Stocks and bonds are the backbone of traditional investing, and they are all that an individual, non-sophisticated investor needs in order to have a strong, diverse portfolio. Stocks are traditionally more risky than bonds, with fewer stocks offering steady, reliable sources of income, but the trade-off is that the long-term increase in value is greater than bonds.
To learn how to invest in stocks in a rational way, you need to understand the different types of stocks, and what type of investor each is appropriate for.
Value stocks tend to be older, more established, from companies with a relatively low risk of going bankrupt. These stocks are more likely to produce dividends, which are small portions of the company’s earnings paid out to shareholders, though many do not. The goal when buying value stocks is to search for under-valued stocks, or bargains, and to hold them at least long enough for the market to adjust itself and be willing to pay the deserved price for this stock.
The older you are, as well as the more critical it is that you have a reliable income source, the more you should invest in value stocks, such as major manufacturing, utilities, and transportation companies.
Growth stocks, on the other hand, are younger, more volatile companies with short histories and higher risk of failing, but also with a chance to double, triple, or quadruple in value in a relatively short period of time. Most people hold on to growth stocks because they want to see this capital appreciation, which is the gain at which they will be able to sell the stock, or the price they sell it for minus what they originally paid for it. The “hot stock tips” you may have seen advertised are usually describing very new start-ups.
If you are younger and can afford to lose some money now in order to see greater gains in the future, and the volatility inherent in growth-based stocks will not bother you, buying some technology, retail, and new start-up stocks may be in your best interest.
When investing in stocks, it is also very important to consider the issue of diversification. A diversified stock portfolio, or one with many different kinds of stocks that react differently to different market situations, is a more stable portfolio that can weather the financial storms better.
Never put all of your investable capital into one stock; in fact, you probably shouldn’t put more than 10% in any one company. Also try to choose companies in different industries, with different strategies and goals. Discount brokers online will charge you a small fee for every trade you make, so try to pick your stocks, make your investments, and leave the stocks alone for the most part, so you don’t generate too many trading fees.
If you are overwhelmed with all the companies out there whose stock you can buy, it may be best to invest via a mutual fund, or a group of stocks that a professional manager buys and sells based on his or her experience in the industry as well as research. Most stock mutual funds have a certain investing style, such as value or growth oriented, and only invest in certain types of companies, such as only companies in the service industry or only large companies.
Mutual funds provide instant diversification within their asset class, but they also charge management fees, usually a percentage of your original investment, in amounts ranging from .75% to 3%. You also need to try to buy shares in at least a few different mutual funds, or you probably will only have diversification in small areas of the entire market.
Discount brokerage firms online will be able to handle mutual fund orders as well, and are probably your best bet for the average person for buying stocks online, because they are cheap, and you probably do not need access to industry research and sophisticated company financials and reports. For most people, creating a diverse portfolio of stocks and holding it for the long-term, is the most profitable way to invest in stocks.
