In this article, you will learn:
What is an investing style and why do I need one?
Finding the right companies to include in your stock portfolio is not an easy task. Even knowing where to start can be difficult -- there are currently over 2000 companies listed on the New York Stock Exchange and over 3000 companies listed on the NASDAQ. Most investors therefore choose an investing style that suits their own financial situation and start looking at the specific types of companies that would let them meet their individual financial goals. Things that go into creating your ideal stock portfolio include your investment timeline, your own personal risk tolerance and even how much time you want to spend managing your stock portfolio.
Choosing an investing style #1: How much should I invest?
There are no hard and fast rules in figuring out how much of your money you should invest in stocks, but there are a few simple guidelines that can make stock investing significantly safer and less risky.
Choosing an investing style #2: What are Large, Medium and Small Caps?
In Lesson 1: What is the Stock Market?, we spoke briefly about market capitalization, or the size of a listed company. While it is obvious that a company of any size could do well or poorly on the stock market, there are general trends for different sized companies that can help you make informed investment decisions. In the investing world, small companies (usually under $1 billion in market capitalization) are known as small caps, medium sized companies (usually $1 to $10 billion in market capitalization are known as mid caps, while the largest companies (greater than $10 billion in market capitalization) are known as large caps. Large, established companies are also referred to as blue-chips.
These different sized companies offer quite different prospects. Small caps often generate their revenue from a couple of core products or are exposed only to specific, smaller markets. As lesser known companies, they may find it harder to secure loans from banks, or they may attempt to grow too quickly and therefore take on more debt than they can handle. The risk of a small cap going bankrupt and taking your investment to zero is significantly higher than for a blue-chip with a long track record such as Coca-Cola (KO) going bankrupt.
On the other hand, small caps are often bringing new products to the market, with huge potential for their stock price if they are successful. While large companies are often happy with growth rates in the single or double digits, growing small companies can achieve astonishing growth rates. If you had bought $100 worth of stock in a small, growing technology small cap called Microsoft (MSFT) in 1986 and held onto it until 2010, your small cap investment would have grown to $23,574 over this time. These kinds of returns are simply not possible for large, established companies.Large caps are far less volatile stocks, and the risk of bankruptcy in large, long running companies is significantly lower than for small caps. More importantly, large caps are often exposed to several markets for their products, including international markets, and their products are often better recognized. For example, based on their well recognized products and long track record of success, it would be very unlikely for a company such as Visa (V) or McDonalds (MCD) to suddenly drop dramatically in stock price. Large caps may also outperform their expected growth and grow in stock price rather quickly. As an example, Apple Inc. was considered a large cap with highly recognizable products in 2005, but still managed to grow its stock price four-fold from 2005 to 2010.