Advice to Individual Stock Investors

If you’ve been following my blog for a while, you’re probably well aware that I don’t tend to invest in individual stocks.  My Net Worth Updates show a nice collection of mutual funds (as well as more debt, both credit card and student, than I would prefer), but no individual stocks.  There’s quite a few reasons for this, from my lack of time to do the needed research in order to make intelligent investments to my generally conservative nature.  For me, for now, investing in individual stocks just doesn’t make too much sense.

But I’m not the only person in the world (which is probably for the best; as much as I like my alone time, I would probably go insane with absolutely nobody else around).  I realize that some of my readers might want to invest in individual stocks, whether to expand their investing horizon, to help diversify their investment portfolio, or simply for the fun of trying to pick winners.  So, to provide you with what help I can, here are a few tips on how to go about investing in individual stocks that should hopefully help to keep you in the black:

1. Don’t Invest Money You Can’t Afford to Lose in Stocks: This should be the first consideration you make when considering individual stock investing.  Unlike mutual funds, which hold dozens, hundreds, or even thousands of stocks or other investments, and are thus unlikely to lose all their value for any reason short of the complete collapse of civilization as we know it, individual companies can and do sometimes declare bankruptcy, leaving your stock worthless.  While this hopefully will not be the case, you should take care to avoid investing any money whose loss will materially affect your life, either now or in the future.  When you have a solid emergency fund, have paid down your credit card debt, and are fully invested for retirement (using mutual funds or similar very safe investments), then you can consider investing in individual stocks.

If you do it right, stock investing doesn't have to be a gamble.

2. Decide How Much Risk You Want to Take: Even within the realm of individual stocks, there’s a range of risk levels depending on the type of stock that you decide to invest in.  A giant, well-established company like Coca Cola (stock icon: KO) has a much lower chance of going bankrupt than does a small company just starting out.  The larger company stocks, then, are much less risky than smaller stocks, and you can decrease the chance of serious money loses by sticking to more established companies.   (Although, you still have some risk; there are any number of large, seemingly stable companies that end up going bankrupt, due either to poor luck, poor planning, or because they weren’t forthcoming about their true financial situation *Cough*Enron*Cough*.)

3. Consider Your Investment Goals Carefully: To (over) simplify things, there are two basic ways to make money from stocks: dividends (regular payments from the company to its owners, that is, the stockholders) and capital gains (the increase in the stock price over time).  These two goals require different approaches to investing.  If you are investing for dividends, you’re going to want larger companies, ones that have a history of paying out dividends for quite a while, and have solid financial ability to keep doing so in the foreseeable future.  On the other hand, for capital gains, particularly in the short term, you’ll likely need to look at smaller, still growing companies; the titans of their field have a tendency to be pretty stable in their stock prices.  Finding the right combination of stocks to meet your needs is one of the trickier parts of stock investing.  On a related note…

4. Know What To Do When Circumstances Change: Things change; the great stock investment today could be a horrible mistake tomorrow.  You need to know what your plans are for various situations that could arise.  What will you do if your stock’s price drops by 20%?  Will you sell and take what money you can get for it, thankful that you got out in time?  Will you buy more shares, using the cheaper price as the opportunity to stock up (pun intended)?  Will you do nothing and just ride out the lower price?  What happens if the price goes up?  Do you sell, and if so, how much?  If you don’t have a plan for each stock you buy, you’re going to eventually run into trouble when an event arises that you weren’t considering and you have to make an uninformed decision.  To avoid that, and make sure that you choose the right stocks, you need to do…

5. Research, Research, Research: You’ve likely gotten the idea by now, but investing in individual stocks requires a lot of time and energy to put into research.  Figuring out your priorities is only the start; then you need to find the stocks that meet your needs from the thousands that are available.  It doesn’t end when you make the purchase either; you need to continue to track your stocks over time.  Jim Cramer recommends one hour per stock per week, a good metric to use to compare your own stock research.  If you can’t (or won’t) put in that level of research, putting your money into mutual funds will enable you to get the stock market’s benefits without quite so much hassle.

6. Be Wary When Investing: The unfortunate fact of life is that bad things happen, and bad people try to take advantage of you.  If you keep up with your research, hopefully you won’t be blind-sided by an unexpected event that drops your stock’s price.  You also need to watch out for unscrupulous people who will try to feed you improper information in order to take advantage of you.  Make sure that you get your information from a trusted source, and don’t put too much money into any one investment.  (Particularly when investing in individual stocks, you need to diversify, making sure that no one stock makes up too great a portion of your portfolio.  I would suggest no more than 20% of your individual stock investment money in each stock, and no more than 5-10% of your total investment money in each stock; that way, one or two bad stocks can’t sink your entire portfolio).

There you have it, several tips to make individual stock investing easier.  Here’s hoping you have success while investing in stocks, and success in investing, period!

6 Responses to Advice to Individual Stock Investors

  1. @optionsdude: There is a difference between investing and gambling, although too many people seem determined to turn the former into the latter (which never works out well for them. A good strategy can be quite helpful, although whether someone can stick to it is another matter…

    @Barb: Thanks for the compliment. Frankly, as much as I am tempted to try my hand at stock investing, the incredible amount of research involved is always enough to convince me that I’m better off sticking with index funds.

  2. I’m obviously a little biased, but my company has released a free iPhone/Pod/Pad app on iTunes that can help a lot with cutting down how much time you spend researching (without sacrificing quality, as our model is independently back-tested and proven accurate).

    Basically it simplifies 20 complex factors into an easy to read “Power Gauge Rating” model – and you can also expand upon this data or order free research reports if you do want to dig deeper into your stock.

    Check out Chaikin Power Tools on iTunes or at http://www.chaikinpowertools.com if you’re interested. Again, it’s free and there are no ads or anything.

  3. @Roger: Thanks for the compliments! Thanks for giving it a look. Even if you only hold a couple of individual stocks it can still be pretty useful for determining their general health over the next 3-6 months. It’s good for plucking out the bad stocks in your portfolio.

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