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How to Choose Stocks for Your Portfolio

A stock is a share of the ownership of a publicly traded company and entitles the bearer to a share of the earnings and assets of the company, usually a very small percentage per share. As investment vehicles, stocks have several advantages, most notably that they auto-index to inflation, and increases in stock price are taxed at the lower capital-gains tax rates. Most 401k and other investment plans carry stocks as part of their portfolios.

For personal investing, there are several considerations for choosing stocks for your portfolio. You'll need to balance your investment goals and your risk tolerance. In essence, greater risks generate a greater return; however, they also lead to a larger chance that market fluctuations will leave you feeling sick to your stomach, which happened to most investors in 2008.

Basic Concepts

If you're picking your own stocks for investment, you'll start by doing research on a specific business or sector of the economy; the simplest way is to invest in a mixture of stocks whose values are likely to go up (business innovation is what's being rewarded here) while holding on to shares of established performers who pay regular dividends. One passive method of doing personal stock investing is to sign up for a dividend reinvestment program. Shares in these programs pay a dividend; that dividend is held in a trust and will buy another share when the money permits. Only use this strategy on companies with a regular record of paying dividends back to investors.

Diversification

Never put all of your investing eggs in one basket. While tightly focused investing strategies on specific business or business sectors can make skyrocketing profits, they are even more prone to plummeting disasters as people try to cash out on the rising stock price before the rest of the market does. Therefore, always invest in multiple types of stocks in various companies among different parts of the economy. Also, when picking up stocks, look carefully at the price-to-earnings (P/E) ratio. Higher P/Es are a sign of a growth stock for its sector. They're a ready tell that the market expects a given stock to have strong earnings growth, which means that they expect the price to rise in a medium-term time frame.

While you're at it, don't just hold stocks; hold bonds and other assets. Bonds, by and large, increase in value when stocks decline and vice versa. The advantage of bonds is that the risk involved is miniscule. As your portfolio matures, and as you approach your investment goals, shift more of your assets to bonds and other fixed securities.

Mutual Funds & Index Funds

The simplest recommendation for stock choices is to let the professionals handle it. A mutual fund is a banquet of stocks aimed at particular investment targets and specific risk profiles, managed by professionals who spends their time researching companies. Mutual funds have higher fees than trading stocks on your own, but require less direct management. An alternative to the mutual fund is the index fund, which is, functionally, one issuance of stock for every share traded on a specific index. Index fund shares mirror their market index exactly and are passively managed; they offer some of the advantages of a mutual fund at a fraction of the fees and costs.

Last Updated: January 11, 2017