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TAKING STOCK: THE BASICS OF BUYING

the basics of buying stocks

“Stocks are likely to be the best investment you’ll ever make, outside of a house…When you buy a stock, you’re investing in a company. If the company prospers, you’ll share in the prosperity…stocks have outdone other investments going back as far as anybody can remember. Maybe they won’t prove themselves in a week or year, but they’ve always come through for the people who own them.”

Peter Lynch and John Rothchild, Learn to Earn: A Beginner’s Guide to the Basics of Investing and Business

 

Peter Lynch isn’t a disinterested party — after all, he made a fortune managing Janus mutual funds for his clients. His book Beating the Street is an outstanding guide to stock picking. (Learn to Earn, the book mentioned above, isn’t too shabby, either.)

Lynch is making an excellent point, one backed by historical precedent: stocks may go up and down, but they’re also the best long-term approach to get the most out of your money. Based on information collected by the Equity Research Infocenter, the S&P 500 earned an annual return of 11.9% from 1945-1994. U.S. Treasury Bills and Government Bonds, on the other hand, did a paltry 5% in the same period.

What is clear, though, is that investing in stocks are not for the fainthearted. People whose accounts were savaged during the recent downturn can tell you that. It’s important, though, to note that investors who pulled their (reduced) stash out of the market missed out on the rally that followed. That brings us to the first of several ‘rules’ Lynch and others recommend for investing in stocks:

 

*Buy and hold, through good and bad — but don’t buy unless you can catch the stock at a lower price. This is one of Warren Buffett’s foundation rules, one he used to grab a range of stocks, including G.E. “Our favorite holding period is forever,” he once said.

*Look for quality. Check companies’ past history and performance, as well as their current press releases and recent changes. Just don’t make the mistake of assuming that past performance is a promise that stock will do well forever.

*Watch the news. What trends are big right now? What hold long-term promise? Medical and technological advances are especially helpful, and can change a company’s prospects fast.

*”Blue chip” is a very good thing. Companies that have a sterling record, a low level of debt and plenty of cash, are always worth considering. They’re also apt to make you plenty of money in the long run.  McDonald’s (MCD) is a perfect example: since the 1960s, the stock (adjusted for splits) went from $22.50 to $13,570; an $100 investment at the start would have earned its investor more than $60,000!

*Pick stocks that pay dividends. Hundreds of companies pay a small percentage quarterly, if you hold their stocks. Even when the market hits a downturn — and it always does periodically — dividends will keep your stocks continuing to earn.

*Make your purchases a bit at a time. Buying large blocks of stock means you run a stronger risk of losing your initial investment. Buying smaller amounts over a longer period (“dollar-averaging,” it’s called) gives a better range of prices. You may pay more now and then — but you’ll also pay less.

*Consider investing in mutual funds. These ‘stock funds’ began back in 1828 in France, then spread to Scotland. The first American mutual fund appeared in November 1928…only a few weeks after the stock market crash. Mutual funds will generally choose a company type (technology, for example), then combine a group of businesses under that theme, to minimize losses and decrease the danger of relying on one or two pet stocks. Or they may follow a certain market. (See index funds below.)

Mutual funds can keep pace with or even return more than the general market. (Go here for the best mutual funds of 2012, plus links to more.) However, they can also carry hefty ‘front end loads’ (the price you pay to initially invest in the fund), plus annual fees. They may also require a minimum investment that’s substantial. The JP Morgan group of stocks was a good performer for 2012, but they also charged a front end load up to 5.75%, as well as an annual management fee of more than 1%. (The Vanguard funds, on the other hand, don’t charge loads and have lower management fees.) Does your mutual fund earn enough to make up for fees? Take a closer look before you open an account.

*Mix it up — don’t stick to just one or two stocks. At least one of those, according to many experts, should be anindex fund, which “aims to replicate the movements of the index of a specific financial market.” They’re also wildly popular. Wikipedia, whose entry you’ve just read, estimates that 11% of all stock funds are also index funds.

*Don’t panic when the market goes down. Warren Buffett said, “We simply attempt to be fearful when others are greedy and to be greedy only when others are fearful.” When the market tanks, stock prices drop. If you’ve checked your research, and feel the company still has good long-term prospects…why not buy more, while the prices are still low?

*Look for a good discount broker — or a company that offers package investing. Every time you buy or sell stocks, except when you buy directly from the company in question, it’s going to cost you. These fees on ‘trades’ can add up. The answer? Look for companies that offer discount commissions — Scottrade, for example, only charges $7 per trade, no matter how few stocks you buy. (Mutual funds can often be purchased this way, as well.) If your money’s limited, look for a company that lets you open an account with a low starting amount. (Scottrade, for example, lets you start with a balance of zero dollars, then gradually add as you go. You can make it a 401(k), as well.)

If you’ve got more to invest from the start, take advantage of it with a package special, like that currently offered by Ameritrade: no trade fees for 60 days, and they’ll even throw in extra cash up to $600. (Provided, that is, you’re willing to invest a substantial amount of money with them: minimum deposit is $25,000. Go here for specifics.) E*Trade is offering a similar special: no commissions for 60 days, and up to $500 added. (Go here for more.)

 

Stocks can be an effective way to grow your retirement funds, especially when combined with mutual funds, CDs, bonds and other vehicles. Broaden your stock experience by reading as many articles on the subject as you can —NASDAQ’s “How to Invest” section is a good start. Another  way, suggested by Peter Lynch and other experts, is the “fantasy football” approach:

1.  Give yourself a phantom $10,000 or $20,000

2.  Do the research, and pick out several stocks you’d like to invest in

3.  ‘Buy’ them on paper

4.  Keep a notebook, including date and price ‘purchased’

5.  ‘Hold’ them for 6 months, keeping regular track of progress

How’d you do? That research will help you decide whether your real money should buy those same stocks — or others more worthwhile. Whatever you decide, buying stocks can become an interesting way to build your retirement, brick by brick.

4 Responses to TAKING STOCK: THE BASICS OF BUYING

  1. Buying on paper is a great way to learn about investing in the stock market. I did it for about 6 months before I finally took the plunge and I ended up doing quite well initially. I can tell you though that there is no greater lesson learned in the stock market than to lose money. I remember the first time that I lost some serious money and it was one of the best things that ever happened to me when it came to learning about the stock market.

  2. For you paper traders out there, the Wall Street Journal has a new stock-picking game: Beat the Darts. And if you win, they actually send you Cool Stuff. Go here for more:

    http://online.wsj.com/article/SB10001424127887323478004578302323252355436.html

    I’ve also invested in mutual funds, Kay Lynn — and have done quite well in them, especially Janus. But they’ve not been as successful consistently as I’ve done with individual stocks, carefully studied for a while before I invest. (Or invest in gradually over a period of 6 months or so.) Whatever way works for you best — it’s important not to let this valuable way of earning income go by without trying it.
    Thanks, all of you, for writing and contributing.

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