10 Basic Stock Investing Tips
When you buy a stock, you’re literally buying a piece of a company. That piece of paper represents a share of ownership, which gives you a claim to that company’s assets and earnings.
Historically, the rich got richer in part thanks to their exclusive access to investment knowledge and advice. Today’s technology means that a wealth of information is available to would-be investors—but much of it is crowded with industry lingo and hard-to-decipher suggestions. Here are 10 tips for beginners interested in getting the most out of their money by investing in stocks:
Tip #1: Assess your financial situation.
Before you invest, make sure you have the funds available to make the commitment. A good rule of thumb is to have little or no debt (especially credit card debt) as well as six months’ worth of living expenses in an emergency savings account (more if you have a family). If you’ve got that solid financial foundation, you may be in a position to begin investing in stocks.
Tip #2: Think in terms of risk vs. return.
It’s simple: If you want higher returns, you’ll have to buy stocks that carry more risk. If you don’t want to take on risky stocks, you’ll have to settle for those with lower returns. Most investors fall somewhere in the middle of being extremely risk-averse and risk-ready. Which is why it’s important to…
Tip #3: Diversify.
Companies range in size, sector, volatility, and types of growth patterns (ex. growth and value). The smartest investors don’t buy all of one type of stock—they diversify their portfolios by putting money in not only different stocks and mutual funds, but different types of funds with different volatility. If you put all your money into technology stocks in the 1990s, you lost everything when the dot-com bubble burst in 2000.
Tip #4: Don’t get emotional.
Investing is a long-term commitment, usually meant to bolster retirement funds—not fund your next big-ticket purchase. Investors who trade too often based on market fluctuations are making it harder on themselves. Over the short term, market behavior is often based on the alternating virtues of enthusiasm (“Everyone loves this new product!”) and fear (“This looming scandal is going to be very bad for business.”). But over the long term, the bottom line—company earnings—will determine a stock’s value, and companies with a solid foundation can withstand quite a bit of flack.
Tip #5: Assess a stock’s volatility.
To anticipate a company’s volatility (and therefore avoid your own emotional reaction to a sudden drop in stock value), look at its rolling 12-month standard deviation over the past 10 years. In laymen’s terms, look at the stock’s average performance over that time span. A normal standard deviation is about 17%, which means that it’s completely normal for that stock to increase or decrease in value by 17%.
Tip #6: Buy low, sell high.
The advice seems obvious—buy stocks when they’re priced lower, sell them when they’re priced higher—but it can be as difficult as walking away from the Vegas blackjack table when you’re on a winning streak. To protect your stock portfolio from above-average risk, harvest the stocks that have done well and put those gains into stocks that have underperformed. It seems counterintuitive, perhaps, but that’s the essence of rebalancing a portfolio. So if your stock’s standard deviation is 15%, and it drops more than 15% in a short span of time, it may be a good time to rebalance and buy more of that stock—because you know it’ll likely go up again.
Tip #7: Understand how market expectations work.
Stock price is based not on performance but on how investors think it will do. We all hear the rags-to-riches stories of stock investing: a little-known company hits it big and thereby makes all of its stockholders rich. But notice that first qualification: the company was little-known. Too many investors fail to undetsand that the market’s expectations for a given company are built into the stock’s price, i.e., it’s not enough to invest in a company that will have above-average growth. You need to find a company that will grow more than the market expects it to. That involves doing a better analysis of a company’s future growth rates than all of the industry’s highly trained professionals—which is both difficult and unlikely.
Tip #8: Invest in well-managed companies.
While much investing canon insists, “Past performance is no guarantee of future results,” I’d argue that while not a guarantee, it’s a pretty good indicator. Companies that are managed well—by smart people with a nose for new opportunities—usually thrive and expand as prospects evolve. If a company has a reputation for consistent performance, especially when entering a new line of business, that speaks strongly to their future prospects—though the dogma is correct that it’s no guarantee. Nothing is guaranteed, so see tip #1 and make sure you’re not in a position to lose your entire savings on an investment.
Tip #9: Learn the lingo.
To be a successful investor, you have to put yourself through some amount of training. Knowing the difference between an ETF and a mutual fund, the purpose of an index, and the real meaning of risk needs to be knowledge that is at your fingertips. Good sources of self-taught investing include The Wall Street Journal, Kiplinger, Investopedia, Morningstar, and the websites of mutual-fund companies, as well as books like The Investor’s Manifesto by William Bernstein or The Elements of Investing by Burton Malkiel and Charles Ellis.
Tip #10: Get more advice.
While reading up on investment strategy is helpful, the best advice comes directly from a human being who can tailor his or her advice to your specific situation. Investment firms like Charles Schwab, Northwestern Mutual, and Garrett Planning Network have financial planners eager to work with investors of all income levels and investment experience. Don’t be afraid to ask your friends about where they get financial guidance and schedule coffee dates to ask more detailed questions about your options with a financial advisor. If you’re more of a DIYer, at least troll some online forums like Bogleheads.org, a community of investors who are more than happy to share knowledge.
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