This week’s “pin” features stocks. We have compiled a list of basic stock fundamentals with links to further explain the material provided.
1) Sectors. Sectors are a way of categorizing and classifying stocks. They are typically classified by type of business or industry. The fastest growing sectors are currently the health and technology industries, although that varies often.
2) Growth vs. Value. Growth stocks are just as they sound: they are anticipated to grow at an above-average rate. Value stocks, on the other hand, are viewed as bargains in the sense that the market has undervalued the stock and the investor hopes to get in before the market corrects the price.
3) Company size (“capitalization”). A company’s size is measured by its market capitalization. Large-cap companies are typically established with a lower growth prospective than small cap. Small-cap companies tend to have higher growth potential in the long run, but investors may see more volatility with small-cap stocks since small companies have a higher likelihood of running into trouble as they expand.
4) Risk. The possibility of a stock performing worse than expected. There are many types of risk that an investor must consider, such as market risk, political risk, business risk, and others. Typically, the larger the risk, the larger the possibility for return. The best way to minimize your risk is to properly diversify your portfolio.
5) Taxation. Your income and capital gains are taxed unless the stocks are held in certain types of retirement accounts. Some investment strategies can reduce tax liability, but as with all other investment considerations, this must be done with care and prudence.
6) Trade fees. These fees are imposed when stock is bought or sold. Some brokers will label this fee as a “transaction fee.” Trade fees can range in price, so be sure to research a broker’s fees before making transactions.
7) Cyclical vs. Defensive. Cyclical stocks are sensitive to the economic cycle. In tight economic times, people are less likely to spend money on unnecessary items, such as retail and entertainment, which can impact cyclical stock prices. Defensive stocks include necessary items, such as food and medicine. For this reason, defensive stocks tend to change very little when the economy declines.
8) Selecting stocks. The first step in selecting a stock to purchase is to determine your objective and risk tolerance. You must also remember the importance of diversification, as investing in a single company is much riskier than investing in, say, eight or ten companies. The more you know about a company and about the current market, the better. You can also narrow your search for stocks using a stock screening tool.
9) Diversification. This is a technique used to reduce risk in a portfolio whereby a variety of investments are placed within a portfolio instead of investing in only a few companies. As an example, Charles Schwab & Company has created the following visual representation showing how to diversify your portfolio:
10) Stocks vs. Mutual Funds. Mutual funds are used to diversify a portfolio better than individual stocks allow. Each mutual fund contains holdings of several different individual securities, allowing an investor to easily spread his or her investment dollars among several companies instead of just one. Another advantage of mutual funds over stocks is that each fund has a professional manager of its own, who buys and sells securities within the fund so the individual investor doesn’t have to. Every investor is different, so individual circumstances must be fully considered when constructing a portfolio.
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