The Case for Avoiding Stock Investing
First, if you have read our other articles, you know that heavily favor index funds over individual stocks or actively managed mutual funds. Unlike the many books that advertise how easy it is to make money in stocks, we will try to dissuade you once again. Some reasons to avoid investing in stocks, especially for beginners:
- Many analysts, even armed with financial degrees, specialized training, and mounds of tools and data, are dead wrong in their stock predictions. What makes you think you can do better without all those advantages?
- It is much harder to properly diversify with individual stocks. Individual news items can sink a single stock quite quickly.
- Transactional costs will cut into your bottom line over time.
- More frequent transactions require more work come tax time.
- Stock investing requires a substantial amount of your personal time.
Many people love to invest in stocks because it is sexy, but essentially they are gambling. We would guess if you asked 10 people why they owned a specific stock, 8 could not give you a valid technical or fundamental reason.
What are Stocks?
Still here? Great! We have not scared you off so let’s continue. The rest of the article we will attempt to point you in the right direction. We simply cannot teach stock investing in one post.
First, you should understand what you are getting into. You are essentially buying partial ownership of a company when you purchase stock shares. So if Company A is comprised of 100 stock shares and you bought 1 share, you would own 1% of the company.
Ways to Choose Stocks
Realistically, here are some of the ways many people choose stocks:
- Tips from friends, brokers, or wealthy acquaintances
- Choose companies based on products or shops they enjoy
- Magazine, internet or newspaper articles
- Promotional emails or marketing mails
- Paid newsletter alerts and recommendations
- Technical analysis – basing decisions on stock movement and history
- Fundamental analysis – evaluation of business fundamentals
For many of these (specifically the first 4), you need to get pretty lucky to count on long term consistency. Most paid newsletters or subscriptions are fairly awful, but some are reasonable if you do further research on their recommendations.
The last two are where the professionals make their money. Technical analysis can be more viewed as an art, and best left alone by amateurs, especially beginners!
It’s All About the Fundamentals
That leaves fundamental analysis as the most viable option. It is what most of the great, well known investors advocate – Peter Lynch, Warren Buffet, etc. You essentially evaluate a company’s financial strength as well as their management teams and products. Understanding those fundamentals, you can search for companies that fit your criteria – growth (predictable or significant increase in revenues) or value (fundamentals indicate stock price is below company’s true value) are the most common.
Again, all this research is a lot of work and time – and you could end up completely wrong! However, if you are right, the returns on a great stock can be significant.
Recommended Reading
Teaching you financial analysis of a company is not part of this post – especially when there are plenty of books that will do a superior job. Here are some books we recommend that will help you continue your stock investing education:
- One Up on Wall Street – Peter Lynch (Growth Investing)
- The Intelligent Investor – Benjamin Graham (Value Investing)
- How to Make Money in Stocks – William O’Neil (Growth Investing)
Final Thoughts
We still prefer you go with index funds, but we know people are stubborn. If you want to invest in stocks, prepare to do some serious reading and learning, allocate funds you can afford to completely loose, then get started. Good luck!