Stocks 101
Simply put, when you purchase stock in a company, you become part-owner of that company. Along with other shareholders, you all combine as investors in the business, and therefore reap its rewards, or suffer its losses. Stocks are most commonly divided into separate categories depending on the size and type of the company (e.g., mid-cap, small-cap, energy, tech, etc.).
While speculation can drive stock prices in the short term, its long-term company earnings that determine a stocks gains or losses. Speaking of short term, thats when stocks are extremely volatile. Over a span of just a few months or years, stocks can climb to astronomic heights or drop to pitiful lows. But, since 1926, the average stock has returned over 10 percent per year. Thats better than any other investment vehicle out there, and thats why stocks are your best bet for long-term investment.
Picking Stocks
Before you dive head-first into the market, there are a few things you should know about picking stocks. First, the markets performance as a whole is not necessarily a reflection of its individual stocks. Good stocks can keep growing even in a down market, while bad stocks have the frustrating tendency to drop or remain stagnant in a strong market.
Also, remember that history is not indicative of a stocks future performance. Even solid stocks can slip from time to time. Remember that stock prices are based on a companys earnings outlook, not its past performance. If the future looks bright for a company, a $100 dollar stock is probably a good buy. If earnings look less than promising, even a $5 stock can be a waste. Finally, investors determine a stocks value by measuring a handful of primary criteria, most notably cash flow, earnings, and revenue.
Diversify
Its the rallying cry of all smart investors. When compiling an investment portfolio of stocks, its smart to own shares in companies from several different industries. Consider it a hedge bet. When one part of the economy experiences a downturn, youll have other stocks in your portfolio to put your faith in.
When building your portfolio, the safest bet is to pick from financially strong businesses with earnings growth above the average. Surprisingly, that limits the lot to choose from, as only around 200 stocks today fit that bill. A solid portfolio features somewhere in the ballpark of 20 stocks selected from seven or more industries. A general rule of thumb is to invest in stocks with an above-average rate of growth and reasonable valuations.
Buy and Hold
Day trading is a great way to lose your nest egg, but quick. As we noted before, stocks over the short term are highly volatile. Sure, brokers today are offering cheap trades, but beware. There are a ton of hidden fees and taxes involved with day trading, not to mention the amount of attention required by you to monitor the blow-by-blow proceedings of the market. Our recommendation: buy and hold. A ten percent return over the long term is nothing to sneer at.
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