Thursday, May 22, 2008

How to start investing in stocks

One of the things that you often hear from financial publications and TV shows and whatnot is that you need diversification in your investments. This is nonsense, unless you are old or wealthy. If you are young and poor, like me, you need more money. Diversification only protects existing money from losing its value. If you are young and just starting out, you need good stock selection.

First, if you are going to be a really good investor, read everything you can that was written by Benjamin Graham, Peter Lynch, and/or I will also write about how to evaluate stocks in this space, going forward. Study long and hard, unless you want to learn investing by practice (which is really expensive, and can be hard on your relationship with your family, if the term "your family" refers to people who are, on average, about as young as you or younger).

Finally, when you know everything there is to know about value investing and growth investing and have several hundred dollars saved up for your first stock purchase, open an online brokerage account. The best of these is probably one of the cheapest. One good one for new investors is Sharebuilder (and I'm not just saying that because I get paid if you click on the Google ad for them in the corner). Sharebuilder is an online brokerage that I use, and they provide a service that allows you to schedule stock purchases for a Tuesday morning, and pay just $4 in commission. This is strangely cheap, and unusually restrictive, but it should do just fine for newbies who would otherwise be paying more to buy a stock. After all, you probably will be buying just one stock to begin with. (E*Trade might let you trade 25 times for free if you trade 50 times per month, or something like that, but that doesn't help someone like you, now does it?)

Other standouts in the cheap category are Scottrade ($7 per trade, and no fees for IRA's and Roth IRA's - more on those later) and TradeKing ($4.95 per trade), both of which I also use. You might want to try these once you are feeling more adventurous and want to know the joys of a limit order or a free tax shelter.

Now, what about all those people on CNBC and whatnot that fret about the direction of the market? Well, you can ignore them. Very few of the many investors and traders who are doing well actually need to know anything about the direction of the market. Just find a company that no one else seems to be paying attention to, and study it. Do they make money? Are they going to make more money in the future? Is there any reason their shares should be trading for a much higher price? Is it in an industry or sector that is going to do well? Is it better than its competitors in that industry or sector? Is there any risk that could make their shares trade at a much lower price? If you answer these questions Yes, Yes, Yes, Yes, Yes and No (or not much), respectively, you have a winner. Buy it. Follow it and the news about it and about its industry. Ignore the price movements of the other 10,000 or so stocks, because those don't matter. You and your portfolio matter.

Getting back to diversification, if you diversify you have two options: start buying stocks that you don't have time to know anything about, or buy mutual funds/ETF's. The first option is more dangerous than having shares of just one or two companies you know well (and by the way, working for a company or buying its products is nothing like knowing it well, unless you're the CFO), and the second option, while technically safer, is also going to kill your shot at sustained growth >30%. >30% growth is our goal here, so I encourage you to reject that option. We're still young: let's floor it!

Within the next ten days or so I will issue my first recommendation. I will call it my "June 08" recommendation. Pretty clever, huh? As always, do not buy anything unless you know enough about it to own it as your own decision as well as own the investment itself.

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