With the new year's arrival, investors may have many stocks on their wish lists. But before you rush in and fill your portfolio with new stocks, you must do a few things before taking a position in any company.
Buying shares of a business you barely understand can be a recipe for disaster, and if the stock plummets, your resolve to hold onto the stock may not last. So let's look at how quickly you should acquire stocks and some things to consider before purchasing one.
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Is lump-sum investing better than dollar-cost averaging?
The Motley Fool recommends filling your portfolio with 25 stocks, which doesn't mean 25 software or 25 bank stocks. A diversified portfolio made up of companies across various industries and market-cap sizes performs well over the long term and will insulate you if one industry struggles in particular (like tech did in 2022).
So, should you go all-in now if you've got $10,000 to invest? The math says yes. Northwestern Mutual found that between investing a lump sum at the beginning of the year versus 12 even increments throughout the year, a practice known as dollar-cost averaging (DCA), the lump sum strategy outperformed 75% of the time based on rolling 10-year returns since 1950.
This makes sense, because historically, the market is climbing higher so the longer you're invested, the better your returns are.
However, in practice, this is a scary strategy. How often have you purchased a stock, only for it to fall in the following weeks? For me, it's practically every purchase. While lump-sum investing may outperform the large majority of the time, DCA may still be the easier choice to make.
Regardless, what matters is that you are investing, and choosing the right companies will likely make more of a difference than exactly how you put your money in them.
Let's look over some things you should know before taking a position in any stock.
A quick checklist
Say you're looking to take a position in Alphabet, the parent company of Google, YouTube, and the Android operating system. Before purchasing shares, you need to become familiar with the company's business and challenges.
That means you should know enough about the business to make a clear bear case and bull case argument for the company -- here's mine for Alphabet.
Alphabet will succeed if it controls its operating expenses and develops its Google Cloud offering. Its legacy advertisement business must continue to innovate and maintain its status as a must-have platform for advertisers. If its operating expenses spiral out of control, the company's margin profile will be in trouble, jeopardizing future shareholder returns. Advertisement revenue is notoriously cyclical, but it must continue growing after this downturn for the company to maintain its leadership position.
That's my big picture take on the stock, and I can make arguments for either side, but I own the stock because I believe in the bull case much more than the bear case.
Beyond this bear and bull comparison, it's also wise to listen to or read a few earnings calls as analysts ask pointed questions that can provide insight into the company's challenges. This is an easy way to identify metrics, opportunities, etc. to follow when learning a new business or checking in on an old investment.
Understanding who the management team is and how long they've been at the helm is also crucial, because they're driving the company's direction and play the most significant part on the future returns of your investment. For Alphabet, it's CEO Sundar Pichai, who has been with the company since 2004.
That's just part of the process as many investors will find value in further financial analysis and a valuation assessment.
So how quickly should you acquire new stocks?
The answer is: As quickly as you can learn the business. In the meantime, diverting some of your savings to an S&P 500 index fund provides instant diversification, and it can be a good place to start until you feel more confident learning about individual companies.
Most importantly, take your time when investing. While it's easy to feel like you're missing out on the next big thing, any company you choose through careful research should outperform long term, reducing the impact of any short-term price swings when you first make your investment.
