Everyone wants to be financially secure. If you have a house, your house may be your biggest “asset” early on, but you will need to live in it for the rest of your life. Do you want a financially secure retirement or a vacation house in the South Pacific? You must invest your savings if you plan to retire comfortably.
1. Save. Before you can invest, you need money. Don’t start investing until you have a secure job and six to twelve months of living expenses in a savings account, as an emergency fund, in case you lose your job. Learn how to budget your money and to spend your earnings wisely. Most investors have to be careful not to spend any of their profits, and to keep some aside for future use, and for retirement, as well as emergencies.
2. Read. Before you start investing, you need a basic understanding of what a stock is, what it means to invest, and how to evaluate stocks. Get some basic books in stock investing. You should try to read every book on investing you can get your hands on. Here are some of the very best books and resources for all serious investors:
- The Intelligent Investor by Benjamin Graham. Get this on audio CD, listen to it a few times, and it will make a lot of sense. Focus especially on Chapters 8 (market fluctuation) and 20 (margin of safety).
- The Interpretation of Financial Statements by Benjamin Graham & Spencer B. Meredith. This is a short and concise treatise on reading financial statements.
- Security Analysis by Benjamin Graham & David Dodd. This book is considered theBible of investing and will tell you how to analyze corporate finances thoroughly. It is the greatest book ever written and worth every penny and every minute you spend reading it, many times over. You don’t have time NOT to read it. Get this book now, and master everything in this book. That being said, due to its age (it was published in 1934, just after the great stock market crash), it lacks some modern aspects; in particular, it does not tell you anything about the cash flow statement.
- Expectations Investing, by Alfred Rappaport, Michael J. Mauboussin. This highly readable book provides a new perspective on security analysis and is a good complement to Graham’s book.
- Common Stocks and Uncommon Profits (and other writings) by Philip Fisher. Warren Buffett once said he was 85% Graham and 15% Fisher, and that is probably understating the influence of Fisher on shaping his investment style.
- One up on Wall Street and Beating the Street, both by Peter Lynch. They are easy to read, informative and entertaining.
- The Essays of Warren Buffett, a collection of Warren Buffett’s annual letters to shareholders. Warren Buffett made his entire fortune investing, and has lots of very useful advice for real people who want to invest. Warren Buffet has these online and you can also read these online free:http://www.berkshirehathaway.com/letters/letters.html
- If you have some time left, you should also read Buffett’s early letters to his partners from 1956 to 1969; they can (for example) be found athttp://www.ticonline.com/buffett.partner.letters.html
- Buffetology, The New Buffetology and The Tao of Buffet, all by Mary Buffet and David Clark. These are basic books on the investment methods of Warren Buffett. The New Buffetology can be purchased on audio CD.
- For a better biographic insight of Warren Buffet you should read Buffett: The Making of an American Capitalist by Roger Lowenstein. This book will tell you how Buffett refined his investment style over the years and who he is.
- The Secret Code of the Superior Investor, by James K Glassman. This is an excellent treatise on the importance of buy and hold.
- Motley Fool and The Tycoon Report, both excellent online publications
- Wikinvest.com is great place to find information on companies and concepts in the market. It is also helpful to conduct due diligence on the investment information sources themselves. Check out the performance and advice of websites, newsletters and blogs. One resource to conduct this research is at Greedreviews.com
4. Practice. Clearstation has a free “Paper trade” service where you can buy 40 different stocks and you try your hand at building a portfolio. The simplest method is to set a “stop” a dollar below the current purchase price so that you get rid of all the weeds (stocks that are dropping). You hold onto winners and you then get a portfolio of stocks that are trending up (you kept all the winners).
5. Open a stock brokerage account with a discount broker. No specific recommendation can be offered here, as the stock brokerage business is a rapidly changing field. Trial and error is probably the only way to find a good broker, but you should do your own due diligence by checking out their site and looking at reviews online. The most important factor to consider here is cost, i.e. how much commission is charged, and what other fees are involved? Discount brokers generally charge commissions of less than $10/trade, some as low as $1/trade, and some offer a limited number of free trades per year, provided you meet certain criteria. Other than costs, you should also consider whether dividend reinvestment is offered (which is the best way to build up your positions), what research tools are offered, customer service, etc.
6. Build a small portfolio of 10-50 stocks. Blue chip stocks are stocks of market leading companies known for quality, safety, and ability to generate profit in good times and bad, although they are generally fully priced and difficult to buy at a bargain price except in a severe bear market. Choose stocks of companies with proven records of profitability with at least some earning in each of the past ten years, pay at least some dividend in each of the past 15-20 years, at least 30% EPS growth over the past 10 years (using 3-year averages to smooth out variations, for example, average EPS for years 2008-2010 compared to average EPS for years 1998-2000), low debt to equity (less than 1), and high interest coverage (at least 5). Stay up to date with different value investing websites such as Motley Fool or Fallen Angel Stocks to see what kind of deals are out there. If you do not have the time or inclination to learn about individual stocks, buying and holding no-load, low expense index funds forever using a dollar cost averaging strategy is best and outperform most mutual funds. The index funds with the lowest expensive ratio and annual turnover are best. For investors with less than $100,000 to invest, index funds are usually best. If you have more than $100,000 to invest, however, individual stocks are generally preferable to mutual funds, because all funds charge fees proportional to the size of the asset. Even the lowest fee index fund, Vanguard Total Stock Market Index Fund (VTI), has a 0.07% annual expensive ratio. This amounts to only $70 over 10 years for a $10,000 portfolio, but $700 over 10 years for a $100,000 portfolio, and $7,000 over 10 years for a $1,000,000 portfolio. If the expense ratio were 1.50% (typical for an average mutual fund), the fees would amount to $15,000 for a $100,000 portfolio, and a whopping $150,000 over 10 years for a $1,000,000 portfolio.
7. Hold for the long term, at least 5-10 years, preferably forever. Avoid the temptation to sell when the market has a bad day or month or even year. On the other hand, avoid the temptation to take profit even if your stocks have gone up 50%, 100%, 200%, or more. As long as the fundamentals are still sound, do not sell. Just be sure to invest with money you don’t need for five or more years. However, it does make sense to sell if the stock price appreciates too much above its value (see below), or if the fundamentals have drastically changed since purchase so that the company is unlikely to be profitable anymore.
8. Hold onto the winners and do not add to the losers without good reason. Peter Lynch said that if you have a garden and everyday you water the weeds and pick the flowers, that in one year you will have all weeds. Peter Lynch said that he was the best trader on Wall Street for 13 years because he picked the weeds and watered the flowers.
9. Avoid stock tips. Do your own research and do not seek or pay attention to any stock tips, even from insiders. Warren Buffet says that he throws away all letters that are mailed to him recomending one stock. He says that these salesmen are being paid to say good things about the stock so that the company can raise money by dumping stocks on unsuspecting investors.
- Likewise, don’t watch CNBC or pay attention to any television, radio or internet coverage of the stock market. You should focus on investing for the long term, 20 years, 30 years, 50 years, or more, and not get distracted by short term gyrations of the market.
11. Consider selling portions of your holdings as a stock appreciates significantly, at least 50% to 300%, based on quality of the stock. Use upper limit for better quality stocks. Letting your winners run as long as the story is still good will increase your long-term chance for success. Warren Buffet says that you should hold winners forever, but if the price-to-book gets too high (above 100 is definitely too high), you should consider selling the stock.
12. Consult a reputable broker, banker, or investment adviser if you need to. Never stop learning, and continue to read as many books and articles as possible written by experts who have successfully invested in the types of markets in which you have an interest. You will also want to read articles helping you with the emotional and psychological aspects of investing, to help you deal with the ups and downs of participating in the stock market. It is important for you to know how to make the smartest choices possible when investing in stock, and even if you do make the wisest decisions, to know how to deal with loss in the event that it happens.
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