STOCK MARKET INVESTING -- BASIC RULES
The stock market, despite its undeniable risk, is the essential lifeline to maintaining a productive investment portfolio over the long term. Good production means overpowering the ongoing inroads of inflation and taxes, with something left over for a contented retirement. Add to that the fact that the U.S. stock market is the most liquid investment institution in the world, allowing critical portfolio mangement flexibility. Any stock can be bought or sold during market hours with one phone call.
Individual Stocks
RESEARCH CRITICAL: Any stock purchase must be based on studious research. Value Line Investment Survey is one of many helpful research tools. Check the business section of your local library. Look principally at three financial trends: price, earnings and dividends. If these trends have been generally on the rise over the past 10 years (or better, 25 years) then that stock is certainly worth consideration. Don’t be swayed by a stock price’s level. A $100 stock could easily be more profitable over time than a $10 stock. Caveat: Invest, don’t speculate.
DIVERSIFICATION CRITICAL: Stock purchases must be made with an eye toward broad portfolio diversification. Diversification can take the sting out of a declining stock’s price because other stocks could rise to provide coverage. Unless a portfolio is weak throughout or the market takes a broad plunge, all portfolio components are not likely to fall on the same day. The benefits of diversification are best felt over the long term. Caveat: Don’t put all you eggs in one basket.
ASSET ALLOCATION: An important part of any diversification plan, often called “asset allocation”, is the inclusion of income stocks in the portfolio. Growth stocks are more attractive to most investors, but salting them with some stocks that pay good dividend yields -- like utilities and real estate investment trusts -- provide a small but effective safety net. When a portfolio value sags, that income generally stays the course to salve wounds on at least a short-term basis. Caveat: Have a plan.
DON’T PANIC: Personal patience is indispensible to success in the stock market. Plan on holding those quality stocks -- ones with good prices, earnings and dividends trends -- for the long term. Focus more on portfolio changes over time rather than daily changes in portfolio components. A “long term” is an indeterminate period of time. Track your portfolio yearly and make any major changes no more than once a year. No portfolio will run unchanged forever. Remember that selling a stock for less than what you paid for it triggers a reportable tax loss. Caveat: Don’t panic and don’t try to time the market.
HUNT FOR BARGAINS: Employ “value buying” when possible. That entails buying a stock when its price has been depressed by technical rather than fundamental forces. A technical decline, for example, occurs when a stock’s price falls simply because the stock market is in a broad decline and investors have started to sell all stocks, good and bad, in an arbitrary manner out of panic. A fundamental decline might result when the company faces a severe financial problem. If it looks temporary, ignore it. If not, the stock may have to be sold. Value buying is best employed when the broad stock market has fallen so sharply that a number of “bargain buys” are created among quality stocks. Watch lists of strong stocks that are hitting 52-week lows in price for some purchase prospects. Caveat: Employ value buying cautiously.
AN OVER-USED MEASURE: Most market analysts place heavy importance on a stock’s “price-earning ratio” or “P/E” when deciding when a stock is undervalued or overvalued, that is whether it’s a bargain buy or not. This is a mathematical relationship between the stock’s price and the company’s earnings record. A high P/E indicates that the stock’s price has been run up out of proportion to its current earning-per-share and thus may be overvalued and in danger of falling. On the other hand, a low P/E indicates that the price of the stock is lagging its earnings ability, may be undervalued and thus a good buy. The lingering problem is there’s no set rule as to what is a high P/E and what is a low one. This problem has swelled into a controversy with the explosion in technical stocks and their super-high P/E’s. Setting some strict P/E benchmarks in that market sector and many good stocks would be bypassed. Caveat: Look more at promise than P/E.
CONTROL COSTS: Never pay a higher commission to buy a stock than is absolutely necessary. Wise, independendent investors, and that should include all of us, will deal with discount brokers. Online trading has gripped the country because of its easy. If you need someone to hold your hand, put your left hand in or right or the other way around. There’s so much free advice and literature available that ignorance as an excuse for paying a high commission is no longer acceptable. Caveat: Act like any consumer when buying stock.
KEEP ON TRACKING: Learn where to track your stocks on a regular basis. Shareholders shouldn’t be so obsessed as to check prices daily, but probably 90 percent do. The Wall Street Journal is an indispensible resource to the investors with a portfolio of say $50,000 or more. Checking prices and company news through the Internet is another efficent tracking mechanism. The time-honored market gauges such as the Dow Jones Industrial Average and the Standard & Poor’s 500 Stock Index will impart a sense of market direction, but may not offer on a daily basis a clue as to how your portfolio is performing. Entering your portfolio online so that the price changes will be recorded continuously is an effective way to set up your own personal market gauge.