{"id":47266,"date":"2021-08-26T11:35:00","date_gmt":"2021-08-26T15:35:00","guid":{"rendered":"https:\/\/www.shortform.com\/blog\/?p=47266"},"modified":"2021-09-02T19:17:03","modified_gmt":"2021-09-02T23:17:03","slug":"how-to-decide-what-stocks-to-buy","status":"publish","type":"post","link":"https:\/\/www.shortform.com\/blog\/how-to-decide-what-stocks-to-buy\/","title":{"rendered":"How to Decide What Stocks to Buy: 3 Key Strategies"},"content":{"rendered":"\n

Do you want to know how to decide what stocks to buy? What are three crucial strategies you should know about?<\/p>\n\n\n\n

One of the most difficult decisions<\/a> 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 \u201cautopilot\u201d strategy, the \u201cinterested-and-engaged\u201d strategy, and the \u201ctrust-the-experts\u201d strategy.<\/p>\n\n\n\n

Find out how to decide what stocks to buy below.<\/p>\n\n\n\n\n\n\n\n

How to Decide What Stocks to Buy<\/h2>\n\n\n\n

Once you\u2019ve 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.<\/p>\n\n\n\n

Below, you\u2019ll find Burton Malkie\u2019s three strategies for picking stocks: The \u201cautopilot\u201d strategy<\/strong>, the \u201cinterested-and-engaged\u201d strategy<\/strong>, and the \u201ctrust-the-experts\u201d strategy<\/strong>.<\/p>\n\n\n\n

Understanding these strategies will help you work out how to decide what stocks to buy:<\/p>\n\n\n\n

The Autopilot Strategy<\/strong><\/h3>\n\n\n\n

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) <\/strong>rather than individual stocks or industries.<\/p>\n\n\n\n

The autopilot strategy is Malkiel\u2019s preferred method of investing. No matter how knowledgeable or engaged the investor, Malkiel advises building the core of a portfolio around index funds<\/strong> and only making active bets with excess cash<\/strong>.<\/p>\n\n\n\n

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<\/strong> over an S&P 500 fund. This is because the S&P 500 index excludes smaller stocks<\/strong> that, historically and on average, have outperformed larger ones<\/strong>. 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. <\/p>\n\n\n\n

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<\/strong>.<\/p>\n\n\n\n

The Interested-and-Engaged Strategy<\/strong><\/h3>\n\n\n\n

Holding a diverse portfolio of index funds is a low-maintenance and moderate-risk strategy ideal for large sums like your retirement savings<\/strong>. That said, some investors\u2014for example, those with a taste for gambling\u2014will find indexing an entire portfolio boring and may want to try their luck picking winners.<\/p>\n\n\n\n

Malkiel advises that thrillseekers only speculate with secondary monies <\/strong>that they can afford to lose, and that they follow four key principles.<\/p>\n\n\n\n

Principle #1: Only buy stocks whose earnings growth promises to be above average for at least five years<\/strong><\/h4>\n\n\n\n

Simply put, earnings growth is what produces winners<\/strong>. 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<\/strong>.<\/p>\n\n\n\n

Principle #2: Never overpay for a stock without a firm foundation of value<\/strong><\/h4>\n\n\n\n

Expensive stocks with bloated P\/E multiples can burn you twice over <\/strong>if earnings don\u2019t materialize (because both dividends and capital gains will decrease). <\/p>\n\n\n\n

What you want are reasonably priced stocks with positive growth prospects<\/strong>. Although determining the precise value of a stock is effectively impossible, you can <\/em>tell whether a stock is reasonably priced by comparing its P\/E multiple to that of the market as a whole. If a stock\u2019s P\/E is well beyond the market\u2019s, you might be wise to stay away. If the P\/E is comparable to the market\u2019s and there\u2019s the promise of growth, that\u2019s a better bet. <\/p>\n\n\n\n

(Note that it\u2019s OK to buy stocks with P\/E multiples greater than market\u2019s as long as growth prospects are above-average as well<\/strong>.)<\/p>\n\n\n\n

Principle #3: Keep an eye out for castles in the air, and take advantage<\/strong><\/h4>\n\n\n\n

If you come across a firm-foundation stock around which buzz might build\u2014for example, because the company is about to hire a charismatic CEO or debut a new technology\u2014those are stocks worth purchasing<\/strong>. The key is to buy in before the builders of castles of air drive the price up.<\/p>\n\n\n\n

Principle #4: Trade as little as possible<\/strong><\/h4>\n\n\n\n

With the advent of commission-free brokerage products, the expenses of trading have been considerably diminished. Nevertheless, you should hold your purchases as long as possible<\/strong>, and, if you have to trade, sell your losers before your winners<\/strong>.<\/p>\n\n\n\n

This is because selling your losers reduces your tax burden<\/strong>. Before the end of a calendar year, Malkiel will sell off most of the stocks on which he\u2019s seen a loss to lower his tax bill. There are special cases in which it makes sense to hold a loser\u2014for example, when the company has solid growth prospects\u2014but, in general, you stand to gain by offloading at a loss<\/strong>. <\/p>\n\n\n\n

The \u201cTrust-the-Experts\u201d Strategy<\/strong><\/h3>\n\n\n\n

Some investors might prefer to entrust their money to a professional. But Malkiel\u2019s years of studying actively managed mutual funds have yielded two key insights: One, that fund managers\u2019 past performance has little bearing on future performance<\/strong>, and two, actively managed funds rarely beat the average market return for long<\/strong>.<\/p>\n\n\n\n

Exercise: How to Decide What Stocks to Buy<\/strong><\/h3>\n\n\n\n

Explore what the autopilot strategy, the interested-and-engaged strategy, and the trust-the-experts strategy mean for you. Then, work out how to decide what stocks to buy.<\/p>\n\n\n\n