You've probably seen some articles addressing the "Best Stocks for New Money" -- my colleague Rex Moore has written one himself. It occurred to me recently, though, that it would also be good to examine how investors should invest their old money.
What do I mean by old money? Well, I'm not referring here to the greenbacks of blue bloods -- the fortunes of Astors and Vanderbilts and the like. Instead, I'm referring to money that's sitting in your portfolio and that has been there for quite a while. You see, when we're looking for new investments, it's often because we have a newly accumulated bundle of money to invest -- perhaps $3,000 or $5,000 or so, that we've saved from our last few paychecks. When we focus our investing on these sums, we may be ignoring an even bigger component of our financial well-being: the rest of our portfolio.
Imagine that you have a portfolio of securities valued at around $100,000, and that you have $5,000 in cash now, ready to invest. Go ahead and find the best place you can for that $5,000. But take some time to think about your old money, too -- that $100,000.
The best places
Here's a critical concept to understand in order to improve your investing results: Put your hard-earned dollars into your best ideas. Try this exercise: Make a list of all the stocks that you think are great values right now. Include all the ones you own and ones on your watch list. Include any stock you're aware of and are interested in owning, because of its attractiveness and promise. Jot them all down. Then rank them, in order of attractiveness. You should be thinking about what they're really worth, and what they'll be worth in the future. Which ones have the best prospects relative to their valuations?
Here comes the eye-opening part. Are you not yet invested in some of your top ideas? Are you invested in some of the stocks ranked near the bottom of the list? For many of us, the unfortunate answer to both of those questions is "yes." Think about what this means. It means that while you might think that Stock A has a good chance of growing at 16% per year, on average, for at least a few years, and that Stock B is likely to grow at maybe 11%, you've got thousands invested in B, and nothing in A. Does this make sense? Not to me.
I understand how it happens, though. It's happened to me. I may have invested in a company long ago with high hopes, and though it's disappointed me over time and perhaps I've even lost money on it, I'm hanging on. My expectations are lowered, but I stubbornly want to make money on it. I'd be much better off selling and moving the money into an investment I have more confidence in -- I have a better chance of making money there instead.
Keep in mind
Focusing on your best ideas doesn't mean that you should be popping in and out of stocks rapidly, as you continually readjust your expectations. Keep in mind, for starters, that our estimates are just that -- estimates. So leave room for at least a little margin of error. Also, remember that frequent trading can leave you with a bigger tax bill -- such as when you sell successful holdings before you've held them for a year. In such situations, they'll face short-term capital gains tax rates, which can be a lot higher than the preferred long-term rates.
What to do
So what should your next steps be? Well, I urge you to go through the exercise. Rank those companies as well as you can, and make sure your old -- and new -- money is parked in your best ideas. If you don't have great confidence in your stock evaluation skills, rest assured that you're far from alone. You can learn these skills, though, if you have the time and are willing to make the effort. Articles here at Fool.com can help, as can many good books.
If your list is on the thin side, you might benefit by simply screening for promising stocks, then researching them further. I recently ran a screen for companies with returns on assets (ROA) of at least 15% (because that reflects the profitability of assets), EBITDA margins of at least 20% (a sign that they're efficient operators), and P/E ratios of no more than 18 (which shows that they're cheap to reasonably priced). It returned 104 companies, some of which were quite familiar names:
Abercrombie & Fitch
Let us help
Another option is to let someone else, a trusted party, do much of the research legwork for you. Along those lines, I invite you to test-drive, for free, our Motley Fool Stock Advisor service. There, Fool co-founders David and Tom Gardner recommend two stocks each month, along with a list of their five favorite stocks for new money now.
All told, their picks are beating the market by an average of nearly 40 percentage points since 2002. Click here to take a look at the service free for 30 days. After all, with those kinds of returns, you might help your old money start feeling young again.