The Best Stocks for New Money

If I told you I would hand you some money to buy a few shares of a stock, but only if you could tell me which company was at the top of your buy list, could you do it? Most probably could do no more than toss out a random name, because few keep an up-to-date short list of their best investing ideas.

Yet such a list is crucial -- and beyond the obvious reason of knowing which stocks to buy when opportunities arise. The very act of diligently keeping up with such a list will sharpen your investing skills; you are forced to develop a thesis for every company, and you'll constantly be reassessing the business to make sure your thesis still holds. You'll also be in better tune with valuation, especially relative to other companies in the industry.

For example
I can give you an example from my own portfolio. I have full positions in some stable, blue-chip stalwarts such as Procter & Gamble (NYSE: PG  ) and Anheuser-Busch (NYSE: BUD  ) . I also have lighter positions in some small-caps, Ctrip.com (Nasdaq: CTRP  ) and Buffalo Wild Wings (Nasdaq: BWLD  ) among them.

So when it was time to add new money a few months ago, I felt I had good balance in the portfolio and was free to consider almost any stock. For many reasons, including solid management, reliable cash flows, and compelling valuation, Johnson & Johnson (NYSE: JNJ  ) had been on my short list. After a 10% drop in less than a month at the beginning of this year, it had moved up to No. 1. I pulled the trigger in early February, getting in at $56.95.

Of course, only time will tell if that was a good buy. But because I keep an up-to-date list of my best stock ideas, I was able to buy with confidence when the opportunity presented itself.

Look inward, grasshopper
When making your list, don't forget stocks you already own. All of us will have a limited number of great ideas in our investing lifetime, so many times your best stocks are already sitting in your portfolio, just waiting for new money.

Most of history's greatest investors followed this route. You may already be familiar with Charlie Munger's disdain for over-diversification; he'd rather have his money in a small handful of stocks, allocating not a single penny to any second-tier idea. David and Tom Gardner are thinking along the same lines for their Motley Fool Stock Advisor members, and now each month they publish their top five stocks to buy now for those ready to allocate new money.

That said, don't think that you need to limit yourself to just four or five stocks. In fact, the less experienced you are as an investor, the more diversity you need in your portfolio. This is simply to keep one or two bad mistakes from torpedoing your net worth. Masters like Munger and Buffett are tops in their field; they're not perfect, but it's highly unlikely any one investment of theirs will completely tank and significantly harm Berkshire Hathaway shareholders. The rest of us, however, need a bit more diversification.

But no matter your investing experience, you'll want to focus on your best ideas as you add new money. And as the years roll by, if you were right about most of your ideas, the extra concentration in them will supercharge your returns.

The short story
Do you need help compiling your own short list? The most important consideration, especially for the average individual investor, is balance: between large and small caps, between less risk and more risk, and among different industries. As this chart shows, if you owned ExxonMobil (NYSE: XOM  ) five years ago, buying another oil giant like Chevron (NYSE: CVX  ) would have added no diversification benefit and overweighted you in one industry.

And don't be afraid to seek out qualified help. As I mentioned, David and Tom now publish their own short lists in Stock Advisor; each list contains their five best stock picks for new money now. They happen to be pretty good at what they do, with 56% average total returns for their recommendations since the service began over four years ago, vs. 17% for equal amounts invested in the S&P 500.

It won't cost you a dime to see their lists and all their recommendations. If you're interested, click here for more information on a 30-day free trial.

Rex Moore parks in a driveway and drives on a parkway.He owns shares of all companies mentioned in this article except ExxonMobil and Chevron. This information is brought to you by the Fool'sdisclosure policy. Anheuser-Busch is a Motley Fool Inside Value recommendation. Ctrip.com and Buffalo Wild Wings are Hidden Gems recommendations. Johnson & Johnson is an Income Investor recommendation.


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