How to Avoid Bad Financial Decisions When You Have Extra Cash

I often receive money related questions from fellow millennials. The money struggle is real. Honestly, investing, and buying stocks has never been easier, so I completely understand the temptation. Here are some of the most frequently asked questions about personal finance. They are not business related but since the best excuse for not starting a business is lack of money, having answers is useful.

I have 500 USD in my account, should I invest?

Are you interested in finance sector and investing in general? If the answer is yes, continue reading. If not, skip to the paragraph below.

So you are interested in finance? Invest! Just do it whenever you get an opportunity! Nothing hurts more than losing money. You will receive lectures beyond what any investing guru can teach you. Start with a simulation (there’s tone of them), such as Wall Street Survivor, but don’t get stuck with it. Your decisions will differ when real money is involved. You can also try to invest in cryptocurrencies, although I don’t recommend it. I admit, as an investor I am leaning towards more conservative side, trying not to risk too much. Cryptocurrencies are for the ones loving thrills, because no one really knows how the market works. Is it the same as stock market? Do the same principles apply? Probably not, since the difference is obvious even when conducting the basic fundamental valuation. So be prepared to lose money.

Is finance not your thing? Don’t do it. If you want to invest just because you want more money, starting with so little is not OK. My general rule of thumb is: don’t invest if losing 1000 USD will hurt you. Markets are volatile and largely unpredictable. It’s much better to keep your money in your bank account, create a separate bank account or try to find a suitable saving account. If you don’t have stable income, don’t lock the money, save it so you can withdraw it if needed.

How much you can afford to lose

 

Is it safe to keep your money in the bank?

YES.

Last financial crisis scared us and weakened our trust in banks. But banks don’t just fail. And even if they did, you are still covered up to a certain amount (10.000 USD or so). I’d be worried if I had millions just sitting in a bank. Not because I could lose it. I’d be worried because I wouldn’t be making any passive income off of it.

Banks are perfect for small amounts. You always know how much disposable income you have and you can easily access it. Fees for running a bank account are nowhere near the fees you’ll pay when trading. When investing, it’s possible to lose money even though your investment has grown a bit – just because of those high fees. So be smart and keep access to your funds for whenever you’ll need them.

I’m saving to buy a brand new car. Can you advise me on how to get to 20.000 USD ASAP?

NO.

I’m not helping anyone to save or acquire money for a new car (unless you’re starting a company with it). Wasting money on nice cars, apartments and expensive dinners leads nowhere. I call it lost money.

Try to invest instead of buying. You definitely don’t need a brand new car just to get around. Buy an older model for half the price or even less. Understand your life needs, cashflow, and make educated purchases.

My suggestion: buy a car for 2.000 USD, and invest the rest of the money into your education/product/personal development. It’s worth it. A car will be worthless in 10 years, while investment in knowledge will last a lifetime.

I love Apple. Their products are the best. I should probably invest in them, right?

Loving a company is not the same as owning a part of the company.

When investing in shares keep the following in mind:

  1. Market is volatile and you are in it for the long run
  2. Future is important but so is the past
  3. Buying extremely high might mean it ain’t going any higher

Is this too high or is it just me-

 

Firstly, prices can change quickly. You need to be hooked to screens 24/7 to keep exact track of the market.

But this isn’t necessary if you understand that a slight drop in price doesn’t mean anything serious. You can only be sure of it if you know company’s cash flow and their market value.

To put it simply, if shares are already overpriced by the market, being in it for the long run is impossible. You are sure to lose, especially if we suppose that markets are efficient (reflect the real value sooner or later).

Avoid investing if you don’t know the intrinsic value. Damodaran gives out great tips about price calculation. His web page got me through uni. Beware – the fundamental value is only true for the day of valuation! Meaning, keep track of it every once in awhile and don’t just sell everything if there is a temporary downward trend.

I remember observing shares of Tesla a year ago. Share price at the time was all about the future, since they haven’t even broken even (started making a profit). So investing in it almost seemed like a bet. Fortunately, Elon Musk has ingeniously managed to take all the right steps and the company is growing. There was just no way to know that a year before. It could have turned out completely differently and the investors would have lost everything. In fact – investors could still be at risk, since Musk’s primary choice of financing is debt and according to Damodaran, the value is still lagging severely behind market price.

Generally, people have two strategies for investing: buy high or buy low. Buying high is quite popular among inexperienced investors. The logic behind it: if it’s high then it’s probably good and will rise even higher.

This doesn’t always hold water, especially if there’s a bubble or the economy is heating as a whole. As we speak, there are several concerns about technological funds. Achieving 30% growth in a year is suspicious, when the average return an investor should expect is around 12%.

You have two possibilities: buy a fund and expect it to grow even further for at least a year or invest in a fund performing average or just above and don’t sweat about unexpectedly losing money.

Here’s my take on investing:

I don’t believe in keeping all eggs in one basket. It’s just too risky.

Spread your portfolio and the easiest thing to do is to invest in mutual funds. When investing, try to diversify into different industries and locations.

If you are buying stocks/bonds/contracts, do some math. Follow these video instructions by Damodaran to calculate intrinsic value and do relative valuation. Afterwards decide what to buy. Once you’ve invested, keep your position. Don’t actively trade. It has been shown that sitting on your portfolio outperforms active investing.

Lastly, if it’s going to hurt when you lose money, don’t invest. Just don’t. Keep it somewhere safe for the times when you’ll be able to afford dumb financial decisions.  

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