Are you investing or gambling?
When you start investing on the stock market it can be tempting to think that with just one good stock pick you could turn into a millionaire overnight (or is that just me).
Yes, stock-picking can have a place in your investment strategy, but if you're focused on the allure of a "get rich quick" mentality (I mean, who isn’t), you may be gambling - not investing.
What's the difference?
One of the key differences between investing and gambling is process and strategy. If you don't have a process and strategy in place, it is a sign that you need to establish or refine your plan. Gambling focuses on emotions like hope and excitement. Investing, on the other hand, is all about strategy. With a clear strategy, you know approximately how much your investments will grow and over what time periods.
How do you know if you're investing effectively?
If you're unsure whether your current investment approach is working, think about your investment process and how many of the five elements below are included in your approach.
- Completing no research
If you're not completing any research and putting money into assets based on tips from friends or what you see on social media, you're exposing yourself to increased risk and potentially not doing enough “due diligence” (I learned that’s a fancy way of saying research).
- Investing in micro-cap stocks only
Micro-cap stocks (link to our glossary term for micro-cap stocks) typically have a market capitalisation under $500 million and are ranked from 350 to 600 on the Australian Stock Exchange. With a relatively small market, buying stocks in these companies can be cheap. The downside, however, is that these companies are usually in their infancy and can experience volatile price fluctuations. There's a place for micro-cap stocks in your investing. However, if you're putting all your money into these companies, you could be exposing yourself to unnecessary risk.
- Investing with short term goals
Putting all of your money into short-term investments or activities such as day trading is an indication that you might be too focused on short-term gains without a long-term strategy. There's a place for short term investing, but only once you've mastered the foundations, like establishing a long-term plan and ensuring you have adequate cash buffers.
- Lack of diversification
If all your money is invested in one sector, for example mining industries, you could be over-exposed to volatility in a single market. To help your money grow consistently over time, it’s widely recommended to balance your money across a range of different classes and sectors.
- Having no investment strategy
If you don't have an investment strategy, your investing might not be as effective as it could be. To start putting together an investment strategy, think about things like:
- building up adequate cash buffers;
- how much money you need invested to live comfortably off your returns; and
- when you anticipate you'll start drawing an income from your investments.
Moving forward with a long-term strategy
Investing in different sectors such as equities, commodities, and fixed-income assets could be a great way to build long-term returns. However, to build these long term returns you’ll need to have a solid strategy and process to follow.
If you're unsure how to develop an investment strategy, it might be best to get some qualified financial advice. Investing in this advice now could help you get some great rewards in the years to come.