Most investors can get all the investment diversification they need with certain mutual funds and ETFs. But investing in stocks can be of greater interest to some investors who seek the thrill of attempting to beat the market.
When you purchase stock, you own a piece of a company, which makes you a shareholder with voting rights. You literally have a vested interest in the company’s success.
Investing in stocks isn’t about get rich quick schemes. A long-term investor should use tried-and-true strategies. Choose the one that feels right for you.
Investing in Stocks
Buy and hold
The buy-and-hold approach to stock purchasing is fairly conservative in that the investor purchases high-quality stocks and holds on to them for years. The investor makes money when the stock appreciates in value (producing capital gains when the stock is sold) and through dividends. There is little trading involved.
Take the “buy-and-hold” approach one step further by finding quality stock that is beaten down or undervalued due to economic conditions or changes to the company, and buying at bargain prices. This is the Warren Buffett approach to investing.
Value investing doesn’t always work, though. There are times when companies are in serious trouble and likely won’t be able to recover.
This strategy involves buying stocks in companies that pay dividends. Typically, companies that pay out high dividends are mature companies with little debt – known as “blue chips.” They are often viewed as slow-growth. However, a number of studies have shown that dividend payers perform better over time and with less volatility than non-payers.
A yield is the percentage of the dividend in relation to the value of the share price. An increasing dividend is a good sign that the company is growing its income. But, a high dividend yield doesn’t necessarily mean the underlying stock is healthy.
When comparing companies, consider both the yield and the quality of the stock. Dividends can also be cut which may be an indication that the company is in trouble. So, in general, stay away from companies that are cutting dividends.
This regular payout can be spent, or reinvested for compounded returns. DRIPs are dividend reinvestment programs. They allow you to passively grow your portfolio by reinvesting the dividends into more shares. DRIPS are not available for all stocks.
Sector rotation means you protect your assets during economic turmoil by investing in high-quality companies (e.g. banking, utilities, pipelines and railways). When the markets bounce back, you rotate your portfolio into a more aggressive position by buying more cyclical industries (such as commodities and resources) which can produce significant returns during economic recovery.
You have to be comfortable with the risks and do ample research. If you’re a conservative investor, it’s best to stay away from this strategy.
Stocks that are positioned for growth have the potential to produce high returns. Many are venture or start-up companies that have a new idea, product or service, especially technology oriented. These companies are considered higher risk, so they should be considered only by investors with a high-risk investment profile.
Growth strategies are based on the principle that small companies have huge potential to become big (think Apple, Google and Amazon back in the day). To profit from investing in small, growth-oriented companies, you absolutely must have research to support your decision, understand the business model, and be able to interpret financial statements properly.
A word about diversification
Whether you’re investing in stocks with a strategy of growth, value, or income, you still need to incorporate a sufficient number of stocks to diversify your risk.
A diversified portfolio contains about 20 companies, chosen for diversity in size, industry, sector and location. Much more than 20 stocks and you’re going to have a hard time keeping up with the latest news, evaluating and making informed decisions.
Wait until you can buy at least five individual stocks with a reasonable number of shares to start off with and then add more.
How to buy stocks
You can purchase stocks through a licensed investment professional who works at a stock brokerage firm, or on-line with a discount brokerage account.
In the first instance, a full-service stockbroker (investment adviser) charges a commission or fee for their advice. In the second, you invest based on your own research, without professional advice, saving fees in the process.
Shares can be purchased directly from the issuing company through a share purchase plan and a dividend reinvestment plan (DRIP) where your dividends are used to buy more shares. This is beneficial because it means your dividends are automatically reinvested. Some companies also allow employees to invest a portion of their pay directly into shares of their company.
As an investor, it’s critical that you buy shares only in companies that fit your investment personality and investment needs. Honour your tolerance for risk – not someone else’s. The money you invest is never guaranteed, nor are you guaranteed any dividend payout.
One of the best ways to learn about stocks is to pick a few of your favourite companies and follow their performance for a few weeks or months. You can set up a (free) mock portfolio through most brokerages.
In part 2 we’ll look at some methods of evaluating stocks to determine which ones are best for you.