Building a Stock
Most people buy stocks
to earn returns that are higher than what they would earn on fixed income
or cash investments. However, owning stocks involves risk. Your company's
stock may fail to perform well or the overall market may decline and take
your stocks down with it. To reduce these risks and to try to maximize
the returns on your stock investments, it makes sense to carefully build
a portfolio of stocks carefully.
There are no guarantees
with stock investing, but here are four issues to keep in mind:
-- What portion of your assets should be in stocks?
-- How many stocks should you own?
-- How do you choose the stocks to buy?
-- When should you buy them?
How you divide your total portfolio into stocks, bonds and cash investments
will influence your total returns greatly. Over the long-term, stocks
have provided the best returns with the greatest risks. Bonds provide
steady income and should provide for the return of your principal on maturity.
Cash investments, like savings accounts, treasury bills and CDs, have
more liquidity and the lowest risks, but usually with the lowest returns
Your asset allocation
should be based on your time horizon and your tolerance for risk. Generally,
the longer your time horizon and the greater your risk tolerance, the
greater portion of your investments you should consider for stock investing.
However, even young investors should remember that stocks do not always
go up. This is especially important if young investors may need the funds
for some other purpose like buying a home or funding a college education.
How many stocks?
There is no absolutely right answer. You should own a diversified portfolio
that gives you exposure to the overall market, but not so many that you
cannot do your homework when selecting them or not follow them after you
buy them. You should also make sure to have stocks in a variety of industries
so a slow-down in one segment of the economy does not ruin the return
of your total portfolio.
One rule of thumb
to consider is to own at least 3 or 4 stocks in at least 4 or 5 industries.
This will give you relatively broad exposure and should not be so cumbersome
that you cannot stay aware of what is happening with each company.
Again, there is no absolutely right answer. Thousands of professional
investors and mutual fund managers spend all their lives trying to choose
the stocks that are going to perform well. Some are more successful than
Ultimately, the value
of a stock is determined in the open market by what other investors are
willing to pay. Their opinions are most likely influenced by their perception
of how the underlying value of the company is going to change in the future.
In other words, stock in companies whose income is expected to rise should
be more likely to rise in value over time. Therefore, the key is to identify
companies that are going to be successful. Unfortunately, that process
in not always easy.
You may want to start
by selecting industries where the future looks bright. Companies in those
industries are likely to have the opportunity to increase sales and profits.
For example, the outlook for the healthcare industry is probably better
than the outlook for the farm implement industry. The American public
is getting older and needing more health care, while the number of farms
is shrinking and the productivity of farms is increasing.
Then try to identify
the companies that you believe will do well in that industry. The competition
in all industries is intense. Companies that are well run, profitable
and gaining market share may be the leaders of the future. That is not
to say that innovative start-ups are bad choices, just be aware that they
may be riskier.
on companies has gotten much easier over the past few years. Almost every
public company has a website where you can request information. In addition,
many popular websites have money or finance areas with useful information.
If you have a brokerage relationship, you can ask for research reports.
Many public libraries also have reference sources you may want to check
When to buy
It is easy to say, "Buy just before stocks are going to rise."
Unfortunately, no one can accurately predict the short-term direction
of the stock market or individual stocks. To deal with this uncertainty,
spread your purchases over time, perhaps 4 to 6 months. That way you can
avoid putting all your funds to work at the top of a market cycle. If
the market goes down, you will end up with a lower average cost. If the
market goes up, you will have missed some profits, but hedged your risk.
Building a stock portfolio takes time and effort. Do your homework and
have a strategy. Even if you rely on an advisor, remember that it is your
money and the future results will affect your future financial security.