Here's a common set of questions, courtesy of a reader named Darla:
I want to try investing in stocks. I have never bought stocks and I don't have a brokerage account. I have [X number of dollars] in an index fund in a rollover IRA. Should I use that? What if I lose it? What's the best way to learn to pick good stocks?
What Darla needs is a sandbox.
You mean like the cat uses?
No, not a litterbox, a sandbox. When you're in a sandbox, you can dig and dig and experiment with all kinds of mound shapes and building techniques, and run your trucks wherever you want, without tearing up Dad's lawn.
In this context, a sandbox -- the term comes from an interview with Money magazine columnist Jason Zwieg in last December's issue of the Fool's Rule Your Retirement newsletter, by the way -- is created when you mentally fence off a small portion of your retirement portfolio to invest in stocks. According to Zwieg, most investors will do best if they have 90% or so of their portfolio tucked away in index funds (he calls that the "lock box"), and use the remaining 10% to satisfy their urges to "play" -- or in our case, to learn.
Image source: Getty Images.
But how do we know what to buy?
Master the basics
Before you can knowledgably choose stocks, you'll need to know the ups and downs of valuing a company, and where to find the information you need. Fortunately, you've come to the right place -- here at the Fool, we're happy to send you to our elite stock-investing school, all expenses paid.
And once you've read through that, look at how pros evaluate a stock. Take a 30-day free trial of one of the Fool's stock-picking newsletters -- Stock Advisor is a great choice for new investors -- and spend some time reading the stock-recommendation articles carefully. Look at how the analysts review the strengths and weaknesses, and examine what information they depend on, and where it comes from. You'll be surprised how quickly you learn.
The fine art of choosing stocks
Once you've digested the basics, a little wisdom-sharing is in order. Here are my personal rules for choosing stocks:
- Buy companies you understand. Buy companies you know and like (though not your employer!) -- but only if the business fundamentals are there. Car enthusiast? Honda (NYSE:HMC) looks strong right now, but will it stay this strong if oil prices keep falling? It's possible that long-suffering Ford (NYSE:F) is finally worth a look, but be careful -- and don't let your judgment be swayed by your love for the '66 Mustang you had years ago.
If you can't explain how the company makes money, who its competitors are, and where it's going, you won't know when it's time to sell. I learned that one the hard way with JDS Uniphase (NASDAQ:JDSU) back in the dot-com years -- a $30,000 mistake. Oops. - Don't even try to buy at the bottom or sell at the top. If you buy low (and ignore it when it goes lower) and sell high (and ignore it when it goes higher), you'll make plenty of money and sleep soundly at night. Don't worry about trying to get every last dollar.
- Be aware of your own weaknesses. I wrote about my unfortunate experience with NutriSystem (NASDAQ:NTRI) a while back -- or perhaps I should say my "wisdom-building experience." Read that article for the whole tale, but here's the nutshell: Humans are wired to make certain kinds of mistakes with money. Being aware of the wiring can help you avoid expensive mistakes.
Last but not least, think long-term. Buy stocks you'll be comfortable holding for a while -- at least a year, maybe more. I know of wealthy families who have held blue-chip stocks like Pfizer (NYSE:PFE), JPMorgan Chase (NYSE:JPM), and PPG Industries (NYSE:PPG) for generations. That doesn't mean you have to hold everything you buy for the rest of your life -- you should only hold it as long as it makes sense to hold it. But for maximum return with minimum fuss, don't think in terms of days or weeks -- think months, or better yet, years.
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