Investing on your own in the stock market: It’s not for novices!
Thinking about investing on your own in the stock market without investment advice? Take some time to think it over: Going it alone is a tricky business.
There are two areas that you need to fully understand:
- The markets – They are volatile and unpredictable. Knowledge and expertise are required to:
- perform the appropriate financial and economic analyses of the companies you’re considering investing in
- properly understand the characteristics of the investments you’re thinking about buying
- Your ability – You will be responsible for your decisions and the results, good or bad. Investing on your own requires that you:
- be comfortable with online technology
- be able to manage investments and financial planning without outside advice
- be up to date and current with news and company information
- have the time and be prepared to research investment options
- consider your level of financial knowledge, needs and investing goals
- have access to required financial, tax and other expertise and knowledge
- able be able to tolerate risk and have sufficient financial resources to withstand the loss of all or some of your money if there’s an unexpected turn in the market
Think you can spot undervalued securities? Think you can tell when it’s the right time to enter the market? Think you can “beat the indexes”? Few of even the most sophisticated investors possess these abilities. Overestimating your knowledge and abilities can be very costly.
Investing versus dabbling
Investing, unlike dabbling, requires knowledge and expertise, and while investing has risks, dabbling carries even greater risks.
A. This is what investing looks like
Before investing in the shares of a publicly traded company, you need to understand and assess the business, risk exposure, capital structure, financial performance, indebtedness and other facets of the company. Analyzing these and other aspects is absolutely essential to maximize your chances of making a profit on your investment and minimize the risk of losing money. This analysis takes time and a willingness to familiarize yourself with the company’s financial statements and the information they provide on its performance, financial position and cash flow situation. A knowledge and understanding of key financial ratios is also important.
After you analyze all the company’s fundamentals, the stock’s value may not reach the levels you had hoped for. A stock’s value can be influenced by many factors that are external to the company, including the general economic environment, political or financial crises, trade tensions between countries, natural disasters, and public health issues. Investing based on an informed analysis therefore still carries risks.
People who dabble or speculate in the stock market don’t usually have a plan or perform fundamental analyses or, if they do, they take dangerous shortcuts.
B. This is what dabbling looks like
Dabblers don’t typically have a plan. They may rely, for instance, on the latest newspaper article about a company, on the words of an acquaintance who has heard that the share price “is going to take off,” on the fact that the company’s stock recently fell sharply in price, or on rumours on social media. Individual investors who rely on such “information” run the risk of seeing their “investment” quickly lose its value, which is artificially inflated as a result of speculation by other dabblers.
This is one way Manitoban dabblers can lose their money to fraudsters
The MFSA monitors the market to uncover and stop fraud schemes. Despite this, individual investors are more likely to fall for a pump and dump scheme, a scam often linked to penny stocks. A pump and dump scheme involves fraudsters accumulating a company’s stock and then artificially inflating its value by spreading fake positive news about the company through a variety of popular communication channels, such as the Internet and social media. The fake news makes the company seem more appealing than it really is. Dabblers then rush to buy the stock, driving up its market price. When the fraudsters feel the stock price has risen sufficiently, they sell their accumulated shares and make a big profit on the backs of their victims, who are left with worthless shares.
Before you invest on your own in the stock market on a discount brokerage platform, you should carefully determine your investor profile as this will be instrumental in knowing how to invest and what you should invest in. Areas that you should consider include:
Financial Goals – are savings, investment or spending targets you hope to achieve over a set period of time. These need to be specific and realistic.
Investment Objectives– An investment objective is the purpose a particular investment or combination of investments serve to meet your financial goals, such as saving to buy a house or for retirement
Time horizon – An investment time horizon refers to the length of time that you are intending to hold the portfolio.
Financial Situation – Be upfront when considering your financial situation. Know what you own, what you owe, what you earn, what you spend.
Liquidity Requirement – will you need your money (and have to sell your investments) in the short, medium or long term?
Risk Tolerance – Risk tolerance is generally how much variability (ups and downs) in returns in the market the investor is prepared to accept.
Investment Knowledge – How much do you really know and understand about investing? This will certainly affect whether or not you choose to go it alone or enlist the help of a professional.
Be thorough when searching for and analyzing information
For example, if you want to buy the shares of a company, review relevant documents that will answer questions such as:
- What indications are there that the investment will be profitable?
- What could affect the company’s profitability? Is the company facing legal proceedings? Has a caution been issued regarding its viability as a going concern?
- Does the company operate in an industry with good future prospects? What are the company’s competitive advantages and production capacity? Who’s on its management team and board of directors?
- If it’s a manufacturer, is its equipment state-of-the-art or obsolete?
- What is the company’s financial position? Publicly traded companies are required to produce quarterly and annual financial statements. The company’s financial statements and other material documents, including , annual reports, management’s discussion and analyses (MD&As), annual information forms and news releases, can be found on the SEDAR
To invest in the stock market, you generally need a long-term investment horizon
Will you need your money in the short term? If so, buying shares of a publicly traded company may not be a good idea.
Market volatility and the external factors mentioned earlier may cause the value of your investment to drop just when you need your money. You would then incur a loss when selling the shares.
If you have a short investment horizon, then it’s better to stick to safe investments that generate lower returns without the unnecessary stress.
Consider that you could lose all or part of the value of your investment
Never forget the harsh truth about investing in the stock market: Regardless of your knowledge, expertise, analyses and past successes, there are no sure bets. The company you invested in could experience major financial difficulties that could quickly lead to insolvency or bankruptcy, in which case you could lose all the money you invested.
This post was adapted from an article originally published by the Autorité des marchés financiers (AMF), and shared here with their expressed permission.