If you've been wary of investing in securities consider this: over the long run stocks consistently outperform other investment vehicles. Although there is no foolproof formula for achieving success in the stock market, learning the basics will help ensure that you get started on the right foot, reports the California Society of CPAs (www.calcpa.org). The following should serve as a framework for first-time investors.
Don't Plunge In Without a Plan
The first and foremost step is to evaluate your investment needs. Before purchasing stocks, you need a clear understanding of your investment time frame and your tolerance for risk. For example, if you plan to buy a new home or finance a child's college education within the next few years, investing in stocks may be unwise. When it comes to risk, don't assume more than you can afford in the hope of striking it rich.
Educate Yourself
Once you are comfortable with your investment philosophy and risk profile, educate yourself about the stock market. Newspapers such as the Wall Street Journal, Barron's, and Investors Business Daily are good places to start, along with monthly periodicals such as Forbes, Fortune, and Business Week. All are excellent sources of financial and company data. Numerous financial Web sites also provide the latest investment information, while many financial-oriented portals offer informative articles. In addition, the Securities and Exchange Commission (SEC), the watchdog of the industry, offers comprehensive educational resources at www.sec.gov/oiea1.htm.
Strive to Diversify
One of the best ways to minimize investment risk is to diversify the stocks you hold. Don't make the mistake of risking everything on a single company or one business sector. Instead, vary your holdings by industry -- such as finance, manufacturing, utilities, and pharmaceutical -- and by size, or what's called "market capitalization."
Large caps are companies with capitalizations of more than $5 billion, mid-caps are those with capitalization of more than $1.5 billion and small caps have capitalizations of less than $1.5 billion. The risks and rewards of each of these kinds of companies vary. For example, large caps may cost more, but there is typically less risk of company failure. The potential for growth with mid-caps and small caps is greater than for large companies. But the smaller the company, typically the higher the risk.
Learn What to Look For
You can look at a company's ESP (earnings per share) to see if it is making money. A company with an increasing EPS quarter after quarter and year after year is typically healthy.
One of the many analytical tools employed by stock researchers is a stock's price-to-earning (P/E) ratio. The ratio is arrived at by dividing last year's EPS into the stock's current price. P/E is a convenient way to compare stocks in the same industry or to evaluate one stock's performance compared to the market as a whole. Keep in mind that there's no perfect P/E ratio. If the ratio is high, it can mean that a company is overpriced. On the other hand, a small, rapidly growing company can have a high P/E yet still be an attractive investment. The P/E ratio is usually part of a stock's quotation.
The Value of Mutual Funds
Many individuals don't have the time to research individual stocks themselves or the funds necessary to adequately diversify their holdings. Investing in mutual funds can help overcome these challenges. A mutual fund is simply a group of stocks or bonds or a combination of the two chosen by a professional manager to meet specific investment goals. Most funds diversify their holdings by buying a wide variety of investments in particular areas.
You can benefit from mutual funds in several ways. First, you will have someone knowledgeable working for you. Secondly, you can diversify with limited capital. And thirdly, in many instances, you can invest relatively small amounts in these funds -- sometimes as little as $1,000.
Finally CPAs point out that it is important to keep in mind that economic and other forces can impact the return on any stock investment you make -- whether you choose to purchase stocks individually or through a mutual fund.
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