Are you new to the world of investing? If so, welcome! Natural first questions for beginners include, "What should I invest in?" and "What are the best investments?" I've got some answers for you, but they may not be what you expect.
Invest in books
Before you get to actually plunking down your hard-earned cash on investments, you should be relatively well versed in how the stock market works, how to deploy your cash effectively, and how to avoid basic errors. Common errors include investing in penny stocks, buying overvalued high-flyers, being impatient, bailing on stocks when the market falls, and so on. You should have developed reasonable expectations, too, such as not expecting to double your money in short order, and expecting to make plenty of mistakes and lose some money occasionally, despite all you've learned.
Here are just a few of many good books that will make you savvier and improve your chances of investing profitably:
You can get a good grounding via books such as The Motley Fool Million Dollar Portfolio: How to Build and Grow a Panic-Proof Investment Portfolio, by David and Tom Gardner (one of our Motley Fool books); The Elements of Investing: Easy Lessons for Every Investor, by Burton G. Malkiel and Charles D. Ellis; and the classic, One Up On Wall Street: How To Use What You Already Know To Make Money In The Market, by Peter Lynch.
The seminal Common Stocks and Uncommon Profits by Philip A. Fisher will take you a little further along.
John Bogle, the father of index funds, has some solid offerings, too, covering mutual funds and investing in general: Common Sense on Mutual Funds and The Little Book of Common Sense Investing: The Only Way to Guarantee Your Fair Share of Stock Market Returns.
That last book is part of a nice series of "Little" (and short!) books that cover a variety of key investing topics. Others that would be useful to new investors include The Little Book That Still Beats the Market, by Joel Greenblatt, The Little Book of Big Dividends, by Charles B. Carlson, and The Little Book of Value Investing, by Christopher H. Browne.
Invest in index funds
Once you feel relatively comfortable about investing, you can start committing some dollars. A great way for most people to start is with index funds -- which includes both mutual funds and exchange-traded funds designed to track and essentially replicate the performance of certain indexes. Index funds are actually great for just about all investors. It's hard to outperform the overall market consistently, so there's no shame in just sticking with low-cost index funds. Broad-market ones are ideal, such as the SPDR S&P 500 ETF (NYSEMKT:SPY), Vanguard Total Stock Market ETF (NYSEMKT:VTI), and Vanguard Total World Stock ETF (NYSEMKT:VT), offering, respectively, the largest 80% of the U.S. market, the entire U.S. market, or just about all of the world's stock market.
Invest in individual stocks
Finally, you can consider investing in individual stocks. You can just stick with index funds, but if you want a chance to outperform them, you can try. This is where having read a bunch of the books above and some others, to boot, will help you even more. You need the time and interest to research and follow a lot of companies, and you also need to have developed some stock analysis skills.
Without significant stock sense, you might jump into a high-dividend stock, not realizing that its dividend is high because it's been falling. Or you might buy a stock because you love the company's potential, without realizing that it's not yet profitable, or is saddled with crippling debt.
Beginning investors -- and all of us, really -- should stick to companies they know and understand, or can know and understand. Dividend payers are a good idea, because their dividend payouts can be especially welcome should the stock or market take a temporary spill.
If you're hunting for dividend-paying stocks, go ahead and seek solid yields -- say, 2% or more -- but be wary of very high ones, such as 7% or 10% yields. They may be tied to companies that are struggling, in which case the payouts could be reduced or suspended. Look for solid dividend growth during the past few years, too, as that can make a 2.5% yield much more attractive than a 4% one that isn't likely to grow much.
And assess the payout ratio, too. It's the result of dividing the annual dividend amount by the last year's worth of earnings per share. A low payout ratio -- say, below 50% -- reflects plenty of room for growth, while a steep one -- say, 80% or more -- is less appealing. And finally, learn enough about the company to be confident of its future. It should have durable competitive advantages (such as a strong brand or economies of scale), and healthy financial statements (lots of cash, strong and growing profit margins, little or no debt, etc.).
By investing in your financial education and index funds -- and if you wish, individual stocks -- you can get off to a great start in the investing world, and can start building a better future for yourself.
Longtime Fool specialist Selena Maranjian has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.