With modern brokerage services, investing is easier than ever before. The latest apps can buy stocks with just a few clicks. Anyone with £5,000 might see a simple path to targeting a lifelong second income.
However, such simplicity can mislead newbie investors. There are plenty of traps to fall into, and one in particular that would mean kissing any new income source goodbye. Let me explain.
New to investing
Let’s imagine typical new investors, inexperienced but with a few thousand in the bank. They want to make their money work for them and are open to the idea of investing in the stock market.
A first investment is in an American tech firm. A friend hyped the stock up after making a five times return. The next investment is in a total market world index fund for some safety. Finally, they buy the shares in a couple of 8% dividend stocks as they like the idea of a passive income.
They watch the investments over the first year with a sense of worry. It’s no surprise. Their life savings are zipping up and down with the chart on a computer screen. They feel tempted to sell but resist after noticing more up days than down.
After a year passes, they’re thrilled to see how much money they’ve made. The markets performed well and US tech had another banner year. They’re proud to see the portfolio has comfortably beaten major indexes like the S&P 500 and the FTSE 100.
Now, they’re feeling less worried and more relaxed. They;ve saved up a few more quid from the day job and those dividends are burning a hole in the brokerage account. Why not make more investments?
Uh-oh
They pick a Chinese tech firm that’s supposedly ‘the next big thing’. They’ve been reading Warren Buffett and Ben Graham and find a couple of great ‘buy-and-hold’ companies too. They spend some time day trading and even dabble in options contracts.
This year does not go well. After a global economic slowdown, the portfolio crashes 35%. The panic is overwhelms and they can’t bear to watch their savings dwindling any further. The lot is sold. After two years of investing, they have less than at the start point and are left with a very sour taste.
This example is hypothetical, but it’s based on real experiences. And while our imaginary friend (s) blundered in more ways than one, I’d say the biggest error was the absence of an investing philosophy.
Rather than follow one sensible strategy, they threw a lot of things at the wall, hoping something would stick. With no philosophy as a guide, our investor(s) acted on instinct and panic-sold when stocks were at their worst.
Philosophies
For some, an investing philosophy means buying index funds and waiting 30 years. Those after higher returns often follow Warren Buffett’s ‘value investing’ approach, which involves buying a few great companies and holding the stock for a long time.
For anyone starting in the stock markets with a few thousand pounds, I’d say having a philosophy is a non-negotiable. A philosophy keeps me consistent, and consistency is how big goals like a lifelong passive income are chased down.
The post £5,000 in excess savings? Here’s one trap to avoid on the way to a lifelong second income appeared first on The Motley Fool UK.
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John Fieldsend has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.
