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Do you want to know how to decide what stocks to buy? What are three crucial strategies you should know about?
One of the most difficult decisions an investor has to make is how to decide what stocks to buy. But, with approximately 2,800 companies listed on the New York Stock Exchange, where does one start? Economist Burton Malkiel recommends three strategies for picking stocks: The “autopilot” strategy, the “interested-and-engaged” strategy, and the “trust-the-experts” strategy.
Find out how to decide what stocks to buy below.
How to Decide What Stocks to Buy
Once you’ve determined the ideal asset allocation for your age, economic situation, and risk tolerance, the next step is working out how to decide what stocks to buy.
Below, you’ll find Burton Malkie’s three strategies for picking stocks: The “autopilot” strategy, the “interested-and-engaged” strategy, and the “trust-the-experts” strategy.
Understanding these strategies will help you work out how to decide what stocks to buy:
The Autopilot Strategy
The first strategy for picking stocks is the autopilot strategy. This approach consists of purchasing broad index mutual funds or exchange-traded index funds (ETFs) rather than individual stocks or industries.
The autopilot strategy is Malkiel’s preferred method of investing. No matter how knowledgeable or engaged the investor, Malkiel advises building the core of a portfolio around index funds and only making active bets with excess cash.
While the S&P 500 index funds are generally the most popular type of index fund, Malkiel actually recommends that investors choose a total market index fund over an S&P 500 fund. This is because the S&P 500 index excludes smaller stocks that, historically and on average, have outperformed larger ones. Try to find a fund indexed to the Russell 3000, the Wilshire Total Market Index, the CRSP Index, or the MSCI US Broad Market Index.
Of course, diversification is the key to a successful portfolio. But one need not abandon index funds to diversify: There are funds that track REIT, corporate bonds, international capital, and emerging market indices.
The Interested-and-Engaged Strategy
Holding a diverse portfolio of index funds is a low-maintenance and moderate-risk strategy ideal for large sums like your retirement savings. That said, some investors—for example, those with a taste for gambling—will find indexing an entire portfolio boring and may want to try their luck picking winners.
Malkiel advises that thrillseekers only speculate with secondary monies that they can afford to lose, and that they follow four key principles.
Principle #1: Only buy stocks whose earnings growth promises to be above average for at least five years
Simply put, earnings growth is what produces winners. Not only do consistently above-average earnings boost dividends, they also result in higher P/E multiples. That means higher capital gains on top of dividends.
Principle #2: Never overpay for a stock without a firm foundation of value
Expensive stocks with bloated P/E multiples can burn you twice over if earnings don’t materialize (because both dividends and capital gains will decrease).
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