The Handy Investing Answer Book. Paul A Tucci

the investment is sound, with great potential, a short or long market dip will tend to move even the best of stocks down. Sector risk is similar; even if you invest in a winning sector, if the market in general declines, it may affect this sector as well. Some sectors may move less or more, given a variety of variables that influence that particular sector. Even if you pick the right stock and sector, an unexpected event that affects the stock price, value, or demand for the stock may occur, and this may negatively affect your returns.

      Why is information overload a huge risk factor when I invest in individual stocks?

      In hopes of generating more viewers and readers, media companies must create stories to keep their consumers interested. With the proliferation of Internet usage by the individual investor, the once secretive investment community may in fact use and have access to much of the same information that individuals use. Financial stories abound in today’s world, and the less-than-savvy investor may become overwhelmed or panic upon the release of any news story. Many people in the investment community believe the global financial news has a degree of homogeneity, in which all media sources report on approximately the same stories, making individual investors who follow such news outlets and networks unnecessarily anxious, even when the story may have little impact on the stock’s long-term price. The unprofessional investor may be unable to distinguish the difference between a meaningless piece of information and one that may affect a stock’s price.

      What are some common mistakes investors make when thinking of buying stocks?

      Some common mistakes may include buying at a high price and being averse to suffering a loss, therefore holding the stock too long; putting too much weight in past historical information to guide him in making an investment decision; an inability to distinguish between many investment choices; and insensitivity to brokerage and management fees associated with trading individual stocks. Some experts also note the failure on the part of the individual investor to understand how difficult it is to “beat the market,” to do better than the returns of an underlying stock exchange, or to outperform a broad array of stocks such as an index.

      Why do some experts believe the individual investor should avoid investing in individual stocks and mutual funds, and should rather invest in indexes such as the S&P 500?

      In a recent article, Forbes cited a few studies that support the argument that we should avoid investing in individual stocks. In a study published by Dalbar, Inc. in 2003, researchers found that in looking at average annual returns from 1984 to 2002, the annual average return of the S&P 500 was 12.2%, while mutual fund managers achieved a 9.3% return during the same period. The article also cited an annual report issued by Standard & Poor’s, the S&P Indices Versus Active Funds Scorecard, finding that by mid-2012, 89.8% of all managed domestic (U.S.) funds failed to beat the performance of the benchmark S&P 500 Index. Furthermore, the scorecard reported that in 2009–2012, 73.2% of managers underperformed the Index, and in 2007–2012, 67.7% underperformed the Index.

      What about the success of high-performing stocks?

      The experts at Forbes also cite a study by Longboard Asset Management that analyzed 3,000 individual stocks from 1983 to 2007. Their findings showed that 39% of these stocks were unprofitable, that 19% lost 75% or more of their value, 64% underperformed the market, and that just 25% of the stocks were responsible for the great gains in the stock market during the period analyzed.

      What are some important points to know when I invest in stocks?

      According to experts at CNN/Money, you need to understand several important points when you begin to invest in stocks. A stock represents your ownership in a company, and also represents your ownership of assets, liabilities, and current and future earnings or profits of the company (and the perception of the possibilities of hitting these earnings targets). The stock market is a very diverse marketplace consisting of many entities that can be arranged and understood by several attributes, including the size of the company (measured by market capitalization), the sector in which it competes, and its type of growth pattern based upon historical performance, among many others.

      From 1983 to 2007 only 25% of stocks were responsible for most of the growth in the market, while the majority either underperformed or were unprofitable.

      The price of a stock at any given moment depends on a wide variety of factors, including earnings, especially for the long-term investor. It may also be influenced by the sentiment of its buyers and sellers, fear created by information about the company and its competitors, and macroeconomic news that may have an effect on the company’s performance. According to the same experts, since the 1940s, stocks (as compared against bonds, cash, real estate, and other savings choices) provide for nearly a 10% return over the long term, better than most other investment choices. It is important to note that the performance of any one individual stock does not represent the overall performance of the market. A great individual stock may beat an index over time, but may also decline even when the market in general is booming.

      Because of the dynamic nature of businesses and the marketplace, it is difficult to use a stock’s historical performance to gauge whether or not its value will continue to grow; even great companies run into unexpected problems. These unexpected occurrences may influence a stock’s price and value. Diversification of a portfolio seems to mitigate many risks. Furthermore, you should not judge a stock simply by looking at its price or the relative price in its sector or industry, because there are many fundamental factors that may contribute to a stock’s underlying price. For the long-term investor, it is better to buy and hold great stocks than to generate many short-term trades for a variety of expense-related reasons, such as short-term capital gains taxes, commissions on trades, and exposure to many market risks.

      Can I pay too much for stocks?

      Yes. Like anything you buy, if you are first in line to buy a stock, you may get a very good deal, because the company may have anticipated less demand for the stock than there really is. So if there is great demand for a stock, the price of the stock may increase quickly—in a few minutes, or even seconds, from the initial offering price, until all the stock’s buyers and sellers have been satisfied during the trading day. If you arrive at the sale late, the price could be many percentage points higher than in the morning, and you may end up paying more than the person who bought the stock first thing in the morning.

      What is an “initial public offering” (IPO)?

      An initial public offering occurs when a company wishes to offer its stock shares to the public, hoping to raise capital for the first time.

      Why should I care about IPOs?

      An IPO can give you the opportunity to invest in a company at an early stage in its development. Individual investors may be able to purchase those shares that large institutional investors haven’t purchased, giving you the opportunity to profit from the sale of the shares.

      How many initial public offerings occur in a year?

      In the 1990s, because of the onset of the Internet era, an average of 193 IPOs occurred per year. After the economic crashes in the 2000s, IPO activity fell to an average of 48 per year.

      How large is the IPO market at the NYSE?

      The NYSE/Euronext raised more proceeds for the initial public offerings of stock than any other exchange in the world. In 2008 alone, the NYSE raised $45 billion in IPO proceeds, approximately 21% of the total IPO capital raised throughout the world. The next largest market for IPOs, Hong Kong, raised $12 billion.

      On average, how long has a company been in business before it issues shares for the first time to the public?

      On average, most companies have been around seven to eight years before they “go public.” At this time, after the IPO is made, the original investors in the company may be paid back money for their initial investment.

SELECTING INDIVIDUAL STOCKS

      What are some decisions an