Investing In Stocks
I know I have mentioned that you should use mutual funds for your retirement fund. So why am I bringing up investing in stocks? Individual stocks tend to have larger dividends than index funds, even those that have high dividends. I know stocks with dividends larger than 5%, sometimes much larger. On Vanguard’s High Dividend Yield Index Fund their dividends never beat $0.30 per share. With their price slightly above $30 per share that would be <1% dividend every quarter or around 4% every year. And based off the dividend history, the dividends do waiver, especially during recessions, so do not expect the dividends to increase much.
These dividends can provide cash flow for you before retirement. While cash flow should be obtained off stock growth, this requires selling shares. Dividends can provide cash flow without having to sell shares.
Also, individual stocks are riskier. While there can be growth, especially over the long-term it is much less guaranteed than investing in mutual funds. For your retirement funds, considering you may need these funds in the future, you should try to minimize risk while maximizing gains. Therefore, my advice in investing for retirement and income will be different.
Investing In Stocks Is Not That Scary
One word of advice I have received is that you do not need to be an expert in the stock market to invest. You just need to be knowledgeable about certain companies and businesses. Since I receive news of pharmaceutical companies and biochemical developments I can receive front-line knowledge (not insider trading knowledge). Therefore, I have a bit of focus on healthcare and pharmaceutical companies. I do plan to reach on to other sectors in the near future.
You can choose specific stocks with different levels of risk. There are small cap, medium cap, and large cap stocks (I have heard of mega and micro cap stocks too, but only in some cases). The value of the company determines which cap they lie in. Large cap companies have a value over $10 billion. Medium cap have a value between $2 billion and $10 billion. Small cap have a value less than $2 billion.
Large cap businesses are less volatile and do not have very significant economic growth before a recession. Small cap businesses are very volatile and can have significant growth before a recession (sometimes not though). The most general advice I can give is to buy large cap stocks particularly during times when the global economy is questionable. Small cap stocks, if you are interested in them, should only be purchased at the a point of recovery after a recession.
Choosing The Right Stock
There is no such thing as a right stock. There is however, a right stock, at the right time, for the right person, in the right conditions. Let’s say there is an exploding stock, everyone is yelling to buy the stock. This stock will only be a good buy for a short time. The increase in growth will be heavily inflated. You should not be investing in stocks everyone is screaming to the world to buy, because there will be a time where everyone screams to sell it, and the price will drop.
Many investors have their own strategy, and you should too. You should choose how much risk you want to take, and how long you plan to ride out the stock (however, it should be ridden out for at least a year. My first recommendation is that if you have just started investing in stocks, do not buy enough to exceed 15% of your assets. You can grow your portfolio later. Do not feel disheartened, I have just started investing in stocks myself and have yet to report great gains in my portfolio.
My personal strategy is to buy mostly large cap stocks, preferably those with large dividends. They will not waiver too much during questionable times in the market, and their dividends tend to be higher. I have mentioned the advantages of these dividends earlier, but they can be even more resourceful with individual stocks.
What Are The Right Number Of Stocks?
There is no magic number. Many people suggest diversification, but Forbes explains how investing in the market will only give you average gains. Warren Buffet even states how diversification is pointless when someone actually pays attention to their stocks and their companies.
Now I know, some of you are probably mad, because I recently recommended that you put your investment fund into a mutual fund and that most actively managed investments do not beat passively managed investments. However, this is mostly considered over a certain time period, such as 10 years, not to mention looking at them shortly before the recession of 2008. Even so, the balanced mutual fund I use for my retirement fund has outperformed many of the indexes except the S&P 500 over ten years.
However, according to The Motley Fool, if you want to actively invest and spend 5 to 10 hours researching you choices every week, you should feel confident owning only 5 to 10 companies (don’t worry about starting with only one stock as long as you plan to buy more in less than 2 years). If you wish to pay some attention to these stocks (but not much), then 20 should be fine. If you do not want to pay any attention whatsoever, just use diverse mutual funds or index funds.
PE Ratio And Other Measurements Of Valuation
There are scales to determine the valuation of stocks including the PE ratio and the PEG ratio. Simply put this is the price to earnings per share (EPS) ratio. For instance, if a company costs $40 per share, and has a dividend of 2.5%, the dividend provides $1 per share. Therefore, the PE is 40. The general idea is to find a stock with a PE ratio that is low. A low PE shows that the stock is likely undervalued, while a high one suggests the stock is overvalued.
The PEG ratio is frequently considered to be a more accurate scale to determine the valuation. It is simply the PE ratio divided by the growth rate. While dividends themselves can be a good sign of the valuation, the growth rate should not be ignored as this also determines the valuation. A stock with a high dividend, but low growth rate does not always show high valuation.
However, these ratios themselves are not sufficient to determine their valuation. For instance, one of these ratios may be small, but let’s say that the PE ratio is smaller for one business, but the other has a revolutionary product in the works. There is much need to analyze the company first.
So you need to “buy low” how do you do this? There are multiple analyses in which suggest when to buy a stock (some mentioned above). However, every analysis has their own factors in which influence their decisions. While it is wise to heed their words, you should do you own analysis. My recommendation for buying large cap stocks is to look at the 52 week high and low. For large cap stocks, it is not very likely for the price to become much lower than the 52 week low. Try to buy when the current price is close to the 52 week low.
However, you must also pay attention to the company itself. Look at the company’s quarterly reports, news, and other people’s analyses. For instance, before I recently bought a certain stock from a company that was on sale, I looked at some of their news. They had promising ventures that may pay off in the near future. Last year, they did not do too well. I looked into what went wrong, they bought a company and it did not go well. This does not suggest the company would fall further anytime soon, just a blunder. Therefore, I thought it would be a good buy. Not much time has passed for me to report whether my purchase was profitable.
The point is, you should never be investing in stocks just because they are low, buy them because you can see them getting higher.
If you are going to be investing in stocks, the best idea is to buy and hold your stocks. I do not recommend selling large cap stocks completely any earlier than 1 – 2 years after the purchase date. For small cap stocks, they are much more dependent on short growth so I do not recommend selling any small cap stocks completely earlier than 3-6 months after the purchase date. However, you can (and probably should) sell some shares earlier. This can be as early as 3 months for dividend stocks (enough time to receive a dividend) and even earlier for growth stocks. I recommend you look at some analyses beforehand including the PE and PEG. However, let’s say within that time, your stocks doubled, you can sell a fraction of them to make some cash.
You will never time the highest price of a stock on purpose. So don’t try. However, if there is a period of good growth, and the PE ratio is suggesting overvaluation, that may be a good time to sell. Don’t get too greedy and stay attentive to financial news for the company.
While preparation is the key to success, determination is the key to maintaining that success. This not only applies to the stock market, but every other endeavor in life. Have a disciplined plan going into the stock market and keep with it while only making minor changes.
To find your strategy, I highly recommend reading The Best Investment Advice I Ever Received. This is a book written by CNBC business news anchor Liz Claman who interviewed Warren Buffeet, Steve Forbes, and many other investors. They all have their own strategy, which you can try to follow from long-term investing to attentive growth investing. Listening to their wisdom will help you choose your investing strategy.
Risk in stocks can be managed, I will explain how in another post. Try your hands in the stock market and you will be surprised at how quickly you can forge your wealth.