Question
Q: Okay, My S/O and I want to start in the stock market. What are some good things to remember when just starting out? I'm not asking for tips or rumors, just how to start out.
A:
The single most important thing that I would recommend to you, is the
"percent at risk" concept. It does, of course, need to be adjusted so
that persons with smaller total amounts of money can do anything at all.
Obviously, if all you have is $100, 0.75% of it (equals $0.75) is not
going to buy anything in the way of an investment. On
probably can only have one thing, preferably something like a U.S. Savings
Bond Series EE which will at least eventually become worth more, pay you
for the use of your money, and always be there so that you can cash it
out (anytime after the first six months), for more than you paid for it,
without causing you any problems at tax time in the intervening years.
For $1,000, I would be inclined to suggest as many as ten things. At
least one of them should be those same EE Bonds, $100 worth (or maybe more
if there's fewer things in total than ten). Most places, you can't get a
worthwhile money market account in this range, but there are a few where
you can get a lot more interest than on a bank account for as little as
$100-$250 input. There's more effort involved in trying to buy stocks in
this total value range, but the rest could go into several different high
quality dividend paying stocks, at the rate of perhaps $100 worth for each
stock you buy.
For $10,000, I would be inclined to suggest as many as twenty things,
now getting down to a maximum of about 5% for any one stock. Again there
should be at least some EE Bonds or Series I Bonds (at least $500 worth)
and absolutely for sure a money market account (even the most expensive
retail accounts only require $2,500 to set up) plus the rest in quality
stocks at the rate of perhaps $500 worth for each stock you buy.
For $100,000 (which happens to be the "typical" liquid net worth of
American families as measured at some recent date), I would suggest AT
LEAST thirty things (that's the statistical level at which "adequate
diversification" starts to set in). Again at least some EE or I Bonds
(at least $3,500 worth) to provide some secure money against only the
rainiest of years. Again for sure a money market account with at least
$5,000 in it. The new things at this level are such as exchange-traded
closed-end muni bond funds (provides some tax-free income which has
started to be a question by the time you reach $100,000 in assets) and
perhaps some real estate related investments (such as Real Estate
Investment Trusts) which pay partly-tax-sheltered income at a higher than
typical yield. The rest again in quality stocks at the rate of perhaps
$3,300 maximum for each stock you buy. Also at this level, it starts
making sense to "scale into" the stocks you buy, i.e. buying perhaps
$1,600 worth when a stock first gets into buying range and the rest only
if it goes down some meaningful percentage further.
Once you get beyond 30 different things of sufficiently different
kinds (obviously 30 different tech stocks are *not* going to satisfy the
requirement), the underlying reason for "more different things" (which is
adequate diversification) starts to become less important. Also, the
percentage of your total portfolio which has to be kept in such things as
EE Bonds and other "rainy day" kinds of investments CAN become less, so
long as it is "enough" cash to carry you through the absolute worst
earnings and job environment conditions that you can foresee. Six months
is what some adviser-type people say for YOUNG working people with
skills sufficient to make finding a new job fairly easy; the period of
time for which you need to allow becomes VERY much longer if you're
something like an engineer or a highly paid executive type, where there
tend to be extreme cyclical demands for employees (everybody gets thrown
out of work at once) or where there just aren't that many jobs of the
kind you need to maintain your standard of living.
For me of course, trading stocks IS my job, so I have to pay very
much more attention to 'risk control', than would a different kind of
person whose primary sources of income are from something other than
stocks. The 0.25% maximum for any one stock purchase, 0.75% maximum cash
input into any one thing under high market conditions, 1.00% maximum cash
input into any one thing under genuine bear market conditions, and 4.00%
(usually 5.00% but the current high market conditions have gotten silly)
maximum size of any one holding (bought with less than 1.00% remember)
are rules that I am comfortable with. Research and other portfolio
management TIME requirements put a practical limit on the number of
different things I can own somewhere around 140 stocks plus the usual
set of diversified money market and bank accounts (so there is an upper
limit on the number of different things a person CAN own based on time
needed, just as there are all those lower limits on the number one
SHOULD own based on adequate diversification).
One final note on "percent at risk": putting ALL of your money into
a single brokerage account or into a single mutual fund (even fund family)
is NOT adequate diversification, even if the contents of that account
are "adequately diversified". In that situation, you are increasing the
risk to YOU of something going wrong with the broker itself or the
management of the fund family.
These are the things which, after 38+ years trading stocks and dealing
with the realities of the securities and financial businesses, I consider
absolutely most important to "remember" when starting out.
1. Set an objective as to exactly what you hope to accomplish. (e.g. what
type of returns you are going after, how much you can comfortably put at risk)
2. Determine what timeframe you want to trade. (day, 2-10 days/swing,
short/weeks-months or long term) Your other obligations will likely control
this. Combine your objectives in #1 with #2 and determine if you can
realistically obtain the results you want in # 1 by using the approach you
chose in #2. If not, then you need to tailor #2 to fit #1.
3. Determine Rules for trading (money management, risk control, risk reward
ratio, amount per trade, which market you will trade, etc.) Learn all you can
about how to stick to your preset rules. This is tougher than you think.
4. Develop some method you will use to trade (breakouts, failed breakouts,
trend reversals, certain patterns, etc.) You don't have to learn them all,
just pick one or two and really learn how they work and keep repeating them
until you become really familiar with them.
5. Read all you can. Include some books on the psychological side of trading
and what types of beliefs may be influencing your thinking.
6. Make your own decisions about your trading/investing.
7. Put some real money at risk, because paper trading just doesn't cut it.