Choosing stocks for your investment portfolio is an important part of building and managing your wealth as well as achieving your broader financial goals. With thousands of stocks to choose from, the process of selecting the right stocks for your situation can be complicated, especially for those new to investing. However, by focusing on a few key principles and conducting thorough research, you can make informed decisions that align with your risk tolerance and investment objectives.
If you need help picking stocks, a financial advisor can work with you to analyze investments and manage them.
Stock Picking Considerations
Your investment portfolio is likely to consist of several different asset types, including cash, fixed-income securities and perhaps alternative assets. Stocks are part of most portfolios, but not all stocks are created equal. Certain shares are more likely to fit with your financial objectives. When selecting stocks for your portfolio, you will have to answer three questions.
First, how much money are you willing to invest? The amount of capital you have available will influence your ability to purchase certain stocks and dictate the level of diversification you can achieve.
For example, an investor with a limited budget might have to decide between buying a single share of a high-priced stock like Apple (AAPL), trading just under $223 per share in September 2024, or purchasing multiple shares of a lower-priced stock like Ford (F), trading at almost $11 per share.
Share price isn’t the only or overriding concern. It’s also significant, from a portfolio construction perspective, that these two companies are in different sectors and have different risk and reward profiles. These factors will also be carefully weighed when making investment decisions.
Second, what are your investment goals? You may want to generate income through dividends or, alternatively, be mostly focused on capital appreciation. Your objectives will influence the types of stocks you select.
For example, dividend-paying stocks like Procter & Gamble (PG) might be attractive to income-focused investors. Growth-oriented investors, however, might gravitate towards companies like Tesla (TSLA), which reinvests profits into expansion rather than paying dividends.
Third, what’s your risk tolerance? Stocks vary in terms of volatility, with some being more stable and others more prone to price swings. Understanding how comfortable you can be when prices swing up or down, will help you choose stocks that match your investment style.
For example, conservative investors may prefer established companies with a track record of stability. More aggressive investors might seek out smaller companies with higher growth potential, even if it means accepting more risk.
How to Pick the Best Stocks for You
Now that you have outlined your parameters, you can further focus on the best stocks for your portfolio by considering these factors:
- Buy what you know: One of the axioms in stock investing is to focus on companies you understand. This means investing in businesses whose products or services you are familiar with. This can give you a better sense of how they generate revenue and whether they have a sustainable business model. For example, if you use Apple products, you might feel more confident investing in the company because you understand its product offerings and customer base.
- Look for a competitive advantage: A company with a competitive advantage in its industry is more likely to maintain or grow its market share over time. This advantage could rest on brand loyalty, patents, network effects or cost advantages. For example, Coca-Cola (KO) has a strong brand presence and distribution network that provides a competitive edge in the beverage industry. When evaluating stocks, consider whether the company has similarly positive qualities that set it apart from competitors and could lead to sustained success.
- Determine a fair price for the stock: Determine whether a stock is fairly priced by analyzing the company’s price-to-earnings (P/E) ratio, price-to-book (P/B) ratio and other valuation metrics. Comparing these ratios to the company’s peers or historical averages can help you assess whether the stock is undervalued, fairly valued, or overvalued. For example, if a company’s P/E ratio is significantly lower than the industry average, it might indicate that the stock is undervalued, provided there are no underlying issues.
- Buy with a margin of safety: Buying stocks at a price below their intrinsic value, a method called value investing, helps protect against potential losses. This provides a cushion if the stock’s price falls. For example, if you determine that a stock’s intrinsic value is $50 per share but it’s currently trading at $40, buying at this lower price gives you a margin of safety. This strategy is particularly useful in volatile markets or when investing in companies with uncertain prospects.
Alternatives to Individual Stocks
You don’t have to pick individual stocks in order to include equities in your mix of assets. Here are some alternatives:
- Mutual funds pool money from multiple investors to purchase a basket of stocks, bonds or other securities. Managed by professional fund managers, mutual funds offer diversification for investors who don’t care to select individual stocks. However, mutual funds typically come with management fees, which can eat into returns.
- Exchange-traded funds (ETFs) are similar to mutual funds, but trade on stock exchanges like individual stocks. They offer diversification and professional management but are often passively managed rather than actively managed. ETFs generally have lower cost than mutual funds and provide the flexibility to buy and sell shares throughout the trading day.
- Some investors also choose to invest in index funds. These mutual funds and ETFs aim to replicate the performance of a specific market index. For example, the SPDR S&P 500 ETF (SPY) tracks the S&P 500 Index. By investing in an index fund, you gain exposure to all the stocks in the index, which reduces the risk associated with picking individual stocks. Index funds are often recommended for long-term investors due to their low fees and broad diversification.
Bottom Line
Picking stocks for your portfolio is a highly individualized process requiring careful consideration of your financial goals, risk tolerance and investment knowledge. By focusing on companies you understand, looking for competitive advantages and buying with a margin of safety, you can make decisions that align with your investment strategy. For those who prefer a more hands-off approach, alternatives like mutual funds and ETFs offer diversified exposure without the need to pick individual stocks.
Tips for Investing
- A financial advisor can help you create an investment plan that is based on your financial needs and goals. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
- Use SmartAsset’s free online asset calculator to determine the mix of stocks, bonds and cash to include in your portfolio based on your risk profile.
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