-Stocks
When used as part of a well-diversified portfolio, common stocks can play an integral role in your quest to achieve your financial goals. Historically, stocks outperform most other investments in achieving long-term capital growth, and may help minimize the negative, long-term effects of inflation. But the market risk with common stocks can be substantial. While an interest-bearing account might earn two percent over a year's time, the price of a stock can rise or fall by that amount or more in just minutes. And while there may be a certain appeal to making decisions on the fly (or trying to time the market as though you were a "trader"), there is no substitute for a long-term, well-thought-out financial strategy.
Your stock choices should be the result of extensive research. Take the time to sift through the securities available to find those that match your risk/return parameters, rather than chasing after short-term trades. This "investor" approach will help you avoid the volatility associated with day trading. Use H&R Block Financial Advisors' Research Center for timely information online.
Look for investments that have fundamental strengths. Stocks in companies with capable management, growing markets, and strong financial positions make sense for many investors. Once identified, examine the individual stocks for a closer analysis.
In addition to their risk, stocks may be volatile. A variety of factors contribute, including company performance; economic factors, such as changes in interest rates or in the rate of unemployment; political news; and events of national or international importance.
Diversification
It's also important to learn about the different types of stocks. Each stock possesses its own unique risk/return characteristics. Generally, the greater the desired return, the greater the risk of loss. Some stocks offer greater stability, while others that are more volatile offer more opportunity for a greater return.
As you consider your investment in stocks, remember the importance of diversification-- not only among different stocks but also among industries.
Cyclical stocks. These are stocks in industries that go up and down with the economy. Cyclical stocks belong to companies that may report strong earnings in one cycle, yet in a downturn, turn around and post losses in the next. Cyclical industries include automotive, paper, chemical, steel and housing.
Defensive stocks. These stocks are typically less volatile than average and thus provide a more conservative return on an investor's money than do the cyclicals. Defensive stocks can be found in sectors whose goods are in demand regardless of the economic environment, including the beverage, pharmaceutical, food and tobacco sectors.
Interest-rate-sensitive stocks. These stocks, which include banks and utilities, fluctuate in value with interest rates since such companies tend to borrow large amounts of money. They typically perform well during times of declining interest rates but poorly during times of rising interest rates. Companies that typically perform better when interest rates are rising, such as those engaged in oil production or the mining of precious metals, are often sought as a hedge against inflation.
Growth stocks. These stocks are in companies that have exhibited faster-than-average gains in revenue over the last few years and are expected to continue to show high levels of profit growth. They may offer investors opportunities for capital appreciation. Many of these stocks are found in the software, telecommunications, semiconductors or biotechnology industries. However, growth stocks tend to have greater volatility because the stock may often be selling at a higher price in the market in comparison to the stock's intrinsic value.
Value stocks. Value stocks typically sell with relatively low valuation as determined by price/book, price/sales, and price/cash flow ratios, implying that their market value may be closer to their book value.
