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You can succeed at investing in any number of ways. But the most powerful way to take control of your finances and strive for truly amazing returns is to go beyond diversified investments and venture into the world of buying individual stocks.
Throughout the week, I've been looking at several things you can do to fix your finances. By dealing with your debt, putting money aside for a rainy day, and getting started by investing in mutual funds and ETFs, you already have the core skills you need to reach a level of financial security that few people ever achieve.
But just as we all eventually take the training wheels off when we're learning to a ride a bike, so, too, does it make sense for investors to look into the benefits of investing in individual stocks. The difference it can make is truly enormous.
Taking the plunge
As I discussed yesterday, mutual funds and ETFs provide a simple, effective method of introducing you to the investment world. Even if you have very limited resources to invest, a fund will give you exposure to a well-diversified portfolio of investments. The more broadly diversified the fund is, the less impact that one or two catastrophic stocks within that broad portfolio will have on your overall net worth.
The problem with that added security is that it comes at the expense of the highest potential returns. During a rally like the one we've seen over the past year, in which the S&P 500 has risen by more than 60%, you might feel as though you can't really expect anything better. Yet although the overall stock market has managed a long-term average annual return of only around 10% or so, plenty of stocks, from obscure small-caps like Harbin Electric (Nasdaq: HRBN ) to better-known companies including Priceline.com (Nasdaq: PCLN ) and Netflix (Nasdaq: NFLX ) , have seen their shares rise between roughly six- and 10-fold since 2005. You're simply never going to find that kind of long-term performance from a mutual fund or ETF.
A good place to start
If this is the first time you've ever bought a stock, though, shooting for the moon might be a tad unrealistic. Rather than simply buying whatever fad stock seems to have the best chance of going through the roof, you should instead pick as your first stocks companies that you can relate to and understand. Investing maven Peter Lynch once recommended that you should buy shares of companies you know -- and it remains good advice today, especially for stock-buying beginners.
That doesn't mean, though, that you should buy bad stocks just because you're familiar with them. But consider:
- Anyone over the age of 3 knows something about Disney (NYSE: DIS ) . But what you may not know is that Disney's unique combination of family-oriented media has helped the company's earnings hold up reasonably well even in an economy in which fewer people have a lot of discretionary income.
- You've probably eaten at McDonald's (NYSE: MCD ) and Yum! Brands' (NYSE: YUM ) Pizza Hut, KFC, and Taco Bell at some point in your life. But it might surprise you to learn that these and similar cultural-icon stocks such as PepsiCo (NYSE: PEP ) have been at the forefront of efforts to capitalize on red-hot emerging markets such as China.
- Although most people know about companies like the ones above, you may also have special knowledge of a particular area. If so, you can use the knowledge to your advantage by evaluating stocks within that area. You'll have an edge over less well-informed investors.
Even if these ideas look good, don't take someone else's word for it -- learn more about those companies yourself. You'll find plenty of resources here at the Fool to help you, and along with other readily available sources, it's easier than ever to find information you need to make a more-informed decision.
Regardless of which stock you end up deciding on, the key is to get past any anxiety you have and invest in your first stock. The potential rewards will go a long way toward helping you get your finances exactly how you want them.
Tomorrow, Dan concludes his weeklong series on how to fix your finances with a look at putting together the perfect investment portfolio.