Investment strategies made easy: here's how to overcome your fears of the market and invest like a pro.
Here are some of the most common beginning investment strategies. The strategy that you choose should be in keeping with your investment objectives, financial means and risk tolerance. Additionally, consider how often you want to read or monitor the financial news.
BUY AND HOLD
The merits of buying high-quality stocks and holding them for the long term are rarely addressed. Yet this strategy can produce substantial returns, without your having to read the financial press every day or even every month.
Historically, the stock market has moved upward, continually increasing in value over time. Clearly, there have been market crashes (1929), market breaks (1987) and market corrections (1989) when the prices of all securities plummeted precipitously. Following each decline, however, the market recovered and moved still higher. Anyone who owned shares or a portfolio of stocks that reflected the broad movement of the market has seen their value steadily increase through the highs and lows of the market. By simply being in the market during a period of sustained growth, such as the 1980s, an investor would have seen his or her net worth increase. The buy-and-hold strategy puts you in a position to profit from this long-term upward trend of the stock market.
Selecting the stocks to buy and hold is somewhat more tricky. Look for stocks of companies that have a high degree of financial strength (including good profit margins), are industry leaders or pacesetters in product sales and development and are taking steps to improve their current market share and ensure long-term growth. The stocks that meet this description are generally blue-chip stocks (except those that have lost their luster, like Chrysler), income stocks (particularly shares of public utilities and telephone companies) and established growth stocks. A typical conservative, income-oriented investor might place more money in income stocks, while a slightly more aggressive, although still conservative, investor might invest more in established growth stocks. The key factor is that the stocks in these categories have the potential to increase in price and pay higher dividends over the long term. For an investor who buys and holds, these features certainly increase the likelihood that the strategy will be successful.
One particularly beneficial aspect of the buy-and-hold strategy is the compounding effect that a dividend reinvestment plan can have on your return. Many companies offer their shareholders such a plan. Instead of receiving dividends in cash, you can direct the company to use the money to buy additional common shares for You. Shortly after you buy a company's stock, you will receive a package of information from the shareholders' relations service department of the corporation. This correspondence welcomes you as a shareholder and invites you to participate in the company's dividend reinvestment plan.
Dividend reinvestment offers small investors an easy way to build wealth. It works best when the company has a solid history of dividend payments and steady price appreciation.
Dividend reinvestment plans do have some disadvantages, particularly in the area of taxation. First, dividends are considered taxable income to the investor in the year in which they are paid out, even if they have been used to buy additional shares of a company's stock under a dividend reinvestment plan.
Second, the investor must keep records of the market price at which each additional share is purchased. If a person sells only some of the shares acquired through dividend reinvestment, different tax rules apply. A tax specialist should be sought for advice in this and similar situations. Despite these complex tax implications, dividend reinvestment plans provide a convenient and easy way for investors, particularly small investors, to build ownership in a company over a long period of time.
Indeed, the buy-and-hold strategy is largely passive, but it should not be thought of as a synonym for what some people jokingly call the "buy-and-neglect" strategy. Investing by neglect - buying small amounts of different stocks, throwing the certificates in a drawer and forgetting that you own them - has been known to provide some investors (or, depending on the degree of negligence, their heirs) with surprising gains, but profits from this strategy are more the apocryphal exception than the rule.
The buy-and-hold strategy has proved to be one of the most convenient ways for small investors to get started in stocks. Investors using this strategy must maintain a long-term view of the market and stay the course through the usual declines or reversals of the market. In a real sense, you are on autopilot after making the initial decision. Minimum vigilance is required - just enough to monitor any changes in the long-term prospects of the company that may warrant selling the stock and investing in shares of a more suitable company.
Dollar-cost averaging is a long-term strategy whereby you invest the same amount of money in a stock or mutual fund at regular intervals - monthly, quarterly or semiannually. You buy the security without consideration of its market price at the time of each purchase. Consistency in the amount invested and the regularity of the payments are essential to the success of dollar-cost averaging in order to minimize pricing and timing risk.
Dollar-cost averaging works on the following simple principles. When the price of the security declines, the fixed investment amount buys more shares. Hence, your purchasing power expands. When the price of the security rises, the fixed investment amount buys fewer shares. Consequently, your purchasing power contracts. Over the long term, you wig discover that the cost of each share is lower than the average price per share during the investment period.
At first reading, this explanation of dollar-cost averaging sounds like a form of investment alchemy. After all, how can securities bought over a period of time cost less than their average price? The simple example that follows illustrates the mechanics and benefits of dollar-cost averaging.
You invest $200 on the first of each month, purchasing odd-lot units of a particular stock or shares of a mutual fund. As is characteristic of the market, the price fluctuates and is therefore different each time you buy the stock.
The average cost per share in this instance was $24.74. This is computed by taking the total amount invested regularly during the 12-month period and dividing it by the number of shares purchased: $2400/ 97=$24.74.
Each share cost $1.09 less than the average price per share during the same period. Given the fact that the price of a security always fluctuates, dollar-cost averaging guarantees that your cost basis will always be lower than the average price per share.
The fact that the average cost is lower than the average price does not mean that you have a guaranteed gain. Such a guarantee would indeed be investment alchemy. If a stock's price trend is downward, for example, the average cost will still be lower than the average price; however, you would have an overall loss on the price of the stock. An examination of the first six months of the period illustrated in the chart illustrates this point. The market price at the beginning of this period is $25 per share. In the sixth month, it is $18, a decrease of $7 per share. The average price per share during the six months is $21.67 ($130/6). The average cost per share, however, is $21.28 ($1200/56.38), 39 [cents] lower than the average price.
Dollar-cost averaging works in both a declining market and a rising market, and its benefits are enhanced when it is combined with a dividend-reinvestment plan. However, the strategy offers no guarantees that you will make a profit on the investment or be protected against a loss.
For each investor, the specific benefits of dollar-cost averaging will be somewhat different, depending on the length of the investment period, the fluctuations in the security's price during this time and the amount of money invested.
Like the buy-and-hold strategy, dollar-cost averaging starts from the b4sic premise that the price or value of stocks has tended to increase over the long term. The success of this strategy depends on your discipline in adhering to the following principles:
1. Invest over a long period of time. Dollar-cost averaging should be continued for 7 1/2% to 10 years. This recommendation is based on the cyclical history of the market. During the past 100 years, there have been about 40 recessions - that is, severe market corrections - or a downturn about every 2 1/2% years. If you continue to invest through about three of these corrections, the benefits of dollar-cost averaging tend to be maximized.
2. invest at regular intervals, monthly or quarterly is preferable.
3. invest regardless of the price of the stock.
4. Choose high-quality stocks or mutual funds. A company or fund with a history of regular dividend payments and the potential for capital appreciation is a good choice. Dividend reinvestment can enhance the benefits of dollar-cost averaging
Be sure you have sufficient fortitude so that you can stick to the plan through highs and lows, and sell out at the peak. Thus, the money allocated for dollar-cost averaging should be wealth-building funds, not committed funds.
Periodically, review the financial statements and other information of the relevant company to determine whether it is still in keeping with your stated investment objectives.
ABOUT THE AUTHOR
On Wall Street, financial brokers and traders aggressively play the stock game from dawn to dusk. For these high rollers, nothing happens by chance when it comes to who wins or loses. No one knows this better than Alvin D. Hall. He's teaching the "old boys" and new ones alike the tricks of the trade.
Hall, 41, is the president of a New York training firm offering courses and training manuals covering the gamut from stock and bonds to futures and options. He also teaches prep courses for the licensing exams required by the National Association of Securities Dealers. Now Hall is targeting the general public by offering a series of books, the first of which is Getting Started in Stocks.
"If you're an expert you tend to talk in the jargon of the industry," says Hall. "I'm a good interface, because I can understand the jargon and translate it into a language the average person can understand."
Prior to starting his own company, Hall was executive director of marketing and licensing programs for the New York Institute of Finance, Wall Street's oldest training school founded by the New York Stock Exchange in 1936. Surprisingly, this street-smart entrepreneur has never had any formal financial training, though he holds a BA in English form Bowdoin College and a Master's in American Literature from the University of North Carolina at Chapel Hill. His trench work came from four years of service with the Wall Street training firm Leo Fleur Inc. form 1982 to 1986.
After the stock market crash of 1990, Hall took an early retirement of sorts, leaving the New York Institute of Finance to form Alvin D. Halls Associates Inc. Today, some of the heavyweights of his clients list include major brokerage houses such as Dean Witter Reynolds, and the NYSE. Not half bad for someone who shuns the title of expert.
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|Title Annotation:||includes excerpt from book and related article on 'Getting Started in Stocks' author Alvin D. Hall|
|Author:||Brown, Carolyn M.|
|Date:||Mar 1, 1994|
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