For that reason, investments made after little research often result in losses. That's the bad news. Jim Cramer, in his book "Real Money," advises investors to never purchase a stock unless they have an exhaustive knowledge of how they make money. What do they manufacture? What kind of service do they offer? In what countries do they operate? What is their flagship product and how is it selling? Are they known as the leader in their field?
Think of this as a first date. You probably wouldn't go on date with somebody if you had no idea who they were. If you do, you're asking for trouble. This information is very easy to find. Using the search engine of your choice, go to their company website and read about them. Then, as Cramer advises, go to a family member and educate them on your potential investment. If you can answer all of their questions, you know enough.
Imagine for a moment you were in the market for somebody who could help you with your investments.
You interview two people. One person has a long history of making people a lot of money. Your friends have seen a big return from this person, and you can't find any reason why you shouldn't trust him with your investment dollars. He tells you that for every dollar he makes for you, he's going to keep 40 cents, leaving you with 60 cents.
The other guy is just getting started in the business. He has very little experience and, although he seems promising, he doesn't have much of a track record of success. The advantage to this guy is that he's cheaper. He only wants to keep 20 cents for every dollar he makes you - but what if he doesn't make you as many dollars as the first guy? That might seem expensive but not if the company is growing fast.
Compare this number to other companies similar to the one you're researching. Beta seems like something difficult to understand, but it's not. Beta measures volatility or how moody your company's stock has acted over the last five years. With beta, anything higher than 1 is high beta meaning higher risk and anything lower than 1 is low beta lower risk. Beta says something about price risk , but how much does it say about fundamental risk factors? You have to watch high beta stocks closely because, although they have the potential to make you a lot of money, they also have the potential to take your money.
This is known as a defensive stock because your money is much safer. You won't make as much in a short amount of time, but you also don't have to watch it every day. If you don't have time watch the market every day, and you want your stocks to make money without that kind of attention, look for dividends. Dividends are like interest in a savings account.
You get paid regardless of the stock price. Before purchasing a stock, look for the dividend rate. If you simply want to park money in the market, invest in stocks with a high dividend. At the same time, there are literally hundreds of thousands of individuals who buy and sell corporate securities on one of the regulated stock exchanges or the NASDAQ regularly and are successful.
A profitable outcome is not the result of luck, but the application of a few simple principles derived from the experiences of millions of investors over countless stock market cycles. While intelligence is an asset in any endeavor, a superior IQ is not a prerequisite of investment success. Everyone is looking for a quick and easy way to riches and happiness. It seems to be human nature to constantly search for a hidden key or some esoteric bit of knowledge that suddenly leads to the end of the rainbow or a winning lottery ticket.
While some people do buy winning tickets or a common stock that quadruples or more in a year, it is extremely unlikely, since relying upon luck is an investment strategy that only the foolish or most desperate would choose to follow. In our quest for success, we often overlook the most powerful tools available to us: time and the magic of compounding interest. Investing regularly, avoiding unnecessary financial risk, and letting your money work for you over a period of years and decades is a certain way to amass significant assets.
Why are you considering investing in the stock market? Will you need your cash back in six months, a year, five years or longer? Are you saving for retirement , for future college expenses, to purchase a home, or to build an estate to leave to your beneficiaries? Before investing, you should know your purpose and the likely time in the future you may have need of the funds.
If you are likely to need your investment returned within a few years, consider another investment; the stock market with its volatility provides no certainty that all of your capital will be available when you need it. By knowing how much capital you will need and the future point in time when you will need it, you can calculate how much you should invest and what kind of return on your investment will be needed to produce the desired result.
To estimate how much capital you are likely to need for retirement or future college expenses, use one of the free financial calculators available over the Internet. Retirement calculators, ranging from the simple to the more complex including integration with future Social Security benefits, are available at Kiplinger , Bankrate , and MSN Money.
Many stock brokerage firms offer similar calculators. Ideally, you should start saving as soon as possible, save as much as you can, and receive the highest return possible consistent with your risk philosophy. Risk tolerance is a psychological trait that is genetically based, but positively influenced by education, income, and wealth as these increase, risk tolerance appears to increase slightly and negatively by age as one gets older, risk tolerance decreases. Your risk tolerance is how you feel about risk and the degree of anxiety you feel when risk is present.
For example, flying in an airplane or riding in a car would have been perceived as very risky in the early s, but less so today as flight and automobile travel are common occurrences. Conversely, most people today would feel that riding a horse might be dangerous with a good chance of falling or being bucked off because few people are around horses. The idea of perception is important, especially in investing.
As you gain more knowledge about investments — for example, how stocks are bought and sold, how much volatility price change is usually present, and the difficulty or ease of liquidating an investment — you are likely to consider stock investments to have less risk than you thought before making your first purchase.
As a consequence, your anxiety when investing is less intense, even though your risk tolerance remains unchanged because your perception of the risk has evolved. By understanding your risk tolerance , you can avoid those investments which are likely to make you anxious. Generally speaking, you should never own an asset which keeps you from sleeping in the night.
Anxiety stimulates fear which triggers emotional responses rather than logical responses to the stressor. During periods of financial uncertainty, the investor who can retain a cool head and follows an analytical decision process invariably comes out ahead. If you choose to invest with a robo-advisor like Betterment , your risk tolerance will be a major factor in selecting different investments. In the short-term, the prices of companies reflect the combined emotions of the entire investment community.
9 Things to Consider When Investing in a Stock
Stock prices moving contrary to our expectations create tension and insecurity. Should I sell my position and avoid a loss? Should I keep the stock, hoping that the price will rebound? Should I buy more? Even when the stock price has performed as expected, there are questions: Should I take a profit now before the price falls?
Should I keep my position since the price is likely to go higher? Since emotions are the primary driver of your action, it will probably be wrong. When you buy a stock, you should have a good reason for doing so and an expectation of what the price will do if the reason is valid. In other words, have an exit strategy before you buy the security and execute that strategy unemotionally. Before making your first investment, take the time to learn the basics about the stock market and the individual securities composing the market. There is an old adage: It is not a stock market, but a market of stocks.
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Unless you are purchasing an exchange traded fund ETF , your focus will be upon individual securities, rather than the market as a whole. There are few times when every stock moves in the same direction; even when the averages fall by points or more, the securities of some companies will go higher in price. Knowledge and risk tolerance are linked.
Experienced investors such as Buffett eschew stock diversification in the confidence that they have performed all of the necessary research to identify and quantify their risk. They are also comfortable that they can identify any potential perils that will endanger their position, and will be able to liquidate their investments before taking a catastrophic loss. The popular way to manage risk is to diversify your exposure.
Prudent investors own stocks of different companies in different industries, sometimes in different countries, with the expectation that a single bad event will not affect all of their holdings or will otherwise affect them to different degrees. Imagine owning stocks in five different companies, each of which you expect to continually grow profits. Unfortunately, circumstances change.