Stock
picking, the craft of choosing stocks to invest in for retirement, can be fun
and anyone can do it. You don’t need to have an MBA or be smarter than Wall
Street. Before you start picking stocks, however, you need to know one thing
for sure: picking stocks individually will almost certainly reduce the returns
in your portfolio compared to investing in mutual funds that buy stocks. Why?
Mutual fund managers have much better access to information and much greater
discipline—as a general rule.
By following these basic
investing steps, you can narrow the gap between what professional investors
earn for you and what you can earn yourself.
1. Just
a taste. Allocate only a small portion, say 10%, of your savings and
investments for direct stock investments. By leaving the bulk of your financial
assets under professional management it won’t matter as much what you do with
the 10% you manage yourself.
2. Enjoy
it or don’t do it. Because picking stocks yourself is likely to reduce your
investment returns, don’t do it if you don’t enjoy it. If you like the thrill
of picking stocks and watching their performance, this can be a fun and
educational hobby.
3. Don’t
get cocky. A considerable minority of people who read this article and start
picking stocks will see that they do better in the first year with their own
stock picks than the market does or by comparison with the mutual funds they
pick. I’m sorry, but it isn’t because you are smart. It is because the markets
are random. You got lucky. Very few of you will do it two years in a row. In
all likelihood, no one who reads this article will beat the markets for ten
years straight.
4. Buy
what you know. You will have a much easier time understanding the business
model and business prospects (the future is more important than the past when
buying stocks) for businesses you know than for unfamiliar businesses.
5. Know
the basics before you buy. If you have an experience with a business that leads
you to think it would make a great investment, be sure to do a little
research—a little “due diligence”—before you invest. You should at least know
the price to earnings ratio, the debt to equity ratio and the profit margin
before you invest. (FamilyShare features an article that explains these
ratios.)
6. Diversify.
No matter what happens, no matter how much you love a stock, no matter who
tells you to buy it, never put more than 10% of your stock picking money into
one stock. You should target having at least 12 different stocks in your
portfolio, so the average investment should be about 8% (or about $800 out of
$10,000). One key to successful diversification is to have twelve stocks that
are unrelated. Owning Ford and GM would not be good diversification—choose one.
The more time you spend
picking stocks, the better you will get at understanding the jargon and process
of investing. If you never forget these six rules, you’ll have fun and you
won’t ruin your retirement plans doing it.
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