Home
| Work & Business
| Investments & Stocks
| Stock Market Investing
| Basics on Stock Market Investing
Basics on Stock Market Investing
by Carmelo J. Montalbano
-
Overview
Basics on Stock Market Investing
Investing in stocks is very different from stock trading. Investing uses a long-term perspective to accumulate capital gains and dividends. Investing involves discipline to reinvest earnings while continuing to save and invest from ordinary income. Trading involves short-term, or even daily, trading strategies.
The stock market historically has produced gains above the rate of inflation and is likely to continue to do so in the years ahead. By investing early and reinvesting dividends and proceeds, the effect of compounding can provide long-term gains.
-
Diversification
Three components should be incorporated into a sound investment policy. The first is diversification, or the spreading of asset risk among many classes of stocks. There also must be diversification among small and large companies, because at different times, each will outperform the other.
Investors should not invest more than 3 percent of their assets in any one stock and no more than 10 percent in any single industry or similar group of stocks.
-
Money Management
Money management is the second key to successful stock investment. Money management determines, through mathematical testing, the optimum amount of funds to put at risk when purchasing a new equity.
To diversify and balance risk, you must first ask yourself how many consecutive losses are you willing to accept before you stop investing. Most people find their risk tolerance to be lower than they had imagined once they start trading. As a result, a small investment is recommended initially, and that can be increased with additional purchases of stock once the stock starts to rise. Typically, another unit of stock is added for every 2 percent increase in price, up to a total of 5 percent of the portfolio.
-
Power of Compounding
Compounding, the third important principle of investing, is done simply by reinvesting dividends and adding to your savings. Regular saving, begun at an early age, allows dividends to be reinvested to buy more stock. Dividends typically make up about one-third of all stock income.
Remember that stock prices are positively affected by moderate inflation. Stock prices and dividends rise as profits rise, even if some of the profit gain is just inflation. The compounding effects of inflation are a primary reason that stocks are an inflation hedge.
-
Protective Stops
Protective stops refer to the amount of money an investor will let a new stock purchase fall before deciding the investment was a mistake. Typically, protective losses should never drop below 8 percent of the stock purchase price.
Protective losses are meant to stop small losses from becoming large losses. Obey your own stops or get professional investment advice, or use mutual funds for investment purposes.
Protective stops also should be employed as a stock rises to lessen sudden reversals or to sell stocks when the trend has changed. Protective stops can be a percentage of price. Long-term trend traders prefer to use a time stop. For example, if the current price goes below the lowest price of the past 20 days, you should sell.
-
Cost-Efficient Investing
A portfolio that performs only 3 percent better per year than a competing fund will hold twice as much value at the end of 20 years. Minimize expenses by using online trading and doing your own research. Online trading costs much less than full-service brokers, usually less than 10 percent of the cost of a full-service broker.
Never invest in load mutual funds, which charge entrance and exit fees, or both, in addition to ordinary annual fees. There is no evidence that no-load funds are outperformed by load funds.
Keep expenses low by trading wisely and infrequently, being diversified to produce consistent returns, and reinvest all income to grow assets over time.
