.g. Apple, amazon, facebook) does exceptionally well, you will reap some of those profits but because you only hold a relatively small % of that company then your gains will be diluted.

This is why passive investing is seen as being less risky than picking only a few select stocks because your money is spread out, evening out the troughs and peaks of the market.

Active investing

Now active investing is when you have a fund manager that actively selects different stocks on your behalf to beat the investment benchmark index.

It comes at a price though.

Fund managers will take a slice of your profits (or losses) as a fee for their services but sometimes this can be worth it if the market turns a certain direction, as they can be more agile than a computer (passive investing).

It is important to know, however, that a lot of fund managers do not beat the market and charge you a fee anyway.

There was a study done that got 10 or so chimpanzees to select stocks against 10 or so fund managers, who selected stocks that they believed would outperform the market.

Guess what?

It was a draw – no clear winner.

The conclusion from this study was that no one is psychic and can predict the future so why pay extra for services that may only deliver the same, if not worse, results?

Now this obviously is a huge sweeping statement and I have differentiated passive and active investing in a crude manner but the whole point of my blog is to just make you aware of the basics.

You can then use this as a platform to then launch into further research if you so wished.

So do you choose passive or active investing?

The way I see it is if you do not have the time to commit to studying a company’s books then you either invest passively or pay a fund manager to do it for you.

If you want to set and forget your portfolio, have cheap fees and leave all the hard work to the computer then go passive.

On the other hand, if you want to try your luck and see if a fund manager can beat the market to get your money work harder AND you’re willing to pay a higher price for this then go active.

There is no ‘one size fits all’ approach to investing, as it is so very personal but hopefully this post today has got you thinking and made you aware of the differences between two investment strategies.

TO DO

Buy the book “intelligent investor” if you want to pick your own stocks.

If you do not, then evaluate what is more important to you: potentially greater gains (active investing) or lower fees (passive).

NEXT TIME

I am going to cover the important matter of platform fees and how to go about choosing a platform that is right for you.

HEALTH FACT 

Studies have shown that people with a more positive and optimistic outlook on life live for longer than those that do not. Go figure!

DISCLAIMER

This blog is for educational purposes only and should not be construed as financial advice. It is purely opinion-based.

Please note that the link is an affiliation link so that if you want to take the plunge into investing and buy the book I recommend, you are buying it for the exact same price as you would normally apart from a get a small commission from it, which I would really appreciate. Thank you!