One of the most common financial misconceptions among the American public is assuming the words "stocks" and "risk" are synonymous.
This can definitely be true in many cases, and if you invest in stocks without really knowing what you're doing, you're just asking for disaster. However, there are simple methods for picking stocks and minimizing your risk, while still setting yourself up for big gains.
History tends to repeat itself
A very common disclaimer when you see advertisements for mutual funds is "past performance doesn't guarantee future results." And it's true: Just because an investment has performed well in the past doesn't mean it will continue to do well. Bear Stearns' shareholders found this out the hard way.
However, past behavior of a company can be very indicative of things to come. Specifically, companies with a strong history of raising their dividends tend to continue to do so. Companies that buy back lots of their own stock tend to keep it up. And, companies that are less volatile than the market tend to stay that way.
Of course, there are exceptions, and no companies are completely immune from industry-specific problems, like the financial crisis of 2008-2009. However, if you form a diverse portfolio of this type of stocks, you'll create an excellent mix that should deliver you solid returns while not being too susceptible to market volatility.
Where to start?
Start by checking out dividend-paying stocks that have an excellent history of raising the payout. Most brokerage accounts have some sort of "stock screener" feature that allows you to narrow down stocks by a certain set of parameters, such as "dividend between 3%-6%" and "market capitalization of $10 billion or higher."
And, there are some websites that maintain lists of stocks that have raised their dividends for many consecutive years, like this one from dividend.com. Every stock on this list has increased its dividend for at least 10 consecutive years, which is even more impressive when you consider that time period encompasses one of the worst recessions in history.
Then, once you narrow down your list, take a look at the "beta" of each stock, which is an excellent measure of how volatile the stocks are, and is included with most stock quotes. The formula used to calculate beta is somewhat complex, but basically a beta of exactly 1.0 means the stock tends to move with the S&P 500. If the index drops 5%, so will that company (in theory).
A beta of less than one, such as 0.4, means that the stock is less reactive to market moves than the average. In this case, if the S&P drops 10%, this stock could be expected to drop about 4%.
With a little research, you'll find that there are hundreds of stocks that fit these criteria, more than enough to form a diverse portfolio. And, if you don't want to do too much legwork, here is a small "cheat sheet" to get you started.
|Company Name||Symbol||Consecutive Dividend Raises (Years)||Dividend Yield||Beta|
|Procter & Gamble||PG||57||3.08%||0.4|
|Johnson & Johnson||JNJ||51||2.68%||0.6|
If you don't want to be a stock picker, why not invest in everything?
The recent surge in popularity of the exchange-traded fund, or ETF, has made it easier for everyday investors to spread their money out over a variety of stocks without committing a lot of money to any mutual fund. And, if you're uncomfortable choosing your own stocks, it may be the best bet for you.
There are ETFs that track all of the major indices, such as the S&P 500. If you invest in one of these, your money is spread out among the 500 companies in the index, with a greater "weight" given to those companies with the highest market capitalizations.
And, there are ETFs that track individual sectors, such as financials or technology. Some ETFs track different countries, so if you want to invest in Brazil, for example, there are ETFs that allow you to do so without the risk of choosing individual stocks in that country.
For a primer on index fund investing, check out this article I wrote a few months back.
The Foolish bottom line
Just because you invest in stocks doesn't automatically mean you're taking on a lot of risk. As long as you take steps to choose low-volatility, rock-solid companies to invest in, you should be able to sleep well at night and let the gains accumulate for years to come.
Matthew Frankel owns shares of AT&T.; The Motley Fool recommends Coca-Cola, Johnson & Johnson, Kimberly-Clark, Procter & Gamble, and Sysco. The Motley Fool owns shares of Johnson & Johnson and has the following options: long January 2016 $37 calls on Coca-Cola and short January 2016 $37 puts on Coca-Cola. 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.