Put some finance types together at a party, give them a few drinks, and soon they're all regaling each other with the story of their first stock -- or the stock that got away, the stock that betrayed them, the stock they married ... you know the drill. I'm no exception.
Fortunately, I don't even need a party or a drink to get me going. Let me tell you about the stock that changed my life.
There I was ...
The year was 1993, and I was attending a rather prestigious business school. I was taking courses in accounting, statistics, and corporate finance ... yet I was learning surprisingly little about the stock market. Of course, I thought I knew a lot more than I did.
Watching PBS one day, I came across a great program for kids called Where in the World Is Carmen Sandiego? Then, when reading The Wall Street Journal, I saw that a software company called Broderbund was publishing the computer game on which the show was based.
Buy what you know, right?
Soon thereafter, I bought 100 shares of Broderbund stock for approximately $3,500. The TV show was so popular, I figured, how could the game not be a smash hit?
The stock did quite well over the next couple of years, and I sold my shares in 1995 to net a cool $10,000 in profit, before taxes. Not bad, eh?
What I did wrong
Given that profit, it might not seem as though I did anything wrong. But trust me -- I committed blunders galore.
For starters, I did little to no research into the company or the stock before buying it. It might have been a great company, but if its stock had already been bid up too high and was overvalued, I wouldn't have stood to make much money. If the company's debt or accounts receivable or inventory was growing much more quickly than revenue, that would have been a red flag. If profit margins or returns on assets were dropping, that would have also been worrisome. I didn't know much about Broderbund's competition, either. But I never thought about those things.
I also didn't have a plan. It would have been smart to have planned to hold until the stock hit my valuation target (if I'd had one), or to consider selling if certain things came to pass, such as a big management change or flagging financial health.
Again, I didn't do any of these things. I just got lucky.
What I did right
Still, I must have done something right -- I made a profit of nearly 300% in just two years' time.
Here was my smartest move: I saved enough money to start investing while I was still young. And whether Broderbund went up or down, I was committed to learning more about the market and becoming a better investor.
That decision to jump can be the most critical financial decision many of us ever make. Because even if Broderbund had gone down, I would have recouped all of that initial investment with the investment gains I've made in the 15 years since.
The stock market, after all, is one of the best ways for individuals to increase their personal wealth over the long term. If you've been sitting on the sidelines for years, the stock market is not working for you.
Now, if you're on the sidelines, afraid of losing your money in a stock that you don't know much about, you should know that there are ways to earn great returns in the market -- even beat the market -- that aren't as reckless as my initial foray was.
What you can do
Mutual funds can be a sensible place to begin as you learn more about the market itself. For example, you might park your money in a simple broad-market index fund, such as Vanguard 500 (VFINX), that will track the market's return by instantly making you a part-owner of companies such as Disney (NYSE: DIS ) ,EMC (NYSE: EMC ) , National City (NYSE: NCC ) , andHewlett-Packard (NYSE: HPQ ) . As long as you aim to keep the money there for five or, better still, 10 or more years, you have little reason to fear temporary downturns like the one we seem to be in.
If you want to try beating the market's return, you can invest a portion of your money in some carefully selected individual stocks or more specialized mutual funds. (As my colleague Rich Greifner has reasonably noted, mutual funds are the "Best. Investments. Ever.")
The Bridgeway Aggressive Investors 1 (BRAGX), for example, sports a five-year average annual return of around 16%, a low expense ratio, and top holdings that recently included Apple (Nasdaq: AAPL ) ,Intuitive Surgical (Nasdaq: ISRG ) , and Potash (NYSE: POT ) . Although that particular fund is currently closed to new investors, keep an eye on it. It may reopen one day. (Read about the market's 10 best funds.)
In the meantime, I invite you to test-drive, for free, our Motley Fool Champion Funds service, which will help you find other mutual funds worthy of your hard-earned investing dollars. (I've found a bunch of winners there myself.) If you're a novice investor, the service's model portfolios can also help you design a strategy that best fits your timeline and risk tolerance.
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This article was originally published on Feb. 29, 2008. It has been updated.
Longtime Fool contributor Selena Maranjian owns shares of Intuitive Surgical and an S&P 500 index fund. Intuitive Surgical is a Motley Fool Rule Breakers selection. Walt Disney and Apple are Stock Advisor recommendations. The Motley Fool is Fools writing for Fools.