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Best Ways to Begin Stock Investing

My blogging friend, AJC over at How to Make 7 Million in 7 Years talked about how a newcomer to stock investing should get started in this post — What is the best way for a newcomer to get started in investing in stocks? In the post, he suggests to use the 2 methods that Warren Buffett uses: Index funds or carefully-picked individual stocks.

There are many ways to answer this. For those of us with little time, index funds are the way to go. But for the savings you get in time, you may well pay for it (and then some!) in terms of lower returns. After all, if you picked 5-10 stocks, over a 10-year period, you might get a 20 percent return, whereas an index fund, like the S&P 500, might return 8-10 percent.

With $10,000, that return differential means you left some serious money on the table (about $36,000). If you spend an hour or two researching some really good stocks (start here), you can assemble a portfolio of stocks that most likely will beat the market (i.e., the S&P 500) over a ten-year period or longer. But if you don't have the stomach or the inclination for it, invest in the market.

At least you'll be average, rather than at 0-3 percent, depending on where you put your "savings." I don't know the foreign markets like I should, but I've done very well investing in foreign mutual funds. In fact, I've had more than 50 percent of my 401k invested in foreign mutual funds for quite some time now. I simply think that the U.S. is only going to grow at a slow rate, if any at all. Surely, our economy won't grow as rapidly as the BRICs (Brazil, Russia, India, and China) in the long-term, probably not even in the short-term.

But because I don't know the individual companies that make up those markets, I simply buy their "market." It's somewhat akin to how we play sectors like telecomm and banking in our own market, but I've extended that strategy to the global market. If I were to take one step further, I might invest in the auto industry, for example, in India, or the waste management sector in China. Both industries are sure to grow by leaps and bounds. So, the "best way" to begin stock investing is to begin by asking yourself these questions:

  • How much am I willing to risk (don't invest anything in stocks outside a retirement account that you're not willing to lose)?
  • How much homework do I want to do?
  • What is my tolerance for volatility?

If you're like most, you'll do well by investing in the S&P 500 and its global equivalents. You'll do better if you pick a few select stocks yourself (more on this in a future post). Even better still, if you have a really strong stomach and spare time or are contemplating a career change, you can invest in the business of YOU. Start your own business in a niche that others won't touch, like in Dirty Jobs. Clearly, some of us don't have the stomach to invest in stocks or stock mutual funds. But it all comes down to how much risk are you willing to take for a given return? Answer that question with a long time horizon and stocks look better and better. Over the past 80 years or so, stocks have averaged far more than alternative investments; in fact, they've averaged above-inflation returns whereas bonds and savings accounts woefully underperformed and lost money when inflation was taken into account. My opinion: Not investing in stocks is riskier than investing in them.

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