For some people, stock picking sounds like a bad homework assignment. For others, it sounds like fun and games. Investing is serious business, but if you’d like to learn how to play, read this article.
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? As a general rule, mutual fund managers have much better access to information and much greater discipline.
By following these basic investing steps, you can narrow the gap between what professional investors earn for you and what you can earn yourself.
Just a taste
Allocate only a small portion, say 10 percent, 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.
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.
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.
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.
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.)
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 percent 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 percent (or about $800 out of $10,000). One key to successful diversification is to have 12 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.
Devin Thorpe, husband, father, author of Your Mark On The World and a popular guest speaker, is a Forbes Contributor. Building on a twenty-five year career in finance and entrepreneurship that included $500 million in completed transactions, he now champions social good full time, seeking to help others succeed in their efforts to make the world a better place.