How to Pick Stock Investments
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People throw around the term "stock picking," and investors often brag about their skilled analysis or good timing. But in reality, picking stocks is a mix of luck and analysis — it's very easy to get wrong, and hard to get right.
No matter what investments you choose, all roads lead to a common goal — growing your money over time. The best way to do that is often not through individual stocks, which can be extremely volatile and require you to concentrate your risk within a single company or handful of companies. (Sure, you could spread your money out among hundreds of individual stocks, but the time and research required for that is beyond most investors.)
Below, some strategies for picking stocks and other investments.
1. Index funds — not individual stocks — can anchor your portfolio
As you embark on what hopefully will be a lifetime of investing, you’re likely to experience both anxiety and excitement. Perhaps your heart is pedal to the metal (I need to invest already!) but your head’s pumping the brakes (I don’t want to lose that money!).
Instead of fretting about which specific stocks to invest in, consider index funds — which can be either of the mutual fund or exchange-traded fund variety. Index funds (for example, those tracking the S&P 500 Index) are good first investments because they offer a simple way to gain exposure to the market without the need to buy all the stocks within the index.
Index funds are easy to invest in, they carry low management fees (what’s known as expense ratios), and their returns are less volatile because they track the performance of an index. Finally, these assets offer diversification, which is key to long-term investing success. Owning a variety of assets decreases your portfolio’s risk, ensuring you don’t get burned by any one investment.
You’ll need an account to get started, either with an online broker or a robo-advisor. The difference comes down to personal preference. If you prefer selecting investments, an online broker is your best bet. If a hands-off approach is more appealing, go with a robo-advisor, where index funds are the name of the game.
A quick explainer on robo-advisors: These providers offer automated investing advice using computer algorithms to build and manage customers’ investment portfolios. Robo-advisors will recommend a portfolio that’s typically constructed of low-cost ETFs and index funds. If you opt for a robo-advisor, you’ll inherently be investing in index funds, even if the algorithm is doing the selection on your behalf.
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2. Individual stocks can come next
Although investing in index funds is a perfectly fine strategy, your journey needn’t end there.
Let your interests be the guide. If you prefer the simplicity and low-cost nature of index funds or ETFs, add more of them to your portfolio. These funds offer plenty of opportunity to enhance your portfolio’s diversification, whether they track specific industries or different company sizes. They also make for an easy way to invest in international stocks.
Ready for something new? You can try your hand at investing in individual stocks. To begin, you’ll need an account with an online broker, along with a sense of your risk tolerance (investing in stocks is riskier than index funds) and investment goals, and a genuine interest in the task at hand. You should also familiarize yourself with the various types of stocks.
» Read more: How to invest in stocks
Don’t be dissuaded by a lack of experience or funds; starting small is a prudent strategy, and there’s no better education than firsthand experience. Make sure you have a solid understanding of the company you want to invest in, some context about its stock price and the basics of trading before you begin. (We have a full article on how to research stocks.)
In general, heed Warren Buffett’s advice: “Buy into a company because you want to own it, not because you want the stock to go up.”
3. Options and futures are a more tactical strategy
For most investors, a well-diversified portfolio made up of mutual funds, ETFs and individual stocks is a sufficient long-term strategy. For others, more nuanced investments may beckon.
If you find yourself getting tempted by a “hot” tip that your best friend’s sister’s boyfriend’s brother’s girlfriend heard from some guy, take a deep breath. While it’s good to feel comfortable investing, it’s bad to be overly confident. Even professional investors regularly get burned, and consistency, rather than a hot hand, begets long-term success.
Instead of chasing tips, dive into your portfolio. Are there holes in your diversification strategy that could use patching? For example, if you own numerous individual stocks within a specific industry (like technology), it may be wise to add ETFs that track other industries (say, health care).
Once you’ve combed through your portfolio, revisit your goals and objectives. If you’re looking for a more tactical investing approach, consider options. These assets have a smaller investment requirement and provide flexibility regarding the duration of the investment and downside risks.
» Read more: How to trade options
If you want to express a speculative view on the market, individual stocks or ETFs, consider futures. These contracts also require a smaller investment and obligate buyers to purchase a specific asset at a predetermined time and price in the future.
4. Whatever you do, stay on course
Regardless of what you decide to invest in, it’s important to maintain consistency by making regular contributions and tweaking your strategy over time, as necessary.
With any new investment you consider, make sure you understand how it works before plopping down money, and never sacrifice the pillars of your portfolio in the process. But by all means, have some fun. Staying engaged in the management of your portfolio will ensure you stay invested for the long haul.