The Smarter Way to Start Investing

Take the best of index trackers, mix in some active trading, and you're on the road to being a successful investor.

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Making the decision to start investing could be the smartest thing you'll ever do. But once you decide to become an investor, you still need to figure out what that means, both in terms of what you'll invest in, and how you'll choose and evaluate the investments you make.

Starting out simple

Boiling it all down, there really are only three-steps for starting out as a beginning investor.

  • First, decide whether you'll be an active trader or a long-term investor.
  • Second, decide whether you'll buy funds or individual shares.
  • Third, find an online share broker to help you buy the investments you want.

That's simple advice. But it may mislead you into thinking that you have to pick one or the other in each of these decisions. In reality, though, you'll find that doing a little bit of everything in moderation can maximize your chances to succeed with your investments.

A Fool's evolution

Legendary superinvestor Warren Buffett once said that his favourite holding period for an investment is forever.

Although you wouldn't want to take that advice literally — after all, you'll probably want to spend that money eventually — the idea is that finding companies that can stand the test of time and deliver solid returns year after year is a whole lot less trouble than worrying about all the short-term bumps in the road along the way.

That's the logic behind index investing. Index tracking funds don't entirely follow a buy-and-hold strategy, because the index components themselves change from time to time.

But the concept is similar: once a company qualifies for an index, buy it and hold it as long as it continues to meet the index's criteria for inclusion. If it ever fails, then dump it and buy a replacement.

When you find great companies, as indexes often do, it makes lots of sense to hold onto them. But that doesn't mean you always have to rely on indexes to do your thinking for you.

Playing defence

Indexes make life easy for investors, but they suffer from a flaw: They're brainless. Often, they own shares that most people would already have cast off as hopeless causes.

Take the S&P/ASX 200 index for example. Telstra (ASX: TLS) has fallen around 70% from its 1999 peak. The end of the dot com bubble, combined with increased competition and increased government regulation has seen shares in the once mighty telco hit the skids.

Realistically, Telstra has little chance of regaining its former share-price glories. But S&P/ASX index tracking funds still had to hold onto the shares as they fell, when many active investors might have decided they had to go.

A much worse fate befell holders of Centro Properties Group (ASX: CNP) and ABC Learning. Shares in the former are down around 99% from their 2007 peak, and the latter has gone completely bust.

Sometime shares do recover, and if they do, index trackers will benefit from continuing to hold them. But trackers don't get to pick and choose which investments they hold — they buy the good, the bad and the downright ugly.

Do a little of everything

The secret to successful investing lies in learning how to balance both active and index strategies.

Consider keeping not only a core portfolio of index funds, but also an online share broker account to let you take advantage of short-term trends and ideas. That way, you can build your skills as an active investor without putting your entire portfolio at risk.

A simple start to your investing career makes a lot of sense. But don't feel like you have to make a lifetime's worth of decisions all at once. If you treat investing as a learning experience, you'll do best by keeping your mind open to all the possibilities within your reach.

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