Carl McCall
By Carl McCall
As a member of the New York Stock Exchange Board from 1999-2003 where I was responsible for investing a pension fund valued at $120 billion, I understand that investing in stocks can appear to be a daunting task. Investing some of your savings in stocks can help you achieve the goal of a comfortable retirement. But it can also be risky if you are not careful.
Owning stock means you own part of a company. Companies sell these pieces of ownership (shares) to raise money to finance their business. When the stock's value increases, an investor can earn money. When a company shares its profits with investors, it's known as paying dividends.
There are various types of stocks that we can buy and risks are associated with each. Index funds are mutual funds that hold all or a sample of the stocks or bonds that are included in a particular index. The S & P 500, which we often hear about and which generally tracks large companies, is an example of an index. Some other examples of index funds include:
- Russell 2000
- Wilshire 5000
- Lehman-Brothers Aggregate Bond
- NASDAQ 100
If you are thinking about buying individual stocks, you will more than likely have to go through a broker. The broker, in turn, will receive a commission when she buys and sells for you. The name of the game is reducing your risk so make sure to diversify your stock choices.
Financial experts tend to group stocks based on their perception of a company's basic financial health, its current price and its historical performance. These categories of stocks include:
- Growth stocks have a high price, although earnings may be low or non-existent. Investors that own this type of stock expect better returns in the future.
- Value stocks have a lower price in relation to their earnings, because investors may consider them a bargain.
- Income stocks are associated with companies that have a history of paying dividends. They tend to be large-caps and utility stocks, and some look at them closely as an investment option for retirees or those near retirement.
It is no secret that stock ownership involves some risk. But a great way to reduce the risk is to buy shares of stock mutual funds (a pool of money from many investors). One of the attractive things about a mutual fund is that a financial professional manages it, decreasing your worries about how to manage your investments. There is also natural diversification built in, as the manager will reduce the risk by spreading your investments broadly.
So, what do you need to think about before purchasing stocks? There are five key principles to consider:
- Keep your fees as low as possible. Fees and expenses reduce your returns over time. But remember, you may have to pay commissions to buy or sell funds and there will always be an administrative fee, known as the "expense ratio." This cost is subtracted from your account, which cuts into your return.
- Consider index funds that seek to mirror the performance of the broader markets they represent.
- Diversify your investments to reduce your risk.
- Rebalance to keep your investment goals on track. Rebalancing refers to adjusting your assets periodically to meet your target allocation of stocks, bonds and cash. Rebalancing helps you maintain your target asset allocation among stocks, bonds and cash. If the value of the stocks in your portfolio increases, the ratio of stocks to bonds could change. Over time, you could end up with more risk than you realize.
- Keep it simple. Owning a few simple, well-chosen investments is a sound approach for many investors.