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Investing Mistakes

There are quite a few mistakes that investors can make when beginning their investing career. In this weeks blog I will be discussing 4 of the major mistakes that I have witnessed occur to others and some that I have also fallen victim to. It is important to keep in mind that nobodies financial journey is perfect and we all make mistakes along the way but if you can avoid them you are just one step ahead of everyone else. Keeping these mistakes in mind will help you have a fruitful investing journey.

Mistakes

  1. Not Understanding the Investment
  2. Lack of Patience and Letting your Emotions Rule
  3. Timing the Market
  4. Failing to Diversify

Not Understanding the Investment  

One of the biggest mistakes an investor can make is not understanding the company they are investing into. Previously we have talked about the importance of understanding the underlying holdings of ETFs but it is just as important to understand the companies you are investing into. You may not be fully aware of the complexities of the business but you should have a general idea of what they do and how their business model operates. Warren Buffet has warned against investing in companies whose business models you do not understand. While it is important to avoid bias towards companies who we favor due to what they produce, it is important to understand the fundamentals. A valuable skill any investor can learn is the ability to read a balance sheet and understand the behind the scenes business operations of the company they are investing into. The amount of debt, liquid assets, and many other factors can say a lot about a company.

Lack of Patience and Letting your Emotions Rule

These two go hand in hand. Value investing is the best way to sustainably and significantly grow your money. It is important to understand that as a value investor you are in it for the long game. By not having patience, selling in market corrections, and buying at peaks you can quickly dwindle down your money. It is important to understand that in a bear market it is only a loss if you lock it in at a loss. As long as your money is in high quality investments there is no need to worry when the value of a stock goes down because the market has proven that it will return again. Understand that whether you are happy or sad our emotions can cause us to make poor decisions. One method people use to remove their emotions from investing is Dollar Cost Averaging which we spoke about last week (What is Dollar Cost Averaging?). This method allows you to systematically put an amount of money into the market at whatever intervals of time you desire to take advantage of market volatility. Whether the market is up or down you invest, resulting in a lower average cost per stock. Whatever method you choose for investing remember that your emotions should have no role in it.

Timing the Market

You may of heard about people attempting to time the market. A popular term floating around is “buying the dip” or options trading would be another way people attempt to time the market. When the market is low it is a time for investors to potentially add more assets into the market but if you are attempting to gain a profit off of every small correction in the market you are bound to lose money. The goal for value investing, the type of investing I recommend to everyone is to hold quality investments for a long period of time. Picking the time to invest in the market is not as important as investing as early as possible. On average the market returns 10% annually which means the earlier you invest the earlier you will have compound interest working for you. Picking a time to enter the market will only result in an inconsistent way of making/losing your money. Timing the market also leads to emotional investing and attempting to get your money back from a loss similar to gambling. Patience and consistency in the market will lead to great results.

Failing to Diversify

Diversification is an extremely important role of investing and by not diversifying you are not taking advantage of everything the market has to offer. Individual stocks tend to go up in value when their sector goes up. The only difference is the degree of which that stock increases.  It is impossible as investors to know what sector will go up. By investing in each sector we can take advantage of sector increases. Failure to diversify creates unnecessary risk. In this case it doesn’t matter your level of risk tolerance you should balance the type of investments you have in each sector of the market. In this way you are not hit as heavily when a sector is down.

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What is Dollar Cost Averaging?

Dollar cost averaging involves investing a dollar amount on a regular basis no matter the state of the market. DCA allows the investor to separate investing from their emotions. Investors can avoid their psychological bias and stay away from the fear and greed that comes with investing.

In this method a long term investor can take advantage of a bear market and see it as an advantage to buy more shares. DCA helps the investor by allowing the investor to purchase a greater amount of shares when there is a correction in the market and a smaller amount of shares when the market is high.

The approach is consistent and can help the investor meet their long term financial goals.  This method typically results in a lower average cost compared to a lump sum purchase of shares.  Lump sum investing is when an investor puts all of their money available at one time. Lump sum investing can result in higher returns if invested at the right time within the market. History favors lump sum investing in terms of profit two thirds of the time. DCA on the other hand has proven superior in avoiding losses. Due to these reasons a person should have a good understanding of their risk tolerance before choosing a method of investment. Find out more about risk tolerance on our Instagram @therichcollegestudent. DCA is not appropriate for everyone but it is appropriate for those who want to invest in individual stocks and wish or need to invest regularly over time. It can help the investor avoid mistiming the market and investing all of their money at a market high.

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Telling Your Money Where to Go

Budgeting makes it possible for you the have enough money to do things you want. By preparing a proper budget you can set money aside for every paycheque for your big-ticket purchases. As college students we have a lot to worry about from maintaining our grades to applying to different programs, budgeting is not one of our priorities. I want to provide some solutions that don’t require much maintenance and will take some of the stress away from managing your money. You will be able to keep track of where every dollar is going and streamline it towards where you want. 

The first step everyone should take is to review your last month’s bank statement (If you’re feeling especially inspired you can do this for the whole year). Find the items where you spend the majority of your money and identify any areas that are especially of concern. As a society, we have a very big problem that is summarized perfectly by Joshua Fields Millburn of “The Minimalists” (Brandon’s paraphrased version) “We make good money but we spend even better money.”

It is important to not only find areas where you enjoy allocating your money but also identifying areas where you can potentially cut back. My favorite quote on budgeting comes from Ramit Sethi “Spend extravagantly on the things you love, and cut costs mercilessly on the things you don’t.” To be able to spend money on the things we want we also have to be able to make some sacrifices. 

Techniques

Once we have identified areas where we allocate our money we begin to budget for those expenses. The most important part of this process is self-discipline, as people, we are very good at convincing ourselves that we need something. In reality, we don’t.  There are a few techniques for this part. 

  • Envelope Method 
  • Incremental Budgeting 
  • Automation

Envelope Method

The Envelope method is probably the method the requires thAT most work. First, decide the categories that you will be spending your money on. Then decide the amount of money you are going to allocate to each category.  Once you have decided, place the physical amount of money into envelopes with the appropriate labels. Every time you go to buy clothes, groceries, gas take the envelope and only spend what is in it. 

When the money is done it’s done.

If you are to need more money you would relocate some of the money from one envelope to another. An example being you have used up your gas money for the month but you still need more gas. Take money from your clothing allowance and use it for gas. 

If you don’t care for the physical envelopes we will discuss a digital method later. 

Incremental Budgeting 

The incremental budgeting method (My favorite method) requires a bit of upfront work but is then pretty sustainable afterwords. It requires you to analyze your spending from the previous year and cut down your spending by a percentage. Through this method, you’ll quickly realize that we don’t need to spend nearly as much as we do. 

That money you save can be put towards your big-ticket goals are simply redistributed back into areas you enjoy. If buying shoes is your thing a portion of the 5-10% that you cut from your budget can be put back into buying shoes (given you’ve paid yourself first). 

We can also begin to plan for future expenses. if you are anticipating having to take out money for student loans you can put the money towards that. If you plan to get a car within the next 5 years let’s save up for it now. Putting in preventative measures to avoid debt will have your future self-loving the person you are now. 

Automation

The automation technique is less about budgeting and more about making your life easier. This technique can be implemented in the previous ways of budgeting. It entails setting up automatic transfers from your chequing account into various other accounts. In this way, we can reduce the risk of carrying around physical cash and reduce the urge to spend money. 

It is completely up to you once you have established your emergency fund how you want to set this up. If you are saving up for a big purchase down the line (5 or more years) you could tie your money up into index funds, mutual funds, or bonds (we will talk about these at a later date). If you need it in less than 5 years you can simply put your money into a savings account. This savings account shouldn’t be directly connected to your chequing account in any way to make it more difficult for you to transfer over a couple of dollars for a not-so-smart purchase. Instead, make it accessible but difficult to get the money. I personally do this by having my two accounts at two different banks, by doing this it requires 1-3 days for my money to be transferred from my savings to my chequing. 

Once you set up the groundwork for the transfers determine what money is going where and how much of it. The money left in your chequing account can be used for the fun items you’re going to purchase during the month, eating out, clothing, etc. 

Setting up a budget is a big step to financial stability that not many people take. By doing this you are already ahead of a lot of people. 

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Start Saving Today

Saving is the most difficult thing to do for a college student. We are constantly faced with peer pressure and societal expectations to spend money. We always have a fear of missing out (FOMO) and feel that we need to spend money in order to keep up with our friends or keep the people around us happy. It is extremely difficult for us to say “no” to coffee or dinner with a friend. Saving does not mean we can not enjoy certain things or have fun or can not go out. We can still do these activities as long as we set a budget and pay ourselves first. By implementing a few suggestions in this blog and future ones I will show you how you can save money while still doing all of your favourite things. 

  • Why Should I Save?
  • Planning for Expenses 
  • Being Guilt-Free 

Why Should I Save?

For most, saving feels useless without a purpose. While we can wait to win the lottery or gamble and become rich in an instant, the chances are very unlikely. Therefore, it is our responsibility to ensure we take the proper steps to become financially stable.

The reason most young people run through all their money every month is that saving feels useless. 

“The money is there, why can’t I spend it”

It can also be extremely tempting when you see the money in your account. That new shirt is only $40, that dinner will only cost me $15. Those numbers quickly add up and before you know it you are spending far too much. 

The key to a successful saving strategy/plan is to make it difficult for yourself to access that money. Here’s a good first step to achieve that, have a separate account, and second, develop an emergency fund. We could talk about what banks offer good accounts and what percentage of your income you should be putting away but just know that anything is better than nothing.  An emergency fund will help you be ready for job loss or an unexpected emergency. An emergency fund is not the same as your savings. This is for emergencies only. 

GOING ON A TRIP IS NOT AN EMERGENCY.  

Having an emergency fund will relieve some of the stress if your car breaks down because you don’t have to worry about finding money to pay for it to be fixed. You also don’t have to go into the D-word, debt. A rule of thumb for your emergency fund is 3 to 6 months of living expenses but $1,000 would be a good place to start. You should also consider potential expenses when creating your emergency fund. Will I have to fly home from university? Is my car in good working condition? Keeping these in mind will help tailor your emergency budget to your needs. Finally, make it difficult to be able to see and spend that money. 

It is important to have a purpose behind saving. Maybe you want to go on a trip, buy a car or make any sort of big purchase. As long as you have a goal you will be motivated to keep saving. Not spending $5 on a coffee won’t make you rich, but that $5 is $5 that you are taking away from your fund to go to Europe. That $20 you spend on clothing is $20 not going towards your next car. Having goals will make it that much more exciting when you reach those targets of $1,000, $5,000, and beyond. 

Planning for Expenses 

Planning for your future expenses can be one of the most beneficial things in your saving journey. You should review your bank statements (given you make most of your purchases on a debit or credit card) to identify your major expenses. There are two types of expenses; fixed expenses and variable expenses. 

Your fixed expenses are your recurring bills such as your cell phone bill, car payments, rent, etc. These are the easiest expenses to set aside money for. As long as you’re making enough money to cover your expenses these should be the easiest ones to plan for. 

Your fixed expenses can also include birthdays, weddings, or Christmas gifts. You know that every year you’ll have to buy gifts at Christmas, therefore, you should be setting money aside every month so when Christmas comes around you don’t overspend or have to find money to buy gifts. 

Variable expenses are the costs that can change depending on your expenditure per month such as groceries, or gas. These are difficult to budget for because they can change so frequently. We should try to make these expenses as predictable as possible and treat them as if they are fixed. We should take the average of our variable expenses for the year and factor that into your budget. 

You have to have self-control and when you have used up your money within the budget you are done for the month. When you spend less than your budget transfer the extra money to save for your big goals. 

Being Guilt-free 

Setting aside money for savings is just the first step in financial stability. In another blog, we will also talk about setting aside money for investing, paying off debt, etc. Saving is the all-important first step into managing your finances properly. 

Once you have set your money aside for saving, your expenses, and investing the money left in your bank account can be used for “guilt-free spending”. Whatever money is left over can be used to buy whatever you want. You have paid yourself first and now you are free to make your own decisions on where to allocate your money. 

If you want to buy a coffee every morning or buy that brand new shirt you want the price should have no effect on whether or not you make the purchase. I would even encourage you to make these ‘guilt-free’ purchases. After all, I do love to splurge on shoes from time to time. 

Saving with a purpose will help you achieve your financial goals, reduce stress and allow you to feel guilt-free when making your consumer purchases. 

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