Many people equate investing with buying stocks, and for good reason. Stocks as a group have, over time, produced stronger returns and produced them more consistently than any other investment. Despite that record, some people still hesitate to put money into stocks, perhaps because they’re concerned about possible losses.
But for most people, buying stocks, either directly or through stock mutual funds and ETFs, is essential to successful long-term investing. The more you learn about the long-term advantages of owning stocks — despite the risk that stock prices may fluctuate more than other types of investments — the more comfortable you may feel about allocating a larger percentage of your portfolio to them. What remains is identifying those stocks that are best suited to your overall plan.
The best argument for buying stocks is that they have historically provided stronger returns than any other asset class. Records going back to 1800 confirm that stocks as a group have provided an average annual real return of about 7% for more than 200 years. Real return is the return minus the rate of inflation.
However, there are also risks in investing in stocks. Despite long-term gains, there have been several periods when stocks have lost value several years in a row, requiring an extended period of positive gains to get back to previous highs.
Price return is measured by the change in an investment’s price and total return is the change in price plus any dividend income the stock has provided. To find percent return, you divide return by the amount you paid to purchase the stock.
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When you buy an individual stock, you pay the price per share times the number of shares, plus commission and fees if they apply. The price changes all the time, reflecting the balance between supply and demand. If investors are mostly buying the stock, the price tends to go up, and if they are mostly selling, the price tends to fall. You can buy through a traditional or online brokerage account, or, if the issuing company has a dividend reinvestment
Plan (DRIP) or a direct stock purchase plan (DSP), you can buy directly from the company. It’s generally inexpensive to buy through a DRIP or DSP, as you pay only a small fee on each transaction. Brokerage firms charge either a commission each time you buy or sell or an annual management fee based on the value of your account. Although the commission varies from firm to firm, it tends to be lower when you trade online.
You have a wide selection of stocks, including those listed on US stock markets, those trading over the counter (OTC), and those sold in overseas markets. There are many ways to compare stocks. One of the most widely used is market capitalization, figured by multiplying the current price by the number of existing shares.
Large companies, known as large-caps, are the most likely to pay dividends, have higher prices per share, and the most reserves to protect them against downturns in the market.
The best known are often referred to as blue chips. Their market capitalization is usually over $10 billion.
Mid-caps, or middle-sized companies, may have greater growth potential and may be lower in price than large-company stocks. But they generally provide less income, if any, and may pose more risk. Their market capitalization is usually between $2 billion and $10 billion.
Small companies, or small-cap stocks, with a market capitalization of under $2 billion, may offer the greatest chance for big price increases and the highest risk of your losing money. There may also be considerably less information available about the performance of small-cap stocks, which makes them harder to evaluate.
Buying what you know
One investment strategy is buying stock in companies whose products and services you know. If what a company provides appeals to you, or fills a need, you may conclude that other people will react in the same way. You can always ask your financial advisor for a professional analysis of a stock’s potential, and you can research its recent and long-term performance. Similarly, you may decide to buy stock in the company where you work, to share in its potential profits. But you’ll want to be cautious about being too dependent for both income and investment return on one source.
Looking for bargains
If you’re wondering whether it’s possible to get stocks on sale, the answer is yes. While stock discounts don’t come on schedule, the way furniture sales do, there are always some stocks that are cheaper than others, including stocks that have fallen in price for one reason or another.
Value stocks are stocks selling at a lower price than the company’s reputation or financial situation seems to deserve. One tried-and-true investment strategy is to concentrate on these opportunities, buying inexpensive stocks with the expectation of selling them when the price goes up.
Sometimes, of course, stocks are cheap because a particular company or industry is in trouble. When times (and sometimes managements) change, you may make a large profit if you buy at or near the low point. There have been several examples in recent years where well-known companies have made dramatic recoveries. However, low prices can also be a sign of a failing company. That’s the risk you take. Trying to decide why certain stock prices are low can be hard, especially if the company doesn’t get lots of press coverage. But if value investing appeals to you, it may be worth developing your expertise. The strategy can provide rewards when you get it right.
If you’re committed to the strategy of concentrating on stocks that other investors are shunning, you’re known as a contrarian. Using the same approach in a more limited way, you can buy on down days, even in a booming stock market. However, you have to be willing to hold on to a stock even if things get worse before they get better, and you have to recognize that the stock may never make a comeback.
As well as being a contrarian by buying individual investments, you might swim against the tide with a contrarian mutual fund or contrarian ETF. But caution is required. Some of these funds are much riskier than others.
Buying Stocks For Beginners – What You Need To Know? by Inna Rosputnia
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