12 Lessons for Investors with Less Than $5,000
by by Peter Leeds
Read all the past Blog entries here
this is a Bizarro world, but there are many advantages that investors
with smaller portfolios have over the whales trading millions. By
embracing these lessons, the little guy can outperform (and sometimes
easily) against the Goliaths of the stock market world. Done right, it
won't be long until a small amount could be transformed into a
1 = Don't look for excessive rewards
The tendency for most small investors is to swing for the fences. They want to double or triple their $500 to put them in a better situation very quickly. They get led by impatience and greed. Unfortunately, this results in them taking on incredible risks...
...and guess how it typically turns out. (Spoiler Alert - Impatience and Greed can't even afford to pay for lunch).
It may seem counter-intuitive, but boring, stodgy investing in your Grandma's favorite companies may actually prove more rewarding. At the end of the day, companies like these (for example, IBM, GM, utilities, chemical companies, etc...) often do very well, and they are certainly much safer than 'the latest hot biotech.'
2 = FOCUS on your advantages
Small investors have lots of advantages, and one of the biggest is focus. Keep a very close eye on the 2 or 3 stocks you are interested in, rather than having to keep dozens straight at once. You will find that by focusing on a few companies, you are able to read every press release, financial report, and even things other people and analysts have said about the company. (Try doing this with dozens of companies - it would be a full time job!)
3 = Most of the benefits aren't related to money
This probably sounds surprising, but it's true. Take it from me; I've been broke; rich; lost $10,000 when I went to use the restroom; made very bad decisions; made very good ones.
I know first hand (ever since I lost all my investment money at 14 years old), that you lose a lot more than the cash. You lose pride... excitement... self-respect. In their place, you get embarrassment, anger, self-doubt.
Everybody in the stock market wants to be able to say, 'I knew that would happen,' or, 'I called it!' They want that validation and all the pride that comes with 'getting it right.' The good news? You can get that feeling with ANY amount of money.
While we are on the topic, I should mention that you will learn much more from your mistakes than your successes. If you are like me, you'll also remember those gaffs long after you've forgotten all the times you got it right. And you get to make those 'learning' mistakes with smaller amounts of cash.
4 = Don't get scared out
Mistakes will happen. Do not let those bad beats spook you out of the stock market altogether. Sure, if you lost a million, maybe you need to wander off into the woods and not look back. However, investors with smaller portfolios are much less likely to get wiped out by any single calamitous event.
Having a smaller portfolio is an advantage in this case, while those with more money are often a few bad trades away from being blown out of the stock market for good.
5 = Buy what you know
If you aren't in the experimental biotech field, then don't try to hit a home run with that latest hot biotech stock your drunk uncle told you about last Thanksgiving. Invest in companies that you understand. That gives you a big advantage over most other investors.
Since you might have a smaller portfolio, and thus invest only in a couple stocks, you can focus in on a few businesses which you deeply understand.
Here's the acid test: If someone were to ask you how such-and-such company makes money, would you be able to clearly and succinctly explain? You will if you truly understand the business. Here is an example: 'How does McDonald's make money?' They sell fast food.
6 = The process and results are no different whether you are investing $327 or $1,540,311
From research to decision to profits, the path you took to get there and the choices you made are the same. You are putting your money into an investment which yields a percentage gain. It doesn't matter the amount you invested, because the underlying stock doesn't have the ability to care or know what you are doing.
Making 10% on a few hundred dollars is the same process as making 10% on a few million. Of course, if you had invested twice as much money, you would have made twice as much profit (or loss). Yet the percentage gain (or loss) on your money would be the same.
Of course, one exception to this concept is that small or thinly-traded investments can be affected by large buy or sell orders. When a trader dumps half a million into some tiny penny stock, they may be inadvertently driving the price higher.
7 = Commission fees swell in power
It is bad enough that you pay $9 (for example) to buy a stock, then another $9 to sell it. That's an $18 commission your broker hits you with! So if you are only trading $100, you would need to make 18% on your money just to break even! If you made that exact same trade with $20,000, your break even would only require a 0.0009 percent gain.
The less you have to invest, the more impact commissions will have on you. Thus, frequent buying and selling can often chip away at a small portfolio rather quickly.
Often investors with small portfolios will throw diversification out the window, and focus on only 2 or 3 stocks at a time. They may also trade very rarely, instead letting their shares sit for months as the underlying company grows. These tactics alleviate many of the issues with commission fees.
8 = Less total risk, greater proportionate risk
Smaller portfolios are exposed to less risk because... well, they are smaller. However, they can suffer greater proportionate risk, meaning a $50 loss is much more significant for smaller portfolios than a larger one.
When a billionaire loses $45,000, they might not even care. Meanwhile, for someone with $2,000 invested in stocks, a $500 loss would be devastating.
There are ancient words of wisdom from Asia which state, 'You will eventually lose all you gamble with.' Just keep that in mind, and never think you are risking less because your portfolio is small (See the next point).
9 = Myth: You risk less with a smaller portfolio
Too often I hear people stating that a stock is very low, so they have less risk. How much lower could a 25 cent stock fall? How much could I really lose from here?
The answer is 100%. ALL of it. Every cent you put into anything on the stock market is at risk. Any shares can fall to zero.
In other words, a $700 investment is just as risky as a $64,000 share purchase.
10 = Slower learning curve (...so speed it up!)
With a tiny portfolio, you typically make fewer trades , and watch fewer stocks. Well, here's one of those moments where you can turn your biggest obstacle into your biggest opportunity, and you do that by Paper Trading.
With Paper Trading you will have zero risk, won't need any money at all, and can trade hundreds of stocks at once. You can also magnify your learning curve such that you are discovering new techniques and testing your decisions as if you had a million dollar portfolio.
This is also how I became an excellent investor, after originally losing 100% of my money when I started out.
Here's how it works:
Pretend you have $100,000 (or whatever amount you like) of imaginary money.
Keep track on paper of real-world stocks you 'would have' bought, and the share price at the time. Decide when you 'would have sold,' check the price at the time, and record how much money you would have gained or lost. Track everything on an ongoing basis until you are consistently pulling in gains.
The beauty of pretending to have $100,000 (or even more) is that you can invest in several different stocks, and make a greater number of total trades than you would have with a small amount. You make more trades, and see some of the results quicker. This greatly speeds up your learning curve. In fact, by the time you are trading with real dollars, you will be better at making profits quicker, and will hopefully balloon your portfolio in short order.
11 = Small trades won't move the shares against you (even with penny stocks)
If you are putting $500 into a thinly-traded penny stock, it probably won't move the price. (You should be using Limit Orders anyway
, so it shouldn't matter). However, what if you had $35,000 to invest? Unless you were careful, that would move the penny stock or thinly-traded investment up artificially, and prices would drop back down as soon as you stopped gobbling up all the shares. You'd already have a loss as soon as you stopped buying!
12 = Results won't matter until you scale them
If you make a massive mistake with a few hundred dollars, you'll live. But what if your losses were much more significant? Some big-time investors wiped out such MASSIVE amounts of money that they eventually pitched themselves off a 40 story building.
Until you build your portfolio to significant amounts, you have the luxury of avoiding any calamitous losses. Until you scale up your average trade amounts (once you have significant amounts of money), you shouldn't be losing any sleep, even over your worst investment choices.
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