Ten Advices

With the bubble of the 1990s clearly over and a return to more rational investing, a lot of individual investors are returning to the stock market.

But many still sit on the sidelines with trepidation. It’s a jungle out there, and there’s a lot you need to know. Here are 10 tips to get you started.

1- Research the market, the sector & the stocks
Investing is all about information. In theory, the more you know, the better you’ll do. But sorting through the information will be your biggest initial hurdle.

2- Don’t assume that free advice has no cost
A number of well-established brokerage houses offer free analyses on their websites and parade their analysts on CNBC and CNNfn. They can be good sources for information, but only when taken with a big grain of salt. Any investor needs to remember two key things about this kind of information:

A- It’s widely disseminated, which means that if you were planning to get a leg up on the other guy, think again.
B- Brokerage houses don’t make money by giving away free advice. Recent Wall Street scandals have shown that analysts at some brokerage houses have been little more than puppets for the brokers.

When analysts were pushing the latest dot-com in the ’90s, the brokers on the other side of the office were selling at a hefty profit.

3- Get familiar with the numbers, but don’t obsess over them
It’s been said that a drunk uses a lamppost the way some people use numbers: more for support than illumination. Stocks are all about the numbers and at any given time, the industry will tout the latest and greatest method of analysis.

The thing to remember is that no number works all the time; if it did, investing would be a science, not an art. You’ll want to learn the factors that go into certain key numbers and keep an eye on them, but if you find yourself saying that because a certain number equals X and another equals Y, the stock must rise, you’re setting yourself up for a fall.

For example, some of today’s investors live and die by the P/E ratio. P/E stands for price/earnings, which means that it’s created by the price of the stock at the time of sale, and divided by the company’s yearly earnings.

A company with a high P/E ratio is generally not a good buy because the number is a quick and dirty way for investors to compare growth, and a high number usually indicates a company that isn’t going to grow and therefore won’t return on your investment.

Another method, which is quite different, is to invest based on a stock’s relative strength. This form of analysis captures the momentum of a company and weighs its performance against the performance of the rest of the market.

Stocks are literally given numerical ratings for a given period. The rating system works on a one through 99 scale, with the higher numbers indicating better buys. Investor’s Business Daily is one of several newspapers that publish these kinds of rankings.

The upside is that the system quantifies the irrational tendencies in the market, but the downside can be just the same. In other words, you may be able to ride the momentum train straight up for a while, but without paying attention to other factors, there’s no telling when the stock will go down.

4- Never pay for advice
Look at the investing aisle of your local bookstore and you’ll see a cottage industry of “make money in stocks” type books. Don’t be fooled. Anyone who had a great stock system wouldn’t share it, not even for $29.95 per book.

5- Stick with what you understand
Investors read about companies the way sports fans read about their teams. When picking a sector or a company, you have to apply some common sense and intuition. If you can’t understand how the company is going to make money, don’t assume that you’re wrong.

Remember Pets.com? There was a time when a lot of people thought that that company had a new business model that would make millions. But it turned out to be just a bad idea. To be a good investor you don’t have to know how to run the company; you need to see the broad strokes of why a particular company can make money.

6- Monitor the market before you buy
Just as you dip your toe in the water before swimming, so too should you watch the market before investing. If you’re only a casual market watcher, spend a month tracking the market by watching a financial news show and reading the business section of the paper. You’ll gain valuable experience with the lingo and get a better sense of how things work.

7- Decide whether to invest long term, or make a quick profit
Everybody wants to make money right away, but asking yourself what you expect out of your investment will clarify your strategy.

Long-term investments are best served by buying funds, which invest on a macro scale. The basic idea is to diversify your portfolio to create steady, lasting growth. However, tactics can vary, with some funds dipping heavily into tech stocks and others opting for more traditional brick and mortar companies.

Other funds work on a more unique premise, like the Vice Fund, which buys companies that make products that cater to, you guessed it, vices, on the theory that people drink, smoke, and indulge no matter how bad the economy is.

Or, there are more conservative options, such as buying a fund that simply tracks an established index, like the Dow Jones. If you choose to buy a fund, check out a well-established website like moneycentral.msn.com (formerly CNBC.com) for a survey of the major funds.

By contrast, short-term buys work on a micro scale. When you buy short term, you’re betting that a company’s stock will rise for one reason or another in a given time period. That kind of investment can be a high-risk enterprise that requires your full attention because you’re putting all your eggs in one basket and you’ll need to know precisely when to take them out.

If short-term investing is for you, pick a broker or online service that trades as close to real time as possible. In the short-term game, seconds count as stocks rise and fall.

8- Shop around for worthwhile brokerage options
A traditional broker relationship can be an expensive one. Brokers charge a commission for each transaction, but that fee reflects more than just the cost of the trade. Essentially you’re paying for the advice of a professional. However, brokers are busy people in a volume business, so when you try to exploit the broker’s advice, you might find that he’s moved on to the next name on his call list.

The objective is to never pay for what you don’t use. Unless you’re investing a great deal of money, you won’t find more than a salesman in your broker.

If that’s the case, you’ll want to look for an online company such as Etrade.com or Scottrade.com, which charge a nominal fee for trades (between $7 and $17 US, depending on the type of trade). All such online brokerage houses will require that you maintain an account minimum, usually about $1,000, but in some cases that may entitle you to several commission-free trades.

9- Buy stock directly from the company
If you’re planning on making a few buys but not doing much trading, consider buying directly from the company. To qualify for this option, you’ll likely need to already own a share of stock in the company.

As a stockholder, you can make use of the company’s investor relations department, which will advise you about the various commission-free options for buying more of their stock.

10- Keep in mind that investing is a gamble
If you’re looking to win big, you must be prepared to lose big. Stock is not FDIC (Federal Deposit Insurance Corporation) insured, which means that unlike a savings account, the potential risk could be as high as losing it all. It may seem like an obvious point, but a lot of people seemingly forgot that lesson during the ’90s tech bubble. The people that survived the bubble did so because they saw the risk and planned accordingly.

By Michael Estrin
Financial Correspondent - Every Tuesday