Wednesday, October 18th, 2017

Follow Us

Evaluating Investments: Part 2

"Make smart choices. Then stick with those choices."

This is the eminently sage, deep, wise, and excellent ShareBuilder investment philosophy. We already looked at the reasoning behind it. (Missed the wisdom? Read Evaluating Investments: Part 1 ) Now we get to the hard part: Just precisely how do you make smart investment choices in the first place?

No magic formulas here. If you want a magic formula, check out some of those unsolicited e-mails, the ones with promises of "ultra quick wealth-building" and "guaranteed" returns.

Back in the real world, there’s no escaping the hard work of evaluating individual investments. It’s the very task that professional investment advisers get ulcers trying to perform. What makes investment evaluation tough isn’t lack of information. Oh no: there’s a ton of information, and you can find plenty by going to the ShareBuilder Research tab .

Easy, right? Just enter the ticker symbol, and … whoa! If you don’t know much about stocks, what you’re going to see can be overwhelming. That’s not Icelandic you’re looking at, it’s Financialeze: Highs, lows, P/E, dividend, EPS, etc. If you don’t speak Financialeze yet – and even if you do – let’s take several steps back. Get out of the dense, spiky trees and look at the nice green forest.

First of all, understand that the greatest financial gurus in the world don’t know what to make of this information. They’re just better than most of us at extracting interesting hints from it. Don’t be intimidated by the existence of people who can balance a weak price/earnings ratio against strong sector growth in their sleep: they too make some good investment choices and some poor ones.

The important thing (especially if you’re planning to plunge right into individual stocks) is to know where you are going, and to understand something about diversity and asset allocation. Why? Because all the facts in the world about an individual investment are meaningless except in the context of your own circumstances and needs. Once you’re familiar with that personal context, you may be in a position to start constructing a list of five or ten stocks for a tentative, always revisable "Hmmm, sounds good to me" list.

But wait. There is an easier way. Investing in individual stocks is just great, if you are comfortable with it. If you’re not (or even if you are), look carefully at the advantages of starting with a few index shares.

Money invested in Global Widget is totally dependent on the fortunes of Global Widget. Maybe you’re betting it will continue its three-decade expansion, and even rise sharply in value as its new UltraGizmo product takes the world by storm. Great… maybe. Great unless tiny, unheard-of MicroDodad, Inc. steals the market. 100% gain? 100% loss? Can we say "roller-coaster"?

You can avoid this scenario by splitting your investment between many stocks and index shares. With index shares, every dollar you put into it is spread across all the stocks in the relevant index. $1,000 invested in the Dow Industrials index (DIA) is spread evenly across all 30 companies, the same amount in the S&P 500 index (SPY) is spread across 500 companies.

DIA and SPY are just two of the 68 index shares you can use for ShareBuilding. In any index, the stocks represented could all go way up or way down at the same time. But, in the long run, you are probably much better insured against extremes than if your money is in a few hand-picked stocks. Not exciting news for the get-rich-quick merchant, but excellent news for the long-term ShareBuilder.

For ShareBuilders who still want to do their own stock-picking, or those who want at least part of their investment to be in hand-picked stocks, the best advice is educate yourself. Read the other articles in the ShareBuilder Education Center.

In virtually all cases, you should be asking yourself whether you think this stock or index share is a good bet for the long-term. You’re planning for retirement, aren’t you? Or college costs, or some other goal that’s years away? If you’re here because you just can’t live without next year’s BMW, get out quick and try "investing" at a casino. So the fact that some company or sector is hot now (or not hot now) is fundamentally irrelevant to a wise choice.

And remember, when Uncle Rodney starts yakking about his 35% annual return in TrendyFund and telling you what a fool you are for not "getting on the up escalator."

Ignore Uncle Rodney. Or use him as a tripod: rest your binoculars on his head, and take a long quiet look at the horizon.

This entry was posted in Investing Basics. Bookmark the permalink.