Baby Steps into the Investment Universe: Beginners: Part 1 of 3
I frequently come across questions on Quora like
- I have $ 100, how do I start investing?
- I want to learn to invest, but where do I start?
These are beginners learning how to invest. We sometimes forget that there is a large investment universe out there.
- There are different asset classes eg stocks, bonds
- There are different investing styles eg technical vs fundamental
It can be confusing for someone without any investing knowledge.
How do you start if you want to learn to invest as a beginner?
1) First get an overview of the various aspects of investing eg fundamental vs technical, active vs passive, etc
2) Once you have some basic understanding, chose your path. This will depend on your personality, the amount of time you have, your educational background, etc
3) Thereafter you proceed with a more in-depth study of the chosen investing path.
This article is to help you go through steps 1 to 2.
If you are a beginner and you go through this article, you should reach a stage where you can make an informed decision on which investing path to follow.
You are taking baby steps into the investing universe.
Contents
- What is investing?
- Why invest?
- What to invest - The Investment Universe
- Comparative benefits
- How do you choose your Investment Path?
- How to invest as beginners
- Why invest in equities?
- What are the expected returns from equities?
- What are the risks of investing in equities?
- The mechanics of putting your money to work
- Why value investing?
- Pulling it all together
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The growing interest in investing as illustrated by Google Trends |
1) What is investing?
- “Investing is the act of allocating resources, usually money, with the expectation of generating an income or profit.” Investopedia
- “Investing is the process of buying assets that increase in value over time, with a goal of generating income or selling for a profit.” Forbes
- It is not tied to any specific asset. You can invest simultaneously in different assets.
- You can learn to invest at any age and start at any time
- It is not about the amount of money you have. There are ways to invest if you don’t have a large amount of savings - eg through regular contributions, through mutual funds
2) Why invest?
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3) What to invest - The Investment Universe
- By asset class eg cash, stocks, bonds
- By investing style or school eg technical vs fundamental, active vs passive
No |
Category |
Type
|
Description |
3.1 |
Types of investment or Asset class
|
Properties/real estate |
Land and/or building
|
Commodities |
Raw material or primary agricultural
produce |
||
Forex |
Currency
|
||
Securities, equities, stocks Refer to 3.2 |
Owning a piece of a company
|
||
Fixed Income, Debt, Bond |
Lending money to a company or govt
|
||
Cash, savings deposit |
Money with you or kept in a safe place
|
||
Futures |
Asset bought for delivery and payment
in the future |
||
REIT - Real Estate Investment Trust |
Investors pooling to own, operate income-producing
properties. |
||
ETF - Exchange Traded Fund |
A collection of securities that often
tracks an underlying index. |
||
Other Derivatives |
Options, swaps
|
||
Cryptocurrency
|
Bitcoin |
||
Others - fine arts or antiques |
Specific collectibles |
||
3.2 |
Securities, Equities, Stocks |
By sector/industry |
Services, manufacturing, financial,
etc
|
By Geography |
Domestic, international
|
||
By size/market cap |
Large, small, mid
|
||
By valuation type |
Value or growth
|
||
By type of shares |
Ordinary, preferred
|
||
By liquidity |
Liquid, Illiquid
|
||
By risk-return profile |
Blue chips, micro-caps
|
||
By how you benefit |
Dividend vs price appreciation
|
||
3.3 |
Investor behaviour
|
Trading vs Investing
|
Short term eg day trading, influenced
by price movements vs Long-term view, influenced by
fundamentals
|
Active vs Passive |
Hands-on approach, more transactions.
Direct stock picking vs Buy and hold, tracking some benchmark,
mutual fund investing
|
||
High-Risk appetite vs Low-risk appetite |
How much loss is tolerable, degree of variability that is acceptable
|
||
Regular periodic vs Lump-sum
|
Contribute regularly, dollar averaging
vs Irregular lump sum
|
||
3.4 |
Investing style
|
Fundamental vs Technical
|
Looking at economic and financial
factors vs Looking at price trends and patterns
|
Quant vs Discretionary
|
Based more on complex mathematical
models vs Based more on human judgments
|
||
|
4) Comparative Benefits
- Forex is the largest and cryptocurrency is the smallest
- Global real estate value is far larger than the global equities market capitalization
Chart 4a: Relative market size of Asset Note: There is no info for cash, futures, and collectibles (Refer to Notes 1) |
Behaviour and style
4.13 Pros and Cons of Trading
Pros of Trading
|
Cons of Trading |
Quick results |
High risk |
Don’t require knowledge of the assets |
Time intensive |
Smaller capital required |
Gains are taxable as income |
|
For assets with high liquidity |
|
Higher commission due to the frequency |
4.14 Pros and Cons of Active Investing
Pros of Active investing
|
Cons of Active investing |
Can tailor a portfolio to meet market
condition |
More commissions due to the frequency |
Flexibility in choosing investments |
More risk since trying to beat the market |
Can take the opportunity of short-term
trends |
Research and time-intensive |
Can outperform the market |
Less diversified than passive
investing |
|
More prone to human errors |
4.15 Pros and Cons of High-risk Investments
Pros of High-risk Investments
|
Cons of High-risk Investments |
Can use leverage |
More risk |
Hugh gains |
Less control |
Have limited liability |
Maybe last to be paid in case of
equity |
4.16 Pros and Cons of Regular investments
Pros of Regular Investments
|
Cons of Regular Investments |
Smooth out market irregularities |
May not be enough to meet retirement
goal |
Investing discipline |
Limited diversification |
Make investing more accessible |
Research shows lump sum does better |
An easy intro to investing |
|
Reduce emotional component |
|
4.17 Pros and Cons of Technical Analysis
Pros of Technical Analysis
|
Cons of Technical Analysis |
The chart provides a clear picture of the price
action |
Too many indicators |
Use objective data, mathematical
precision |
Does not take into account
fundamentals |
Reflects market sentiments |
Ambiguity |
Patterns easily identifiable |
Short term view |
Inexpensive |
No indication of the true worth of the asset |
Can be quickly analyzed |
Harder to construct a portfolio |
4.18 Pros and Cons of a Quant
Pros of Quant
|
Cons of Quant |
Low cost due to automation |
Needs lots of data |
Unbiased, no human emotion |
Not sure it will continue to work |
Efficient |
Prone to garbage in garbage out |
|
Cannot quantify everything |
|
Ignores expertise |
|
A heavy commitment of time and money |
5) How do you choose your Investment Path?
- What are your investment goals?
- What is your risk appetite?
- What are your traits? - there is a series of factors to be considered here from timeframe to interest.
5.1 Investment goals
Financial objectives |
Potential assets |
Preserve capital |
Properties and fixed income |
Generate income |
Fixed income, Dividend-paying stocks,
REIT |
Growing wealth |
Properties, stocks, |
Speculating |
Forex, futures, commodities |
5.2 Risk appetite
- The academic one that correlates risk with returns. The general view here is that higher returns require taking on high risks
- Those who believe that you can generate high returns with lower risk. The most famous proponent of this is Warren Buffett. He believes that you can invest safely by having a large margin of safety and a host of other risk mitigation strategies. You can even expect higher returns.
5.3 Timeframe
- A very short-term trader.
- A short to mid-term investor.
- A long-term investor.
- Investing in real estate generally requires a long term horizon
- Forex trading is generally short-term trading
5.4 Age
- The younger you are, the more risks you can take as you have more time to recover from any losses. You could be a trader as well as invest in forex, commodities, or futures.
- The older probably have more savings and can invest in those assets that require larger sums eg real estate
5.5 Income
5.6 Net Worth
- With a high net worth, you will have more money to put toward various assets.
- With a low net worth, you may be more risk-averse as any loss would have a big impact on your wealth. So avoid exposure to futures, commodities, and forex
5.7 Financial literacy
- How to analyze companies
- How to value them
5.8 Time available
- An active stock-picking approach requires more time than a passive index fund approach.
- Trading requires more time than being a long-term investor
- If you think you can be a successful trader in a few weeks, you are going to be disappointed. I tried paper trading in futures for almost a year and failed to make any money
- It took me years to develop the analytical and valuation skills required to be a value investor.
5.9 Interests
6) How to invest as beginners
- What is available in the investment universe - the comparative benefits and/or the pros and cons of each
- Your profile - your goals, risk appetite, background, interests, and other demographics.
Chart 6a: What to consider when choosing your Investment Path |
Chart 6b. Choice matrix |
- Sections 7 to 9 of this post
- Part 2 and Part 3 of this “Baby Steps into the Investing Universe” series
7) Why invest in equities?
- “…they provide the highest potential returns. And over the long term, no other type of investments tends to perform better.” Morningstar
- “.. the possibility to increase the value of the principal amount invested. This comes in the form of capital gains and dividends.” BlackRock
Pros in investing in Equities |
Cons in investing in Equities |
Earn high returns |
The market can be volatile |
Good liquidity |
The market can crash and you lose a lot |
Flexibility in creating a portfolio |
Time and knowledge for research |
An ownership stake in a company |
Returns not guaranteed |
Can start with little money |
Returns take time |
Inflation protection |
|
Income from dividend |
|
8) What are the expected returns from equities
|
Stock Exchange (e) |
Index |
10 years Jan 2010 to Dec 2019 |
20 years Jan 2000 to Dec 2019 |
% Compounded Annual return |
||||
1 |
NYSE |
S&P 500 (a) |
11.2 |
4.0 |
2 |
Nasdaq |
Nasdaq Composite (a) |
14.7 |
3.9 |
3 |
Tokyo |
TOPIX (b) |
6.5 |
(0.1) |
4 |
Shanghai (SSE) |
SSE Composite (c) |
0.0 |
3.4 |
5 |
Hong Kong |
Hang Seng Composite (d) |
1.4 |
1.9 |
6 |
Euronext |
AEX Index (a) |
6.1 |
(0.5) |
7 |
Shenzhen |
Shenzhen Composite (e) |
3.5 |
6.8 |
8 |
London |
FTSE 100 (a) |
3.5 |
0.5 |
9 |
Toronto |
TSX (a) |
3.7 |
3.6 |
10 |
Bombay |
BSE Sensex (a) |
9.0 |
10.9 |
9) What are the risks of investing in equities?
- Deterioration in the intrinsic value due to socio-economic reasons, political risks, and business risks
- Errors in analysis - those could be due to corporate governance issues
- Behavioural - those due to your biases
- Stock Exchange risks - trading suspension, liquidity issues, market manipulation
10) The mechanics of putting your money to work
11) Why value investing?
- What to buy
- How much to buy
- When to sell
- You buy those companies trading at a discount to their intrinsic value.
- You put more money into those companies that you have the greatest conviction. This could be based on the biggest margin of safety or strongest moat, etc all of which are valuing investing concepts
- You sell when the market price exceeds the intrinsic value.
Pulling it all together
- If you don’t know how to drive, would you just jump into a car and start to drive anyway? If not, why would you start investing without knowing anything about it?
- The first step is then to get some basic understanding of investing - what it involves, the risks, what is available
- This post provides you with a snapshot of the investment universe
- Once you know what is out there, you can then narrow down on what to invest in and/or choose your investing path.
- Thereafter you need to get more in-depth knowledge about the chosen investment path.
- Sections 7 to 9 have other relevant points should you choose to invest in equities.
- If you chose to be a do-it-yourself value investor, then Part 2 and Part 3 of this series are very relevant.
End of Part of 1 of 3
Part 2 is about how to analyse and value companies
Part 3 focuses on how to mitigate risks
Item |
Remarks |
Source |
Properties |
Value of properties in 2018 of 220 c/w
stock & bond of 190 scaled to 2019 by stock & bond size |
|
Commodities |
2019 trading value
|
|
Forex |
6.6 X 252 :
2019 Trading vol annualized
|
|
Securities |
2019 market
cap |
|
Fixed income/bond |
Amount on bond - Aug 2020 |
|
Futures
|
No Contracts traded in 2019 = 19.2
billion No value was available |
|
REIT
|
Value of portfolio in 2019 |
|
ETF |
Assets managed in 2018
|
|
Derivatives
|
Gross contract value 12 x 2 annualized |
|
Cryptocurrency
|
|
b) TradingView
c) Trading Economics
d) MacroTrends
e) Business Insider. Top stock exchange based on the market cap as of Mac 2020
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Disclaimer & DisclosureI am not an investment adviser, security analyst, or stockbroker. The contents are meant for educational purposes and should not be taken as any recommendation to purchase or dispose of shares in the featured companies. Investments or strategies mentioned on this website may not be suitable for you and you should have your own independent decision regarding them.
The opinions expressed here are based on information I consider reliable but I do not warrant its completeness or accuracy and should not be relied on as such.
I may have equity interests in some of the companies featured.
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