If you haven't been involved in the stock market, ask yourself how much
can you afford to lose, both financially and temperamentally. Yes, I
did say lose. The
brokerage community usually asks, ``How much do you want to make?'' A
silly question, don't you think?
I know I have no limit to the amount I am willing to make. ``Two million, not a penny more,'' you may say. I don't think so.
After you have decided that you are willing to accept the risk of loss,
and how much you are willing to risk (even prudent investment has
risk), I would advise starting
slowly.
If you have a few thousand dollars to invest, consider starting with a diversified mutual fund, perhaps Vanguard S&P 500 Index
or
Vanguard US Growth (VWUSX). There are dozens of high quality, no-load
funds that invest in larger company stocks. I would avoid individual
stocks as they increase
both your risk and your potential for reward -- not a prescription for
a beginner.
Give your investment some time. Don't invest in equities with the
intention to pull the money in weeks, months or even less than five
years.
When you're more comfortable with the ups and downs of the market, then
you can consider increasing your investments and broadening their diversification, again
consistent with your risk tolerance.
The worst luck a beginner can have is making a lot of money right away.
After that happens, many decide that investments are guarantees, and
they invest all they
have.
So my advice to you is to invest a little that you can afford to lose.
Watch the ups and downs of the market and become comfortable with the
volatility while at the
same time increase your knowledge in available investment choices and
risks.
Over time, you should have a diverse portfolio of mutual funds
consistent with your goals, objectives, risk tolerance and tax
situation.
Value vs. Growth
VALUATION begins and ends with profits. Just about everybody agrees with that. The faster a company's
earnings grow and the more reliable they are, the more investors will pay for its stock (See How Much Is
This Stock Worth? for more.)
When it comes to strategy, though, Wall Street is decidedly less single-minded. Everybody wants to buy
low and sell high. But how low is low and how high is high?
Generally, the Street is torn between two camps: Growth and Value. Growth investors believe in buying
stocks with above-average earnings growth no matter what the price. Value investors look exclusively for
"bargains," or stocks that are trading at a discount to their usual valuation.
Which strategy makes the most sense? There's no right answer -- people
make money both ways. But there are several reasons why we think a
value approach is superior, particularly for long-term investors.
First of all, history shows that when you buy stocks that are cheap
relative to others (more on that in the next lecture), your returns
benefit over time. It's easy to see why. Suppose you're looking at a
stock that typically trades in a P/E range between 20 and 30. If you
buy it at 20 and let it move up to 29 before you sell, you clearly see
a bigger profit than if you buy at 27, let it move up to 30, and then
sell when it starts to head back down. Even if you ignore short-term
cycles and hold it for the long term, you're better off if you buy the
stock as cheaply as possible in the first place.
The danger, of course, is that the your company has problems that
justify its low valuation. What if it stays at 20 and holds your money
hostage. That's something growth investors rarely have to worry about.
But if you choose companies that are in good financial shape and
there's an explanation for why their stock is selling cheap, chances
are the shares will resume their growth eventually. And if they don't
budge off the bottom, you really haven't lost much. That isn't true if
you mistime your exit from a volatile high-multiple stock and get
caught in a downdraft.
The ideal stock, of course, will have a low P/E and a rapid rate of
earnings growth. Unfortunately, such situations are rare since any
whiff of growth attracts investors and boosts the price. But that
doesn't mean there aren't times when a stock like Microsoft or Cisco Systems is selling at a much lower price than it should. You just have to be ready to pounce.
And that's really the point. Above all else, we believe investors
should be opportunistic as they set out to build a balanced portfolio
of stocks. You shouldn't miss the opportunity to own big, important
companies like Microsoft or Wal-Mart.
But you shouldn't pay too much for them either. The key -- and the
subject of the next lecture -- is learning how to tell when it's time
to buy.
Exchange Traded Funds-ETF's An exchange-traded fund (ETF) is a basket of securities designed to replicate the performance of a stock or bond index (e.g., S&P 500, DJIA). ETFs are listed on an exchange and can be traded intraday at a price set by the market.
ETFs add the flexibility, ease, and liquidity of stock trading to the benefits of traditional index fund investing. To better understand ETFs, it may be helpful to understand index funds, which share some similarities. Both ETFs and Index Funds:
Allow you to buy an interest in an entire portfolio of securities by purchasing a single security
Are passively managed and have limited expenses
Are designed to track the performance of an unmanaged index
Track a broad market index or target a specific sector or segment of the market
Track markets in various regions or countries
Key Differences Between ETFs and Index Funds
ETFs
Index Funds
Shares can be bought and sold at intraday market prices on an exchange. If permitted by your broker, shares on the secondary market can be bought on margin or by limit order, and may be sold short subject to exchange rules.
Shares can be bought and sold directly from the fund at a net asset value set once per day, typically at 4 p.m. ET. Index funds generally cannot be sold short or bought on margin.
Generally have lower expenses than traditional mutual funds (and even some index funds) and may have some tax efficiencies at the fund level.
Tend to have lower expenses than traditional mutual funds.
Don't have investment minimums (i.e., you can buy one share) or sales charges other than the cost of a transaction.
Have investment minimums that vary by fund. Fund shares can be either load (i.e., incur a charge upon purchase) or no-load.
Rapid trading in the secondary market by other investors does not create costs for other shareholders, and since the price is set throughout the day by the market, there is no opportunity for late trading.
Rapid trading by other investors can create costs for other shareholders since the fund manager must have cash on hand (or sell shares of securities to generate cash) to satisfy redemptions.
Shares are not individually redeemable from the fund. Instead, they must be sold on the secondary market.
Shares are individually redeemable from the fund.
Shares are sold on the secondary market at market value, which may be less than Net Asset Value (NAV). There are no sales loads, however, transactions on the secondary market are subject to brokerage commissions.
Shares are redeemed at Net Asset Value (NAV).
Which Is Right for You?
Generally speaking, if you are a long-term investor making smaller, periodic investments, you may want to consider traditional index funds over ETFs, because index funds can be purchased with no transaction commissions.
If you have longer time horizons, larger, lump sum amounts, and are investing in a taxable account, you may want to consider ETFs over index funds for capital gains advantages. Because of the low turnover rate of the securities that comprise an ETF, and because ETFs are not required to sell securities in order to meet investor cash redemptions, ETFs tend to generate fewer capital gains than mutual funds. Keep in mind, however, that you will generate taxable capital gains/losses if you sell the ETF shares.
What Is an Index?
Most indexes are a collection of securities that provide a statistical measure of a market or a subset of a market. The earliest indexes were designed to gauge the market's general direction. For example, the Dow Jones® Industrial Average (DJIA®) was created in 1896 by Charles Dow and originally tracked the performance of 12 large U.S. stocks. The DJIA, like the S&P 500® and Wilshire 5000®, now serves as a benchmark of how well all stocks on the American markets perform each day.
How Indexes Work
Whether an index was created to gauge the performance of the market, or as a benchmark to measure the performance of an investment manager, most indexes are comprised of securities. Some indexes use objective and transparent rules to determine their constituent securities, while others are more subjective.
Reconstitution, or the periodic rebalancing of an index, is important because security characteristics change over time. For example, a small cap security can grow into a mid cap over time. The timing of reconstitution is important, because it allows for close mirroring of the market. Indexes need to be reconstituted regularly; too frequent reconstitution, however, can result in turnover costs for investors.
Passively-Managed vs. Actively-Managed Funds
A long-standing debate exists about the merits of passively-managed (index funds) and actively-managed funds ( traditional mutual funds).
Active management is the deliberate selection of securities — unlike passive index investing, which closely follows the stocks in a particular index. Because active managers perform research to select only the stocks that they believe will outperform the market, their funds tend to have higher expense ratios to compensate the managers and research staff.
An index fund manager attempts to replicate the performance of the underlying index by buying all the stocks that constitute the index, or uses statistical sampling to the extent that buying all stocks is unreasonable. The manager then holds the stock in the fund until the index is reconstituted. Index fund managers don't rely on a research staff, nor do they buy and sell securities as frequently, so the expense ratios tend to be much lower. source Fidelity.com
