When you want to learn to invest, about the biggest mistake you can make is to jump right in with your real money before you know what you are doing. Itâ€™s hard to learn to invest this way because each mistake can cost you big losses and the truth is no one becomes a great investor without making lots of mistakes. The best way to learn about investing is to develop your skills where your mistakes wonâ€™t cost you an arm and a leg -- in a virtual portfolio -- until you have developed a track record that justifies the confidence to invest your real money.
There are lots of places around the internet that will enable you to set up a virtual portfolio for free. Google, Yahoo, and Marketwatch come immediately to mind. So although I am going to talk about what itâ€™s like to manage a virtual portfolio at Marketocracy.com, you can also accomplish much the same thing at any of the other sites.
Setting Things Up Properly
Itâ€™s important to start your virtual portfolio with at least $1 million so you can learn how to assemble and manage a diversified portfolio with at least 20 positions.
There is a big difference between managing a collection of stocks instead of a portfolio.
A portfolio can be managed so that a portion of each individual stockâ€™s risks are diversified away. In this way, the risk of the portfolio can be less than the sum of risks for each stock, and the portfolio can do well even if some of the stocks donâ€™t.
A collection of individual stocks is not necessarily a portfolio. Lots of people buy stocks impulsively. Maybe they read an article about a biotech stock and buy the stock. Maybe they bought a stock after a trusted family member recommended it at a holiday party. The point is that a collection of stocks assembled this way is not a portfolio.
One of the things that makes it hard to learn to invest is that many brokerage statements donâ€™t calculate your returns so you can compare yourself with other managers and market benchmarks.
Consider this common situation. Your year-end 2016 brokerage statement says your account is worth $20,000. Your March 31, 2017 statement says your account is worth $22,000. For the first quarter of 2017, the S&P500 was up 6.07% including dividends.
At first blush, the statements say you are up 10% and the market is up slightly more than 6% so you beat the market. Good job! No more index funds for you.
But, what if your statement shows that you made a deposit of $2,000 at the beginning of March? Itâ€™s not so easy to figure out your return over a period in which you have made deposits and/or withdrawals. It can be done, but itâ€™s just not easy to do it from the information provided on most brokerage statements.
Learning From Mutual Funds
Mutual funds have to deal with deposits and withdrawals every day, yet they have no problem calculating their returns. Hereâ€™s how they do it.
Mutual funds calculate their value each day by dividing their assets by the number of fund shares outstanding to come up with their Net Asset Value per share, NAV for short. The NAV is the price at which the mutual will buy or sell shares to anyone who makes a deposit or withdrawal on that day. Hereâ€™s how it works.
Letâ€™s say that on the last day of 2016, we turned your brokerage account into a mutual fund by issuing 100 fund shares representing ownership of 100% of your account. Since your account was worth $20,000 on that day, each of the 100 fund shares would have an NAV of $200.
Now suppose that by the end of February, your account was worth $21,000 and your fundâ€™s NAV has grown to $210. To make a deposit of $2,000, think of yourself as buying 9.5238 shares of your mutual fund at $210 each.
After the deposit, the account is worth $23,000, and there are 109.5238 fund shares outstanding so the NAV is still $210. This is important because it means that anyone who owned shares in your fund before you made the deposit, has not been made better or worse off because of your deposit.
Fast forward now to the end of March when your brokerage statement says the account is worth $22,000. We divide that by the number of fund shares outstanding (109.5238) to find that your NAV is now $200.87.
To see how you did for the quarter, calculate the percentage change in the NAV between the beginning and the end of the period. In this case $200.87/$200 is 1.00435. So for the first quarter, your return was 0.435% vs the S&P 500â€™s return of 6.07%. Maybe you should stay with an index fund until your investing skill improves after all.
When you are learning to invest, expect to make a lot of mistakes. To avoid the losses from those mistakes, it is best to develop your skills by managing a virtual account.
Be sure to set up your virtual account so that you have enough buying power to put together a diversified portfolio and so that you can calculate returns that can be compared with other managers and market benchmarks.
This is part 1 of a series about learning how to invest, click here for part 2.
Tell us about you
Find us at the office
Eastmond- Sukel street no. 62, 79540 Hanga Roa, Easter Island
Give us a ring
+74 201 709 645
Mon - Fri, 9:00-15:00