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Investing in Common Stocks

Making an investment in stocks is different than speculating on stocks (discussed in a recent article here titled, "Using Stocks for Speculation".)

Stock speculation involves using one or another of different possible approaches to making a short term play on price movement. Price is the thing, and the value of, or prospects for, the underlying company don't matter much (if at all) and you need to have the mind set of a riverboat gambler.

When you buy stocks for investment purposes, price matters but you are also interested in the knowing more about the long term prospects of the companies you buy. While there are risks involved in investing in stocks, you can do so conservatively and you don't have to have a gambler's mentality.

Responsibility:

If you are going to become an investor, you need to be responsible for your own investment decisions. You ought not to expect that someone else will take over this basic responsibility so you don't have to do anything. You will deal with brokers, financial advisors, accountants and others who may have suggestions and advise for you, but you must make your own decisions related to your long term financial well being. What this means is that you will need to educate yourself about investing so you can evaluate suggestions given you by others.

Investment Plan:

It is a wise and fine thing to plan your investment program rather than leave it to chance or impulse. Your investment plan should be part of a larger overall financial plan that speaks to meeting your obligations, providing for insurance coverage against disaster of various kinds, savings for unforeseen emergencies, and how you intend to spend your hard earned dollars.

To implement your plan to best advantage it's best to make regular contributions to an investment program. "Pay yourself first," is a phrase most people have probably heard at one time or another. The idea is to decide on a portion of your regular income to put toward your investment plan before paying anyone else. If you build this notion into your planning some good things begin to happen.

• You won't put off preparing for your financial future for weeks, months, or years. You'll be preparing a little bit with every paycheck.
• You will take advantage of the power of time to compound the value of your holdings.
• If you aren't much of a budget planner, paying yourself first serves as a "default" budget because you are forced to rely on the remainder of your income to pay for everything else.
• And, you'll take advantage of something called, "dollar cost averaging."

Dollar Cost Averaging:

When you invest on a set amount of your paycheck on a regular basis-like clockwork-with the long term in mind, then you don't need to be terribly concerned about day to day changes in the price of stocks or mutual fund shares you hold. When prices are up your contributed dollars will buy fewer shares but they'll more valuable shares. When prices are down, the same number of dollars will buy more shares. The result is that the average cost-basis per share will be lower overall.

Portfolio Management:

In building your investment plan you'll want to make some decisions about how your total portfolio will look. Most people will want to have some ratio of cash, stocks, interest bearing investments.

• There should be enough easily accessible cash to provide funds to deal with emergencies of many kinds without your needing to go into debt to handle them. At a minimum plan for the equivalent of three months worth of your normal income. These funds can be held in passbook savings with your local bank and the interest paid you will just about keep up with inflation so as to retain buying power.
• Interest bearing instruments-bonds, U.S. Treasury issues, certificates of deposit, money market funds-are for the purpose of preserving some of your capital without risk. The interest paid to you will be a little more than the then current inflation rate but won't usually lead to dramatic growth of your capital.
• Stocks are for growth of capital.

The ratios of the above for your portfolio will for you to choose. Generally speaking the older you are and the less risk you're comfortable with the higher the ratio of interest bearing investment should be, and the younger and more risk tolerant you are the higher the ratio of stocks should be.

Once you've decided on the basic ratios your portfolio will have, you can then adjust them as the stock market becomes more "bullish" or "bearish." You will also want to review the portfolio at regular intervals and rebalance it periodically.

Common Stock Investment:

There are two basic ways to invest in common stocks. You can buy shares of mutual funds that hold stocks or you can buy the stocks themselves. Mutual funds are considerably easier to use for the novice investor, but either will require some investigation and study on your part.

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