Stocks & Mutual Funds

Remember in the movie The Graduate, where the older man comes up to Dustin Hoffman, who plays the graduate, and says one word of advice to him. He says plastics, and everyone in the audience laughs because they thought that was very funny. Well, it might have been a funny line in the movie, but in real life if you had bought chemical companies that made plastics in the late 1960's and held them, you would have done very well. So, what’s the point? Picking stocks is in good part analyzing companies and their future earnings. Now stop and think about that for a second. Picking stocks requires analysis of companies, plural. Reading up on one company in an industry and not looking at its competition here in the USA and around the world may not be enough to be a successful stock picker.

For the great majority of us out there, there is an alternative to being a stock picker. That alternative is being a mutual fund picker. Picking the right mutual fund for yourself is a job in and of itself because there are thousands of mutual funds out there to pick from. So, what can you do? You can go to the library and do some research in a publication put out by Morningstar that will give you information about thousands of mutual funds. You can check on a mutual fund over its 3-year, 5-year and even 10-year performance record. You can look at what kind of stocks the mutual fund buys. There are funds that buy large cap, mid-cap and small cap stocks. That simply means they buy either large companies with a capitalization of $10 billion or more, or mid-cap with a capitalization of $2 to $8 billion, or small cap with a capitalization of under $2 billion. Once you decide on a mutual fund or two, then you can just monitor the performance of the fund and not worry about the performance of each individual stock.

For those that want to live more dangerously and buy individual stocks, you better be prepared to learn something about analyzing companies and understanding the stock market. Stocks and their movement sometimes have little or no relationship to what the fortunes of the company are. There are markets where a company can be doing everything right and yet because of market psychology, the price of the stock goes nowhere. In fact, there were companies during the dot com mania that were ignored completely despite that fact that they were growing their business and were becoming stronger companies by every measure. As I stated at the beginning, knowing one company in an industry is not enough.

A portfolio of stocks should have around 12 to 15 stocks to obtain diversification, but then you should follow about 50 companies so that you can have replacements for stocks that do not perform well. People buy stocks for many reasons, but one reason is to see the price of that stock go up. Not only do you need to follow 50 companies, they should range over several different industries so you don’t put all your eggs in one industry. Now if you think you want to play the stock market, have a go at it. As long as you do not do any short selling, you can not lose more than you put in.

Personally, for the average individual that wants to be in the stock market, mutual funds are the way to go. Find a couple of good performing mutual funds, whose expense ratio is not too high and whose performance is good over at least a 3 to 5 year time frame and then put the same amount of money into the fund every month or quarter. Over several years, you will have achieved what some refer to as dollar-cost-averaging. And, if you set the fund up to reinvest the dividends and capital gains, you will have an opportunity to watch the value of your portfolio grow. This is not for the short term. Investing is a long term strategy to beat inflation. If we could all just stick our money in the bank and our money would have the same purchasing power in 5, 10, 20 or 30 years, then we would not need to invest our money. Maybe. But, it does not take an Einstein to figure out that our money loses purchasing power every year. Take a look at the price of gasoline over my lifetime. When I was a teenager, you could “fill up” a tank for the weekend for 50 cents and go out and have a good time. Today the price of a gallon of gas is approaching $4.00, and in some places in the country gas is selling for more than $4 a gallon. What will food, clothing, shelter and health care cost in 5, 10, 20 or 30 years? Because inflation reduces the purchasing power of your dollar, you need to invest. It is just that simple. Stay tuned.