I get a lot of emails asking about what is the best stock to buy for someone that is interested in getting into the stock market. There are so many stocks out there yet no one provides all of the diversification that an investor needs. A well diversified portfolio requires that you own at least five stocks at a minimum and can go up to ten total. That is why I recommend that investors start their portfolios with a different investment vehicle.
Mutual Funds
I always recommend that an investor selects a mutual fund to build their portfolio around. Balanced mutual funds will enable an investor to get complete diversification amongst a number of different asset classes. A good balanced fund will have some large cap, mid cap, and small cap holdings for the equity portion. It will also contain different bonds that are god for providing income for when the market is down. It is tough to find balanced funds with a perfect 50/50 mix between stocks and bonds but you can find funds with a nice 60/40 mix.
Starting with a mutual fund is smart because they can provide safety. You might see your money shrink during a bear market but you will not lose it all in a mutual fund. Since mutual funds invest in a bunch of different stocks, you would need the whole economy to collapse to lose all of your money. If this happens then there would be no point to having cash either since it would be worthless. An individual stock can go belly up whereas a balanced mutual fund will not.
Individual Stocks
Once you have accrued an adequate sum of money in your mutual fund portfolio, you can then start to dabble with individual equities. I always believe that an investor should start with a safe stock to get the ball rolling. You don’t want your first stock investment to be really high risk because you could lose your cash. Stick with the names that you know will be around for at least the next five years. Johnson & Johnson (JNJ), Verizon (VZ), Nike (NKE), McDonald’s (MCD), and IBM (IBM) are rock solid companies that have strong earnings and good dividends. These stocks are portfolio pillars that you can build on.
Look for stocks that are in different industries so you can get some diversification. It would be pointless for an investor to buy shares of the Cheesecake Factory (CAKE), Panera Bread (PNRA), Brinker International (EAT), and Darden Restaurants (DRI). An investor who bought these stocks would be overly concentrated in the casual dining sector. All of these stocks would likely move in the same direction. An investor would do really well when the economy is booming and do really poorly when the economy is struggling. If you are going to invest in a cyclical stock then you need to invest in a defensive stock too.
This means having exposure to a number of different sectors that are not all directly correlated. It can also mean having growth stocks in the portfolio that trade at higher price to earnings ratios and value stocks that trade at single digit P/E ratios. A proper portfolio his a nice mixture of assets that will allow you to make money in bull and bear markets. Look for growth with equities that have the ability to outperform the overall market and fixed income with instruments like dividend paying stocks, bonds, and certificates of deposit.
You will know you have found the perfect mix when your risk tolerance and objectives coincide with your investment portfolio.
Photo by: photologue_np
I would agree with going with mutual funds first then working your way up to individual stocks. What I would like to see more of however is people setting up emergency savings and putting money into 401ks and IRA before anything. I really like T. Rowe Price and their mutual funds. Nice post!
This is just an opinion of course, but I think the average person is better off avoiding individual stocks completely. Mutual funds are really the better way to diversify, even within an industry group. Having a single stock in a given industry doesn’t guarantee participation in the growth of it’s industry, and there are so many variables that can affect one company.
That said, the best plays are the most strategic in nature. Look for the industries that we “can’t do without”, that have a clear place in the future AND reasonable growth prospect. Then invest via mutual funds in the industry. We need to have diversification within a portfolio, but even within an industry group. It might keep you from getting rich, but it will also keep you from going broke. That’s probably more important to the average investor, which is why mutuals are the better play.