Last updated on May 5th, 2022.
The path to the stock investment in the 20s is very diverse. There are those who actively participate by observing and learning from their predecessors. There are also new friends “jumping in” because of FOMO due to the recent hot increase in stocks. However, whether proactive or due to FOMO, the pitfalls for newcomers to the stock market are many, requiring good preparation. So what are the pitfalls here? How do we prepare?
The first pitfall is fees and taxes in stock investing. There are public fees, but there are also very vague fees.
The publicity fee is the fee that investors have to pay to the securities company (broker) every time they buy and every time they sell. Depending on the broker, service package, and transaction value, the feed rate can be from 0.1% to 0.35% of the transaction value. Besides, there are other fees related to the maintenance activities or other transactions of the account.
For example, the fee is 0.15%, applied to an investor with an initial capital of $10.000 and buys and sells again and again with a frequency of 4 times/month. With 48 transactions to the limit of the account, the total fee will then be 48 x 0.15% x $10.000 = $720, or 7.2% of the capital spent.
As such, the investment return must be much higher than this to offset the transaction fees, taxes, and other fees. If investors use x2 leverage, the cost can be up to 14%/year. It is not easy for long-term professional investors to have such a stable profit.
Another hidden cost that also greatly affects the bottom line of an investor is the spread, i.e. the difference between the buying and selling prices.
For example, if the market price of a stock is $10, the bid price is %15 and the ask price is $9.5, the spread will be 1%. If the bid price is $11 and the ask price is $9.9, the spread will be 0.2%.
The size of the spread does not only affect the investor’s final profit. It is also an indication of the liquidity of the stock. The larger this number, the lower the liquidity.
The second pitfall is using leverage to invest without much experience. Many investors win a lot when they first enter the market, just like a new hand gambling legend.
At first, they may only spend a little capital to explore, but when they win, they become subjective, thinking they are very good. Little did they know that it could be luck, right at the time when the market cycle was up.
Overconfidence has led many new investors to invest all (all-in) into securities, moreover, to borrow money through margin to invest.
But using margin is a double-edged sword, it can help increase returns, but can also make losses faster and more severe. For example, in the case of using margin x2, if you lose 10%, your real loss will be more than 20% because you still have to pay interest.
The danger is that when using margin, the amount of investment capital has increased much. Usually, when exploring, investors spend a small amount, like $1000, for example, seeing a profit of 10% in a few days is happy.
But when you put in $100.000, use an extra x2 margin, even if the market adjusts only 5%, the loss will also reach $10.000, enough to wipe out the previous profit. Compared to the original capital, now 100% loss.
The third pitfall is not cutting loss in time. In finance, when calculating the profit/loss ratio of continuous investments, we must use the geometric mean.
For example, a 50% loss, then a 50% gain is still a 25% loss, not a breakeven. Assuming there is $10.000 to invest, loss before profit, then the capital will be $10.000 x 0.5 x 1.5 = $7.500.
You can easily find on the Internet the calculation of how much profit you need to cover your loss. For example, a 10% loss requires an 11.11% profit, a 20% loss requires a 25% profit, and a 50% loss requires a 100% profit.
The fourth pitfall is being too adventurous, and then investing in complex financial products like derivatives, risky products like CFDs, or investing on unlicensed exchanges.
Direct investment in underlying securities through securities companies is also very risky. Therefore, investing on online exchanges, with complex products, with high leverage, the risk will certainly be more than double.
Investing, like any other business, requires preparation. Faced with so many pitfalls, what should new investors prepare?
In stock investment, the first thing that needs to be equipped is knowledge. The knowledge here is the foundation related to the financial position of the business because the intrinsic value of a stock is the discounted present value of the future cash flows.
In addition, it is necessary to understand and distinguish between book value (book value of equity), intrinsic value, and market value (market value or pricing). The truth is that even many experienced investors can’t distinguish between valuation and pricing for a stock.
But knowledge of corporate finance alone is not enough. The performance of an enterprise is highly dependent on the ability of current and future leaders, that is, corporate governance.
In addition, investors also need to have a macro knowledge of the industry, the economic cycle, the monetary policies of the major central banks as well as the fiscal policies of these governments.
Take for example in the economy. Let’s ask the same question as with industries such as finance, energy, real estate, consumer goods, technology, etc., in each period, which industries will prosper and which will decline?
When there are major changes in policy, for example:
in the US, the Democratic Party takes power instead of the Republican Party, which industry will benefit?
The second preparation in investing is psychological. The stock market is an unpredictable place, no matter how hard everyone tries to do it.
Over the long term, markets all grow with the size of the economy, but there will always be corrections or crashes. Among these, corrections can be frequent and unpredictable.
Two important psychological signs in the stock market are greed and fear. Too greedy will easily fall into a swinging peak, and too afraid will fall into a sell-off, selling at market value when the market is plummeting.
Therefore, experienced investors differ from new investors in that their psychology is stable. These investors do not flinch when the market corrects sharply, or impulsively when the market is hot.
The third preparation is the investment methods. In investing, it can be divided into two schools: buy and hold and buy and hold. Regardless of school, it is necessary to understand the principles, ways of portfolio diversification, and portfolio risk management.
For example, for an asset class with a high level of risk, ie large price volatility, it should only account for a small proportion of the portfolio. For example, cryptocurrencies should only account for a maximum of 10% of total assets.
In investing, there is a saying that “knowing is not doing”, which means knowing is not enough, you have to do it. This is to avoid falling into the situation of Rote Learning.
The psychology of simulation investing is very different from real investing. Opening a virtual account, losing 30-50%, the mentality is not the same as spending $10.000 real money to invest. The 20% loss on the $10.000 portfolio is also very different from the 20% loss on the 1 billion portfolio.
When the mind is different, the action will also be different. In most cases, when not calm, it is easy to make the wrong decision.
In your 20s, investing in your career is the most important. It is a sure source of profit and is likely to increase many times in the future. Investing in your expertise, developing a professional network to advance at work is an effective investment.
When there is an accumulation, this is the time to consider investing in securities. Before starting, you need to have the preparations as mentioned above. And make sure you’re aware of the pitfalls.
Investing is a long road and it’s not easy to get rich quick. When starting out in your 20s, think that you have 20 to 30 years to execute your financial plan.
The hardest thing in investing is to practice discipline, perseverance and a strong mentality. If you can do it, you will be successful.
Good luck fellows with your investment and wish you success in your future endeavours.