4 Things to Know Before You Start Investing

 How do you know if you’re ready to start investing? Here’s a thought experiment to see if you have the right mindset.

Imagine you’re at a conference and you sit next to the former chairman of the Nasdaq. He offers you an investment opportunity with guaranteed returns between 13% and 20%. Would you take it?

If you say yes, you’re doing something “natural.” Many people trust credentials. That man was Bernie Madoff, and he made that offer to many smart investors. He had impressive credentials:

- He owned legitimate businesses

- Congress often asked him to testify on financial matters

- He used to be the chairman of Nasdaq

Madoff took people’s money but didn’t invest it. He simply gave them back 13% to 20%, just a little more than the S&P 500 returns, making it seem legitimate. But it was a Ponzi scheme.

Madoff started his scam in the early 90s and wasn’t caught until 2008. Investors lost over $17.5 billion.

However, not everyone was fooled by Madoff. Investor Howard Marks often shares how he didn’t trust Madoff’s offer because it didn’t make sense.

With basic knowledge of investing and finance, we can do the same with investment opportunities. No one can “guarantee” returns.

In this article, I share 4 things you need to know before you start investing. By learning these now, you can save yourself a lot of pain in the future.

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1. The Difference Between Short-Term Trading and Long-Term Investing

Before you start investing, ask yourself: “What is my investing goal?”

Is it to build long-term wealth for a comfortable retirement? Or to increase your income?

The first is long-term investing. The second is short-term. Investors who see investing as a way to make money quickly invest with the mindset that they’ll pull it out in a year or two.

Short-term investors trade stocks, buying and selling within days, weeks, or months. This is fine for people who understand the stocks they’re trading. But most of us don’t want to be traders.

I see investments as a way to build long-term wealth using the power of compounding. My career is for income.

Your mindset shapes your expectations. When it comes to investing, we need realistic expectations.

2. Investing Is a Habit, Not a One-Time Act

Investing is a habit.

A one-time, lump-sum investment won’t do much. If your goal is long-term wealth, you need a consistent investing routine.

Timing the market is hard because share prices are volatile. Prices go up and down monthly. So I use “dollar cost averaging.” I invest a consistent percentage of my income every month, no matter the price.

This reduces the impact of market timing on my investments and lowers my stress.

Let’s say you commit to investing $500 a month. If you invest that amount in the S&P 500 index fund for 35 years, you could become a millionaire. With dollar cost averaging, here’s how your investments might look over 5 months:

Finally, stick to an amount that’s manageable for you. If 30% of your income is doable, great. If not, go with 10% or 20%. It depends on what you can realistically afford.

Life events like having a new baby or buying a house will affect how much you can invest. Adjust accordingly.

The key is to stay consistent over the long term. Invest a little today, more in the future. Whatever it is, stick to your investing goal every month. Your future self will thank you.

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3. How Often Market Corrections and Bear Markets Happen

“Market correction” and “bear market” both mean a drop in the stock market. But they’re different. By definition:

- A correction is when the market drops at least 10% from its recent high. This usually happens about every 2 years due to a major event or economic shock.

- A bear market is a decline of 20% or more, lasting from a few months to over a year on average. Bear markets occur about every 7 years, mainly due to low economic growth.

Why is this difference important? Because corrections happen more often and are shorter, while bear markets can last years with lower growth.

If you’re a long-term investor, you can just stay the course. No need to react to the market. Your returns might dip, but it’s minor in the big picture.

Long-term investors know that over 10 or 20 years, there will be various corrections and bear markets. It’s part of the process.

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4. How to Spot Get-Rich-Quick Schemes

If an investment opportunity seems too good to be true, it probably is. We’ve all heard this, but we can still be tempted to put money into shady investments.

Investing brings two strong emotions: Greed and fear. When we hear about a chance to make more money, we feel greed. When bad things happen to the economy and investors panic-sell, that’s fear.

The key is to recognize these emotions, ignore them, and stick to our plans. I like this quote from John Bogle, the founder of the Vanguard index fund, in his book *Stay the Course*:

“The winning formula for success in investing is owning the entire stock market through an index fund, and then doing nothing. Just stay the course.”

Many of the people Bernie Madoff defrauded were professional investors. Why do smart people fall for bad investments? Because emotions are involved.

Smart investing means managing your emotions. Don’t let impulses guide your investment decisions.

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Having Some Knowledge vs. All the Knowledge

You don’t need a finance degree to start investing. But going in blindly with high expectations can lead to losses.

That’s why I use a simple investing strategy. When I know the basics and understand the market’s fundamental principles, I’m more at ease. I’m not easily swayed by public opinion, news, or self-proclaimed experts.

Similarly, we don’t need to read every book on investing or analyze all historical data. As Warren Buffett says:

“If past history was all that is needed to play the game of money, the richest people would be librarians.”

With some knowledge, you have an edge over those entering the game blindly. Your returns will likely match the pros, and might even be better in many cases.

By : Mustafa Gai @MrGai24, Freelance Writer and Translator

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