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Day 5 - Investing in Stocks

By JLP | February 5, 2006

Well, we are up to Day 5 in our 24-day marathon of personal finance. I hope you guys have been enjoying it as much I have (although it is more work than I expected). Today we are going to talk about investing in stocks.

For most people, the best way to invest in stocks is thourgh mutual funds (tomorrow’s topic) or exchange-traded funds. However, some peopl may desire to invest in individual stocks. Here are some things to consider before you make the leap:

1. Diversify - Unless you are Warren Buffett, it simply isn’t smart to put all of your money in one stock. Phil Town doesn’t agree with me on this one. However, remember Enron. Enron was a high-flying “blue chip” stock until it collapsed. Therefore, I think it is a good idea to have a portfolio of at least 10 stocks in order to get some diversity. There are other people out there who think you need something like 30 stocks in oder to be considered diversified. If you can’t afford to buy more than one or two stocks, consider an exchange-traded fund like the iShares Dow Jones Total Market Index (IYY).

2. Keep Trading Costs Low - This is very important. The more you trade your stocks, the more expenses you will incur, which will eat into your portfolio. The only way to accomplish this is to buy good stocks and basically hold them forever.

3. Have a Buy/Sell Plan - You should have criteria for both buying and selling stocks. Having a strategy in place will help keep your emotions in check. Emotions will KILL your portfolio.

4. Make use of resources like Value Line. Some people will disagree with me on this one but I have found Value Line to be an excellent source of company information. A subscription to Value Line is $600 per year but I have received advertisements for $200 per year. Also, most libraries purchase a subscription so you can read it for free if you want to.

Those are just a few of the many, many things to consider when buying stocks. I think most people will find tomorrows topic on mutual funds much more beneficial. Now, here’s some other articles around the blogosphere on the topic of investing in stocks:

FatPitchFinancials:

Become Friends with EDGAR

Why I Study Warren Buffett

Arbitrage and Special Situations

FreeMoneyFinance:

Trade Sparingly and Invest for the Long Haul

Experiment in Polyglot Blogging:

Is realizing short-term stock gains beneficial?

Part I: Are you beating the market? How do you know?

Part II: A relatively straightforward way to figure out your stock portfolio’s performance

Portfolio performance vs SPY spreadsheet

Canadian Financial Stuff:

Experts that got it wrong (1)

Experts that got it wrong (2)

Topics: Investing |

Comments to “Day 5 - Investing in Stocks”

Brian Says:
February 7th, 2006 at 1:03 pm

Here is a good read from Charles Munger, a business associate of Warren Buffett:

http://www.paladinvest.com/pifiles/MungersWorldlyWisdom.htm

“A Lesson on Elementary, Worldly Wisdom As It Relates To Investment Management & Business”.
Charles Munger
USC Business School
1994

excerpt:

[i]And the one thing that all those winning betters in the whole history of people who’ve beaten the pari-mutuel system have is quite simple. They bet very seldom.

It’s not given to human beings to have such talent that they can just know everything about everything all the time. But it is given to human beings who work hard at it ‑ who look and sift the world for a mispriced be ‑ that they can occasionally find one.

And the wise ones bet heavily when the world offers them that opportunity. They bet big when they have the odds. And the rest of the time, they don’t. It’s just that simple.

That is a very simple concept. And to me it’s obviously right ‑ based on experience not only from the pari-mutuel system, but everywhere else.

And yet, in investment management, practically nobody operates that way. We operate that way ‑ I’m talking about Buffett and Munger. And we’re not alone in the world. But a huge majority of people have some other crazy construct in their heads. And instead of waiting for a near cinch and loading up, they apparently ascribe to the theory that if they work a little harder or hire more business school students, they’ll come to know everything about everything all the time.

To me, that’s totally insane. The way to win is to work, work, work, work and hope to have a few insights.

How many insights do you need? Well, I’d argue: that you don’t need many in a lifetime. If you look at Berkshire Hathaway and all of its accumulated billions, the top ten insights account for most of it. And that’s with a very brilliant man ‑ Warren’s a lot more able than I am and very disciplined ‑ devoting his lifetime to it. I don’t mean to say that he’s only had ten insights. I’m just saying, that most of the money came from ten insights.

So you can get very remarkable investment results if you think more like a winning pari-mutuel player. Just think of it as a heavy odds against game full of craziness with an occasional mispriced something or other. And you’re probably not going to be smart enough to find thousands in a lifetime. And when you get a few, you really load up. It’s just that simple.

[b]When Warren lectures at business schools, he says, “I could improve your ultimate financial welfare by giving you a ticket with only 20 slots in it so that you had 20 punches ‑ representing all the investments that you got to make in a lifetime. And once you’d punched through the card, you couldn’t make any more investments at all.”

He says, “Under those rules, you’d really think carefully about what you did and you’d be forced to load up on what you’d really thought about. So you’d do so much better.”[/b]

Again, this is a concept that seems perfectly obvious to me. And to Warren it seems perfectly obvious. But this is one of the very few business classes in the U.S. where anybody will be saying so. It just isn’t the conventional wisdom.

To me, it’s obvious that the winner has to bet very selectively. It’s been obvious to me since very early in life. I don’t know why it’s not obvious to very many other people.[/i]

Personal Finance Roundup Says:
October 4th, 2006 at 4:59 pm

“2. Keep Trading Costs Low - This is very important. The more you trade your stocks, the more expenses you will incur, which will eat into your portfolio. The only way to accomplish this is to buy good stocks and basically hold them forever.”

That’s the biggest one I had to learn. When I first started I would get good returns but the mutual fund fees would kill me. I now prefer no load funds.

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Day 5 - Investing in Stocks