Here are my wacky, uninformed, cynical, yet somewhat reasonable responses to CNN's Money101 article. Am I taking this stuff too literally?
1. Stocks aren't just pieces of paper.
When you buy a share of stock, you are taking a share of ownership in a company. Collectively, the company is owned by all the shareholders, and each share represents a claim on assets and earnings.
If you want ownership in a company, buy bonds. Stocks have the lowest claim on assets and you have to pay $50 or so to get the paper itself.
However, bonds only outperform stocks in certain markets. Don't buy bonds just to get the "proper" portfolio mix. Buy them when there is a flight to safety.
2. There are many different kinds of stocks.
The most common ways to divide the market are by company size (measured by market capitalization), sector, and types of growth patterns. Investors may talk about large-cap vs. small-cap stocks, energy vs. technology stocks, or growth vs. value stocks, for example.
There's only 1 kind of stock - that is the ticker symbol you pay for with the price you bid on it.
3. Stock prices track earnings.
Over the short term, the behavior of the market is based on enthusiasm, fear, rumors, and news. Over the long term, though, it is mainly company earnings that determine whether a stock's price will go up, down, or sideways.
Earnings don't matter. Look at Google, Apple, or any rapid-growth high-tech company. (not that either of those are bubble companies, but there are companies with stronger earnings that aren't doing as well) Over the long term, price can be expected to be manipulated. It is not earnings but the impression people get about the company from financial releases. What if the earnings aren't really the earnings, and the financial statements aren't accurate?
4. Stocks are your best shot for getting a return over and above the pace of inflation.
Since the end of World War II, the average large stock has returned, on average, more than 10 percent a year - well ahead of inflation, and the return of bonds, real estate and other savings vehicles. As a result, stocks are the best way to save money for long-term goals like retirement.
Partially true. Stocks are also the best way to lose money for long-term goals like retirement too. It is not just what you buy, but when you buy it that matters.
5. Individual stocks are not the market.
A good stock may go up even when the market is going down, while a stinker can go down even when the market is booming.
This is not necessarily true for stocks that fall into index funds and other portfolio funds.
6. A great track record does not guarantee strong performance in the future.
Stock prices are based on projections of future earnings. A strong track record bodes well, but even the best companies can slip.
A strong track record, or high gains, usually sustain themselves unless there is a story or the gains are manipulated. See Google for a great track record that could guarantee strong performance in the future.
7. You can't tell how expensive a stock is by looking only at its price.
Because a stock's value is depends on earnings, a $100 stock can be cheap if the company's earnings prospects are high enough, while a $2 stock can be expensive if earnings potential is dim.
A $100 stock is a $100 stock. Of course it may not be worth $100, but that's what it's selling for so that's how expensive it is.
8. Investors compare stock prices to other factors to assess value.
To get a sense of whether a stock is over- or undervalued, investors compare its price to revenue, earnings, cash flow, and other fundamental criteria. Comparing a company's performance expectations to those of its industry is also common -- firms operating in slow-growth industries are judged differently than those whose sectors are more robust.
Again, sometimes this doesn't matter - it depends on which portfolios of funds the stock resides in and what economic cycle investors feel we are in.
9. A smart portfolio positioned for long-term growth includes strong stocks from different industries.
As a general rule, it's best to hold stocks from several different industries. That way, if one area of the economy goes into the dumps, you have something to fall back on.
Not necessarily true. Dump your losers as soon as they hit your risk/reward limit. A smart portfolio doesn't include large losses.
10. It's smarter to buy and hold good stocks than to engage in rapid-fire trading.
The cost of trading has dropped dramatically -- it's easy to find commissions for less than $10 a trade. But there are other costs to trading -- including mark-ups by brokers and higher taxes for short-term trades -- that stack the odds against traders. What's more, active trading requires paying close, up-to-the-minute attention to stock-price fluctuations. That's not so easy to do if you've got a full-time job elsewhere.
If you own any individual stock, ensure you have the time to pay close attention to it. If you don't have the means to monitor it, either through yourself or your advisor, you shouldn't be buying it. Since I'm my own advisor, whenever I'm going on vacation or feel iffy about the markets, I dump the bulk of my portfolio. Oddly enough, a couple days later the market tanks and I got out at the top. I still have the nasty habit of getting out when everyone else abandons the ship, when I should be getting the bailing bucket and waiting till the sun comes out.
In blackjack, would you let the dealer play your hand if noone else was watching and you stepped away from the table? How about if the dealer was betting against you and counting the cards? And every buy-in or cash-out cost you $60 in commissions?
The stock market is a gamble. They key is not to win, but to cut your losses early, preserve your initial capital, and take gains.
Source: Money101 Lesson 5: Stocks