If I had some spare money and decided to start investing for the first time, I think one of the things that might be put me off is not knowing where to begin.
Below are some common pitfalls when people start investing – and one way I would seek to avoid falling into them if I had only £300 to invest.
Pitfall 1: greed
Most people invest in the hope of financial return. But greed can be what dooms an investment.
If I owned a cross-section of the stock market overall, I could hopefully benefit over time from any improvement in the broad economy. But I would miss out on the potentially stellar returns of an individual industry pioneer. That greed tempts many people to put their money into speculative companies with unproven business models. Sometimes that turns out well. But it could be a costly mistake even with £300, if I invest in a company with an unrealistic assessment of how it is likely to perform in future.
Pitfall 2: understanding valuation
One way I find companies in which to invest is using a product or service I like a lot then deciding to invest in it. That was part of my rationale for investing in Apple and Google owner Alphabet before.
But a good and even highly profitable business does not necessarily make for a rewarding investment. That is because other investors may also see the potential in a business and rush to buy its shares, pushing up the price. So the shares may be overvalued by the time I buy them. That can mean that, even though my thinking about the business growing fast turns out to be correct, I still lose money on the shares.
Pitfall 3: lack of diversification
The adage against putting all our eggs in one basket is familiar. But when it comes to investing, some people ignore it – potentially putting their whole investment at peril. The temptation can be strong, for example because one is so excited about the prospects for a particular share. Also, while a big portfolio lends itself to being spread across different investments, dealing costs could mean that if I invest only £300, it can be difficult for me to diversify cost effectively.
But risk is risk — and could wipe me out. I think diversification is a critical risk management for an investor, no matter how much or little they have to invest.
I would start investing in an index fund
Those three pitfalls help explain why, if I was to start investing today, I would consider putting the £300 into shares of an index fund that tracks a selection of leading shares, such as the Vanguard FTSE 100 index Unit Trust.
That would not offer me the potential returns of an industry pioneer. But it would expose me to a diversified collection of businesses that by and large ought to move roughly in line with the economy overall. That means I could still lose money if the market overall is overvalued. But I would not need to spend lots of time considering the valuation of individual companies without really knowing yet how to do it. My objective would not be excitement – or even very high financial returns. Instead, I would be focussed on learning about how shares work while trying to manage the risks to my £300.
Christopher Ruane has no position in any of the shares mentioned. Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool’s board of directors. The Motley Fool UK has recommended Alphabet (A shares), Alphabet (C shares), and Apple. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.
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