Buying stocks is a great way to grow wealth over time. But if you're going to add a stock to your portfolio, you should do so for the right reasons. Here are a few really bad reasons to pick one stock over another.
1. It's in the news a lot
Companies that get a lot of press aren't automatically companies worth buying. And there are perhaps no greater examples of this concept than meme stocks.
Early on in the year, meme stocks like GameStop (GME -1.09%) and AMC Entertainment (AMC -0.94%) were all the rage. Investors were clamoring to own these companies due to a Reddit frenzy that broke the internet.
But both GameStop and AMC are questionable investments when we stop and think about it. These days, it's easy to download video games online, so the need for a retailer like GameStop may be waning.
Movie theaters, meanwhile, faced challenges before the pandemic because digital content increased the competition and inspired Hollywood fans to spend their money elsewhere. And now, in the wake of the pandemic, there's even more risk.
This isn't to say that GameStop and AMC absolutely shouldn't go in your portfolio. The point, rather, is that you shouldn't buy a stock solely because it tends to get a lot of hype.
2. Your friends own it
You may have friends who have had success owning specific stocks. But that doesn't mean those are stocks you should rush to scoop up.
Your friends may have a different approach to investing than you do and their financial goals may be different. So you shouldn't buy stocks just because someone you know recommends them. That said, you can consider making an exception if you have a friend who's a stock-picking wiz and understands your risk tolerance and goals when making recommendations.
3. Its share price is inexpensive
Stocks trading at a low price may seem enticing since you can buy shares of different companies for a more diverse portfolio. But just because a stock can be acquired on the relative cheap doesn't mean it's a good buy.
In fact, penny stocks -- those that trade for under $5 a share -- are extremely affordable on a per-share basis. But many of those stocks are speculative. Instead of seeking out stocks with a low share price, you should instead aim to find stocks with attractive share prices given their value.
A better approach to buying stocks
Sometimes, learning to choose the right stocks can be a process of trial and error. And you shouldn't beat yourself up for investing in companies that turn out to be a bust. At the same time, it's generally not a good idea to buy stocks for the above reasons. Instead, aim for stocks that:
- Offer lots of growth potential
- Have strong finances and management
- Have a clear edge or value proposition
- Help diversify your portfolio
- Support your long-term investing goals
With any luck, this approach will allow you to grow wealth without exposing yourself to undue risk.