Stocks, like investors, come in all varieties. So do mutual funds. There's something for everyone in the investing world. The question every investor asks is: which is one (or ones) are right for me?
So much depends on your personality. If you have no tolerance for risk, then don't buy any. Stocks and mutual funds have lots of risk, even the most stable, rock solid ones. That's because they function in the real world. The real world is fraught with surprises, many negative, some positive. The best laid plans often go astray in a world that has terrorists and heavy competition. Great management can only do so much but it can't control outside events that affect bottom lines negatively. If you want no risk, put your money under a rock or a mattress. You won't make any money on your money, but you won't lose any either, except in times of inflation when your money is losing value as it sits.
Some investors think buying U.S. government bonds (or notes or bills) carries no risk. They're almost right because the government can always print more money to pay interest or refund an issue. Except when there's a debt ceiling limit. As there is now. If a new debt ceiling isn't passed, then part of the penalty may be that interest isn't paid on outstanding government debt and/or that issues that are maturing won't be paid off. Furthermore, if there is a default, the value of U.S. government issued debt will go down, hurting outstanding issues in their prices. So there is some risk to owning even U.S. government debt, but it's very low. And with low risk comes low reward. As of this writing, 3 month bills are yielding .03%. A few days ago, it was .01%.
If you have some tolerance for risk, then you'll want to consider the large cap, solid earning stalwarts or mutual funds that specialize in them. Many of them are the ones that make up the Dow Jones Industrial Average. These are 30 companies with large capital bases and (most of the time) increasing revenues and earnings.
Just don't think all risk (and volatility) is eliminated with this approach. You'll still get plenty of both. It's just that these large stocks tend to go down less and recover quicker when the stock market has its inevitable wacky moments.
Of course, there are plenty of great large cap stocks outside the DJIA. You can find them in any stock screening program by looking for stocks that have a Market Cap over $10 billion. Stock screening programs are at Web sites like: www.finviz.com, www.screen.yahoo.com/stocks.html, www.google.com/finance/stockscreener, www.marketwatch.com/tools/stockresearch/screener/
For mutual funds, check out: www.screen.morningstar.com/StockSelector.html, www.forbes.com/lists/2010/42/mutual-funds-2010-lens/
Let's move up the risk ladder to where you can tolerate risk completely. Now you're into stocks with no earnings, no revenues and lots of hope. Some of these stocks will make it. Most won't. If you put all your money into these high risk stocks, you won't have much for very long. If you can keep 10% of your portfolio in this area, you'll be fine. But investing in stocks with only promises is like putting all your money on one number at the roulette table. Most likely you aren't going to walk away with more money than when you arrived. Some of the industries well known for producing wonders and whimps are bio-technology, technology, China, eco friendly, wind, nanotechnology. The list is long and full of skeletons. Some of them have a few of my bones.
Which stock is right for each investor comes down to individual tolerances for risk. Many investors shouldn't be in the market at all because it only causes stress (it does for everyone it's just that some people handle stress much better than others). Having given that danger signal, the market is still a great place to have your money earn money. It's just a matter of picking the stock or mutual fund that allows you to have the least stress. Of course, the higher a stock goes, the less stress you feel. So picking the right stock or mutual fund that goes up nicely is still the basis for the best stock. That's the challenge we all face, no matter our tolerance for risk.
- Ted Allrich
July 12, 2011