Posted by Robert on February 18, 2013
From time to time, people ask about how they should invest their money. Occasionally, they are looking for stock tips. Before getting into that, I want to be clear that advice is usually worth what you pay for it. Part of the reason for that is that anyone can be an armchair quarterback or an armchair stock picker. It really takes no special skill or insight to be able to stand b y the watercooler and say: “I think Blackberry is in for some smooth sailing.” (Or the opposite.) The other part of the reason that free advice isn’t usually valuable is because the person giving advice needs to really understand your individual situation before giving advice that will be useful to you.
Why do people look for stock tips? I think that one reason might be related to why people buy lottery tickets. But more often, it’s probably the complexity that causes people to wonder where to begin. In Canada, the TSX lists over 300 companies and the Venture exchange lists hundreds more. In the US, the exchanges list thousands of companies. Where does a potential investor start looking?
Tip #1: I would start with the constituents of the TSX 60. The companies in that list are large, well-established and well-researched. It seems unlikely that any of those companies would go bankrupt overnight. If trouble is on the horizon (as was the case for Blackberry five years ago), it should be visible from a distance. There are still plenty of risks, but overnight insolvency isn’t one of them.
Tip #2: Don’t pick too many or too few stocks. If you choose just one, you will likely be in for a roller coaster ride. Wait, did that make it sound like fun? Think of a fishing boat in the ocean during a raging storm. Most people can’t stomach that kind of volatility and be tempted to sell (even at a loss) and swear off stocks. At least with a portfolio of stocks, gains in one will somewhat offset losses in another. If you choose every stock in the TSX 60, however, you’ll waste your energy and possibly spend too much in commissions. Anywhere between 10 and 30 stocks provides all the benefits of diversification, while controlling costs.
Tip #3: Choose companies that aren’t similar. There would be no benefit to buying all the gold producers of the TSX 60, and no other companies. When gold goes up, they all benefit, but when gold goes down, they all suffer. It makes far more sense to buy the most attractive gold producer and something totally unrelated like a retail store. That way, the fortunes of the two companies are unrelated and they should zig and zag separately (except when the entire market rises or falls).
Tip #4: Don’t overthink. Spending more time on deciding what to buy has been shown to make investors more confident, but it doesn’t help them make better decisions. To clarify, people who research stocks longer don’t choose better stocks, they just feel more strongly that their stocks are better. It can’t hurt to keep in mind that your investment isn’t guaranteed and it could go wrong. There’s no point watching the ups and downs of every day, but checking in once a week or once a month to ensure nothing has gone off the rails is only responsible.
Picking stocks isn’t for everyone, and it isn’t always fun. For investors with the time and the interest and a large enough portfolio, it can be profitable. For someone who wants to learn, starting small is a great way to gain experience without taking undue risk. Do you pick stocks? Have you had successes and failures? What would you tell someone who is thinking about buying individual stocks?