The struggles of the novice investor
Overcoming fears and taking first steps
When you are new to any experience or endeavor, it can be scary at first. This is especially true with investing, where you are putting your hard-earned savings on the line. If you are just starting off, the fear can be outright paralyzing. Even more so, if you are generally uncomfortable with risky things. Add to that little to no knowledge of how markets work, plus lack of time to read and learn more about the world of finance, and you might feel like giving up on the idea altogether. But stop right there! For all these challenges, there are solutions literally available to you at your fingertips nowadays. Take a deep breath, calm your nerves and let’s talk about where you can start.
Disclaimer: This post is for educational purposes only, expresses the personal views of the author and does not constitute financial or investment advice. The author is not sponsored by or affiliated with any investment intermediary or other financial or research institution that may be referred to in texts or links.
All sorts of barriers…
When it comes to your money (and most other things, really), it is only natural to be averse to losses. Most of us work day in and day out to earn a living. We put a lot of effort, and sweat, and sometimes even tears, to see that bank account balance grow at least a little bit every month. So, it is not surprising that we do not want to experience that “Aaaaaand it’s gone!” moment, as in the popular South Park reference.
There are some very influential studies on this topic. The works of Nobel Prize winners Daniel Kahneman and Richard Thaler, among others, have made the concept of investor loss aversion (i.e., that people prefer small, guaranteed outcomes over larger risky outcomes) widely accepted. And a 2020 global study led by Columbia University researchers found that loss aversion is a common behavioral trait across many countries, confirming the validity of the original concept in showing that people tend to be risk-seeking when maximizing gains, but risk-averse when minimizing losses.
Academic research is one way to look at this, but it is the regular person’s views that make this such a relevant issue. If we look at some surveys of individual investors, we could better understand the reasons for these fears and behaviors. A 2018 GfK survey in Germany (reference 1) showed that when asked what the biggest risk in investing for them is, most of the respondents pointed to volatility, in one form or another (the red/amber marked segments in the pie chart).
But fear of market fluctuations is not the only problem. There is a whole lot of other reasons some of us are reluctant to even start, that go beyond the unpredictable movements of asset prices. Another survey from the UK (2023) (reference 2) revealed that some of the biggest reasons are related to preferences for cash accounts, as well as lack of trust in investment intermediaries or how they handle our money. A prominent reason highlighted by a large majority (70%) of the respondents is insufficient knowledge. Perceiving the process as too stressful or too risky and complicated also doesn’t help with confidence.
Clearly, the reasons why people hesitate to start investing, are numerous and caused by a deeper lack of confidence, comfort with the unknown and fears of fraud. Not everyone experiences these, but a sufficiently large majority does.
Dissecting and addressing your insecurities
When we first start thinking about investing, it’s likely we begin by asking ourselves some of these questions: what should I do first, how much should I invest and in what, how much risk should I take?
If you work with a financial advisor or a financial planner, they can provide a lot of specific guidance and help you answer any questions so that the process becomes much easier. But if you are opting for the DIY (‘do-it-yourself’) approach, then the information available out there (especially online) can be quite overwhelming, confusing and even contradictory at times. So, once again, take a deep breath and let’s get into some of the most common questions.
Where should I start and how much should I invest?
Before even looking at anything remotely related to investments, I would suggest that you take a really good look at yourself first. This might sound a little like self-psychoanalysis (it probably is to some extent), but please bear with me for a minute.
Any financial decision you might make, including investing, has a specific purpose and context within your life, whether that’s buying a house, having a wedding, or starting a business.
So, as a first step, think about what you want to achieve and where you want to be or go in your life, not just in the near term but in the long run as well. Your life goals will help you define your financial goals, which in turn will put your investment options and potential choices into a more concrete frame. Of course, I am fully aware that life goals are not always easy to determine well in advance, especially for a 30/40/50-year horizon. Chances are, these will change over the decades. But brainstorming about them helps get at least some clarity so that you know, for what you are aiming. I have a useful guide how to think and define personal financial goals right here.
Next, think about your current financial situation:
- What do you already own — real estate, financial assets, checking/savings accounts, vehicles, businesses, a villa in the mountains?
- What do you owe — do you have, for example, student loans, mortgage debt, credit card debt, etc.?
- How much do you earn and how much do you spend on a regular basis? Do you have any irregular income or expenses?
This information will help you understand whether you can afford to invest more or less, whether you can take more or less risk, how far you are from your goals and what buffers you might have that can enable you to be bold, or, alternatively, prevent you from having to resort to undesirable (and possibly costly) funding sources.
If you do not fully understand your financial present, misguided investment decisions could jeopardize your financial future. In the process of analyzing this information, you will get a better picture of your actual liquidity needs, of your discretionary spending that you might be able optimize, and your ability (or inability) to fund your goals. I do recommend creating personal net worth and income statements, or at least a budget — because it will provide a clear overview of all things described above and serve as a tool for you to track and keep yourself in check. It will also help you find out how much you can invest. For me, reverse budgeting is the best tool to ensure financial goals (including investing) are prioritized and successfully met.
Finally, be aware of your constraints and your tolerance for risk. Some examples of constraints would be — if you have dependents that you need to care for, a property you must maintain, or a regulatory limit as to what you are not allowed to invest in or dispose of. There are many questionnaires and tools available to perform a self-assessment of your risk tolerance (your capacity and willingness to assume risks), most of which are flawed and over-complicated. I must admit, I also use such a tool, simply because it is useful in gathering important information. But these tools ask questions about situations and scenarios that you are usually not experiencing at the time of answering. Hence, your actions and reactions are likely to differ when real stress events take place, and your nerves and biases are being truly tested. You can get an idea with this one from Vanguard.
Assuming you already know your goals, I would suggest that you think instead about your time frames and your constraints, how much downside moves in your portfolio you believe you can stomach (before losing your mind) and how much you can actually afford to lose. The less you can tolerate, probably the less willing and able you are to invest in risky assets (even if your goals, capacity for risk and time horizon imply otherwise). At the end of the day, you should not go with a decision to take so much risk that it puts enormous stress on you. If it constantly makes you feel like you need to check whether the market crashed, and how much you lost, your worst instincts will likely kick in, you will be more prone to error and to panic selling or irrational reactions to changes in market sentiment.
How do I know I will be better off investing rather than putting it all in a savings account?
Unfortunately, the answer to this question will always be — you do not, not with a 100% certainty anyway. But is anything in life ever a 100% certain? (Don’t worry, this is rhetorical.) The truth is, you could be using a savings account and then your bank turns out to be Silicon Valley Bank, and the government refuses to extend deposit protection when it goes bust.
Instead, you could think about it like this: I have my goals and needs, and my time frame, so I know what I want from my investments. Given this time frame, how likely am I to get the return I want, factoring also the risk? The future is unknown, and past results do not guarantee future performance. But this is also true for cash — e.g., tomorrow central banks globally could start lowering rates once again to zero (or in some places, negative) territory, pushing rates on savings accounts down as well. And even at present, there are many financial institutions where your real yield (i.e., the nominal interest rate they offer you, adjusted for the rate of inflation) is effectively below or at zero for savings accounts.
With limited foresight, we can look at sufficiently long historical periods (capturing various economic environments), for some guidance (not for forecasting). Our aim is to get the best risk-return trade-off for our time horizon and to understand how likely is it that we lose money from our investments.
If the past is a good guide, then cash and cash-equivalent investment options are generally not the best choice for the long run, even if, within some shorter periods of time, they might offer slightly positive real returns.
The stock market dominates. And this does not hold just for the US market. You can see a comparison over various time horizons and countries in the chart below. And note that the longer the holding period, the lower the probability that you will lose money. This is an important point. If you attempt to trade in and out of the market whenever the worst or best days occur, you are more likely to miss out on equity market performance and realize a lower return instead. It confirms the notion that time in the market beats timing the market, i.e. you have a higher chance to win if you stay invested for longer. The cost of this higher performance is higher short-term risk of loss.
But is the risk higher in the longer run? Another important comparison is the one shown in the next chart where you can see the dispersion of returns over various rolling horizons across stocks and bonds, as well as a 50/50 portfolio. Shorter holding horizons come with more uncertainty and potential for losses as volatility can be much higher. But again, the longer you hold, the more the ranges of returns shrink and converge across the 3 alternatives and for the 20-year period, history shows that it is essentially very unlikely to lose money in the stock market.
How do I address my lack of knowledge?
The most important thing is your will and readiness to learn because, as the saying goes, where there is a will — there is a way. But let’s not get lost in clichés here — we should be practical about this.
There is just too much information out there, and many sources that could confuse you. There are also people pretending to offer knowledge who, in fact, have a hidden agenda and are trying to sell you something. (Well, you can accuse me of doing the same, sharing links to my webpage… :) )
If you have the time to do proper reading, then I would recommend some useful books for beginners which can be a great starting point. If not, you might want to consider reaching out to somebody experienced for help. There is no workaround when it comes to acquiring knowledge. Some ways can be more efficient than others, but at the end of the day, you will need to dedicate some time and effort to this or rely on a professional. There are, in my opinion, several essential areas to look at, that can make you better prepared:
- Personal self-assessment (including goal setting and risk profiling)
- Investment instruments (features, risks, interrelationships, valuation metrics, micro and macro factors)
- Investment strategies and asset allocation decisions
- Understanding suitability
- Risk management
- Behavioral and emotional self-control
- Investment vehicles and their tax implications
- Broker research
- Opening and setting up an investment account
- Types of trades and when to use them
- Monitoring portfolio performance and rebalancing
Now, don’t be scared of how long this list is or how complex some of these things might sound. The goal is not to become an expert (even experts occasionally make wrong decisions and lose money). Instead, you should aim to acquire the fundamental knowledge that will give you the confidence that you understand what you are doing to meet your financial goals. The knowledge that will motivate you to feel like you can make the first steps.
Additionally, there are some core principles which most individual investors should be aware of and consider following, and especially inexperienced ones. You can find them right here.
What investment vehicle should I pick?
You have probably heard this lots of times, but it is not advisable for inexperienced investors to pick individual stocks. Insufficient knowledge about how to analyze companies or systematic return drivers is of course one reason, but not the most important one. The real reason is risk. By attempting to pick stocks, you are exposing yourself to individual companies’ performance drivers that could lead to adverse stock price movements. Even if you pick multiple stocks and create a broader portfolio, chances are, you will not be able to systematically pick winners and avoid losers successfully. In fact, if you do succeed once or twice, this may give you false confidence that you are able to do this all the time, which is unlikely. There are many professional portfolio managers who actively try to steer their portfolios over time, and fail to earn a higher return than their benchmarks (reference portfolios they attempt to outperform) or the market (e.g., a leading market index).
That may sound a little depressing. After all, if that were true, why are all these pros paid for it? That is exactly the point. The average individual investor who is not an expert would, in most cases (perhaps with a few exceptions) be better served by investing in a broadly diversified portfolio across asset classes, sectors, and even in some cases, currencies and countries. This can be achieved without picking individual stocks or assets but by selecting various funds who track the performance of baskets of assets. They are low-cost alternatives to actively managed portfolios and nowadays, they are available to the public at many financial institutions.
Investment funds can help with diversifying your exposures, however the right asset class mix (i.e., in what proportions should various equity funds, bond funds, commodities, real estate, etc. be included in the portfolio) is still a personal question. As Burton Malkiel (‘A Random Walk Down Wall Street’) would say, it is the most important investment decision. In Roger Ibbotson’s words, “more than 90% of an investor’s total return is determined by the asset categories that are selected and their overall proportional representation”.
One thing I must emphasize: simply reading up on exchange-traded funds (ETFs) and then picking and adding them to your portfolio just because everyone — on the internet or your friends — talks about them, is not the right approach. I am not saying you cannot earn money this way, but without a proper strategy suited to your needs and constraints, it is likely that you will fall short of achieving at least some of your financial goals and could make some major error in managing your money. Also, ETF investing may not be suitable for everyone.
What should my asset mix be?
The boring answer sounds like this: finance pros would use the information they got about you and their expectations about asset performance and risk and run an optimization algorithm to make suitable recommendations (simply put). But that answer, as predictable as it is, does not help a total beginner unless they hire such a pro to do it for them.
So, let’s see what you can do on your own. You could use free or paid optimizers offered to retail investors, but in general it is not a good idea to resort to tools you do not fully understand and from which you can’t really get proper feedback or follow-up advice when market conditions and your circumstances change. You could also use generic portfolio structures as guidance (e.g., conservative, moderate, aggressive, etc.) that many brokers or investment platforms design, but those are, as their name implies, not tailored to your specific goals and situation.
Hence, for DIY newbies, my recommended approach has 3 components:
- Make sure you understand your goals, constraints and time frame (as discussed earlier).
These already broadly define what risks you can or can’t tolerate, and what you should aim to get from your investments — appreciation over some extended period, regular fixed income, some combination of both. If you have done a dedicated risk assessment, then you can use the conclusions from it as additional guidance, but it is not a requirement. - Think ahead and form some expectations.
It would be great if we all knew perfectly well what is coming and how it will affect our assets — new technologies with immense profit potential, expansion to new markets with significant growth expectations etc. But we do not. So, this part involves research. That’s why you will often hear from finance people the phrase “Do your research!”.
And it’s true, it is not recommended to skip this. Think of and search for things that give you indications about whether a certain company, or companies in a certain sector, or an entire economy, have good chances to grow and prosper over time. A company could be inventing new things and patenting them, or growing their customer base, or charging premia for quality, etc. Of course, when you invest in funds covering the market broadly, you still need to research — what sectors dominate that fund, what do their prospects look like, and so on. Any potentially damaging information or adverse development in the company’s condition, if not expected by market participants, can negatively affect stock and bond prices.
Moreover, markets move in cycles of changing risk appetite and flows of funds. These cycles depend on whether the economy is exhibiting healthy growth as opposed to a contraction, whether credit is abundant or scarce, whether market participants see rainbows and unicorns in the future, or hurricanes… You can’t control these swings, but you can study them and understand how to act and what to expect for various asset classes in most of them.
By the way, you do not have to do all this entirely by yourself: analysis and expectation reports on key asset classes (from around the world) are usually available from most big players on Wall Street and major institutions globally. You can get ideas from their analysis, get a better gauge of the risks and correlations, and see what the pros expect at basically no cost these days. - Pick what suits you.
Once you know what you want from your investments and when, as well as how various investment options could be expected to perform and what risk they carry (performance is not guaranteed in advance) if conditions change, you can make a more educated decision for your portfolio. Those asset classes which are suitable for your particular needs and goals and violate as few of your constraints and tolerances as possible, should generally receive a higher weight in your allocation, given no person-specific factors that say otherwise.
I can already hear you saying: “oh, this sounds too superficial and general”. And you are right — any adviser or planner will tell you that they essentially need to know your personal situation to give you the best possible specific recommendation. And if you can afford to hire them, then they will make this process much easier on you and support you along the way, guiding you how and what to do (assuming they are doing their job properly and in your best interest, of course).
But if not, then you will need to decide how to tailor this general process further based on what you have learned about yourself and your goals. You might expect to hear very specific options, each with different percentage allocations suggested for each asset class. But if I provided that, I would be assuming that I can just assign all people into X alternative allocation buckets to meet all possible goals and risk tolerances. This does not work because as much as different people have lots of things in common, most people also have unique and special circumstances, wishes, desires, needs, life challenges, that are valid and necessary inputs in these financial choices.
How should I select an investment intermediary and know that I can trust them?
With all these scams we see in the news or in documentaries all the time, you have to ask this. And they’re committed by all kinds of people, from smaller crypto firms and individuals who like to take advantage of people’s ignorance, to the biggest financial institutions in the world. But here is the thing — the average person usually cannot (and should not be expected to) judge competently who is a scam and who is not. Yes, sometimes there are obvious red flags, and statements like “100% guaranteed investment returns” or “Everyone and everything else is a scam but we are the only real deal anywhere in the universe” that should naturally arouse your suspicions… But at the end of the day, it is the job and responsibility of the regulatory bodies to ensure lawful conduct and investor protection.
Which brings me to my point: apart from avoiding the ones who use blatant exaggerations which are simply impossible, you should always make sure the broker is based in a country or region with well-functioning and strict regulations for this sort of activity. That would include, among others, requirements for segregation of client funds, for risk management and capital and liquidity adequacy, for disclosures, licensing for services, for quality and accuracy of information. And the country should also have established systems for investor compensation in cases of default or fraud. If you have a broker that manages your money in ways that involve third parties, for which they cannot be held accountable, then these third parties should be subject to regulatory requirements as well.
At this point, what I described might sound somewhat naïve — given how many times regulators have failed to protect investors or to support legislation with the necessary requirements, as they usually lag behind the pace of financial innovation. Or how many times regulators have shown themselves to be corrupt and submit to lobby interests. All valid points. It’s exactly where critical thinking and gathering as much information as possible are crucial.
When new investment and fintech companies spring into existence, you could challenge what they offer, how they advertise it, whether it can really work as promised and, if that promise is in fact so impressive and better than everything else out there — why aren’t more people going for it? Research the location and whether it has too lax regulations, preferential treatments (no licenses, no taxes, etc.) or protects special interests. You could also look up registration, offering and marketing materials to see how the company operates and performs, and whether it misrepresents something. Some potential clues could be inflated revenues from non-core operations despite loss of customers, persistent investment outflows, irregular items (assets, expenses) explained in ambiguous ways.
Furthermore, if there are ongoing public investigations (either by the authorities, regulators, supervisors, or even financial journalists) and someone has raised some alarms (e.g., in the media), then these are usually signs to stay away. Negative audit reports or qualified audit opinions could also be such a signal. Finally, public opinion can be of great help. Looking into social media posts and opinions, private groups, online forums etc. can reveal a lot about how a company treats its clients and whether they feel they have been scammed.
How can I avoid mistakes in making my trades?
When you are starting out, chances are you will make at least some mistakes, maybe big ones, hopefully only small ones. As said before, even professionals make mistakes (although they might not admit). Errors are not just due to lack of knowledge and experience, or on behavioral basis, they occur also because of the market itself — surprising us, irritating us, testing us. There is famous quote by John Maynard Keynes: “Markets can remain irrational longer than you can remain solvent.” Let that sink in for a moment.
It tells us that most of us should not try to outsmart the market, which represents a collective expression of interest, knowledge, wisdom and sentiment. We should rather learn to live with its ‘moods’ and cope with them by managing our exposures to what causes those moods. There are many ways to do that, such as avoiding positions whose risks we are not able and willing to bear, reviewing our investments and assessing how they fit in our overall portfolio and with our goals, reducing our exposures or removing them when we find ourselves unable to understand them, or adding some additional protection (hedging, insurance).
My approach is to always look carefully and analyze how adding a certain investment to (or removing it from) my portfolio would impact it and its balance of risks. I do that by thinking, what could happen if the company I invest in fails to deliver on earnings? What if there is a recession or interest rates skyrocket? What has happened in the past on such occasions? Can I survive losses of such magnitude? Do I have anything else in my portfolio that will go in the opposite direction at the same time, or will all of my positions lose together? If you go for the DIY approach, doing these mental exercises about your investments can be quite helpful and allow you to build skills and understanding of the dynamics of economies and markets.
Finally, since most mistakes happen because of inability to restrain our emotions and letting them drive our behavior, I can’t emphasize this enough: controlling yourself and your primary instincts is key. Many things flashing red on your screen could cause you to panic. Don’t! People writing online how much money they are making in the latest AI buzz could make you fear you are missing out. Don’t! Being a fan of one company could make you hate their main competitor even when they are outperforming, and you might be reluctant to invest because you are biased. Stop it! You have watched so many videos of famous economists predicting market crashes that you have become absolutely convinced everything will drop to zero very soon… Don’t even get me started!
The more rational, calm and calculating you remain, and the more you focus on the actual cold facts in front of you (NOT someone’s interpretation of them or assumptions or wishful thinking, including yours), the less likely you will be to make errors of judgment. It’s in your best interest to doubt and be critical of everything you read or hear, even if your personal beliefs or ideologies might make you inclined to immediately agree with it, support it, or deny it.
Looking ahead and taking the first steps
All these insecurities and blockers for beginners we talked about so far are seeded in our heads because of many misconceptions about financial markets and investing. Some common ones:
- “It is all a rigged game.”
- “Investing is only for the rich, I have almost no money and hence no chance”
- “The whole financial system is about to collapse, there is no point to invest.”
- “The economy is going into recession so I would be better off waiting.”
- “Market prices are manipulated and do not reflect the true state of things. (Markets are not efficient)”
- “Investing is the same as gambling.”
- “Investing means greed, selfishness and immorality.”
- “Investing is too risky, holding cash means no risk and no loss.”
- “I need to monitor my portfolio on a daily basis.”
- “I can only invest if I am an expert.”
- “To invest, I always need to know the right time to buy.”
You have probably encountered some of these statements. I think they represent a very good summary of the fears we already talked about — being scammed, manipulated, not having proper expertise, enough money etc. And while some aspects of these statements could, under certain circumstances and in certain contexts hold true, I would suggest that anyone who wants to build wealth and learn how to invest make the effort to set these fears aside by improving their financial literacy, and find the courage to take the first step.
In talking to people, I have noticed that, when it comes to money, many often want things or have goals that can be inconsistent. I have heard from beginners things like, how can I get a very high return for no risk. And that’s a somewhat intuitive desire, one that is not so far from financial theory and practice where we try to maximize return per unit of risk or minimize risk for a given level of return. But eliminating risk completely is something extremely elusive. Some have tried. Nobel laureates Myron Scholes and Robert Merton, two of the fathers of the famous Black-Scholes option pricing model, co-founded Long Term Capital Management (LTCM) in 1994, whose stellar returns were only overshadowed by its even more ‘stellar’ failure to extract risk-free returns using option strategies with significant levels of leverage. A riskless return has been a goal of academics and professionals alike for a long time, and in some markets, during some periods, these opportunities do show up. But they are rare and limited and are usually eliminated quickly once they become more broadly known. Markets might not be perfectly efficient all of the time, but they are mostly efficient, most of the time.
If you are stepping into the investment arena for the very first time, then rather than focusing on finding riskless returns, do a bit of introspection first — especially if you are trying to do it alone, with no professional guiding you. How does your brain work — do you overreact, do you get too stressed and anxious, do you feel uncomfortable when you’re not in control? What is important to you, now and in the future — education, family, kids, houses, cars? Do you like to gamble? Are you impatient? Do you have to support anyone with your income? Since your financial life is a function of your real life, your investment decisions should be made in service of your life goals, needs and desires. This is where you start — with yourself.
Conclusion
I know, this was too long. It is because the range of doubts and uncertainties for beginners is so wide, and for good reasons. I firmly believe that anyone can learn how to invest, as long as they are determined to work on understanding and overcoming their fears of taking risks. You can start slow, with smaller amounts, getting to know how it works first and how the market tests you, picking a suitable strategy, then progressing and adjusting as you gain experience and confidence. Patience, calm demeanor and reason will help you go a long way and bring you to a successful completion of your financial goals.
References:
- The GfK survey in Germany took place in 2018 and involved 10,000 participants. It was commissioned by the Flossbach von Storch Research Institute
- The UK Survey took place in 2023 and involved 2,000 participants who had at least £5,000 in savings and had not invested before March 2023. It was performed by Savanta on behalf of Wealthify.
