Methods to Invest in the Stock Market
A share of stock is a partial interest in the ownership of a company. As an asset class, stocks have historically generated more in returns than have bonds and real estate, but only with a long-term time horizon. In the short run, stocks can be extremely volatile. Several styles and schools of thought exist when it comes to stock investing, and what works for one investor might not work for another.
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Growth Strategy
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The growth investor seeks to buy stock in companies that will grow faster than the market as a whole. He looks for companies with rapidly growing revenues, or with a unusual technology or patent that will fuel growth. At times, growth stock companies are not yet profitable, but the growth investor will still look for a solid path to profitability. Growth investors tend to be willing to pay more for a dollar in earnings per share than other investors, if the growth prospects are there.
Value Strategy
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Value investors look for companies selling for less than the value of their assets. For example, a company with net assets worth $1 billion might be selling at a total market capitalization of $0.8 billion. This means the company is trading at a discount to book value. The value investor looks for stock prices that do not reflect the real value of a company. They frequently look for low price-to-earnings ratios compared to the rest of the market, low price-to-book ratios, and often, an attractive dividend yield. The value investor believes that he will reap his share of growth rewards when companies recover from depressed prices to their natural value in the marketplace.
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Indexing
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Mutual funds and financial advisers all have fees, expense ratios, and other costs that are a drag on returns. Capital gains taxes also provide a further drag on returns every time the investor makes a trade, outside of a taxable account. In the aggregate, investment firms under-perform the market by the amount of their costs. Few investment professionals truly add value through superior stock picking over time, once costs are accounted for. The index investor believes the best approach is not to try to pick stocks, or fund managers, but to simply buy baskets of stocks representing the entire market, while keeping costs and trading to a minimum. Research from Morningstar and The Bogle Center shows that index funds routinely outperform 60 percent to 80 percent of actively managed mutual funds, confirming the indexing hypothesis.
Equity-Indexed Annuities
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These are specialized and complex savings vehicles, but they may be of interest to those who are optimistic about the stock market, but who don't want to take investmest risks. If you buy an equity-indexed annuity, you are not investing directly in the stock market. Instead, an insurance company will credit you with a portion of the stock market returns if it rises, and only if it rises. If the stock market remains level or falls, the insurance company will still credit you with a modest minimum rate of return, typically comparable with CD rates. These products are much less risky than stock investments. But they frequently also have a complex and confusing fee structure, high fees, and long surrender periods. Use caution when choosing an equity-indexed annuity, and read the fine print.
Dollar Cost Averaging
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With dollar-cost averaging, the investor buys a fixed dollar amount of stocks or mutual funds each month, regardless of market performance. The dollar-cost averager largely invests on auto-pilot, and does not attempt to time the market. If markets are high, he buys fewer shares. If markets are cheap, the same dollar amount buys more shares. The idea is that the average cost per share using this method will tend to be lower than an approach that buys the same amount of shares no matter what the market performance that month.
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