Familiarity breeds success on the stock market

You’re thinking about getting into the stock market, but all that chatter on television about selling short, stock splits, and bulls and bears confuses the living daylights out of you.

If you’re going to get your hands dirty and use the stock market to build your retirement or your children’s college funds, it helps to be familiar with basic investment strategy and clear on what the various stock-exchange indices represent.

The Dow Jones Industrial Average is the index you always see listed first. “It is the most-followed and best-represented indicator of market activity,´ said Charles Gogela a broker with Central Discount Stockbrokers in Fort Collins. “Probably because it’s the oldest. The Dow Jones originated in the ’30s.”

The Dow is the average of 30 corporations that measure the industrial segment of the market. Those companies are usually long-established and nationally recognized, such as McDonalds Corp., IBM Corp., Eastman Kodak Co., ALCOA and General Motors Corp. The components represent between 15 percent and 20 percent of the market value of stocks on the New York Stock Exchange.

Other averages published by Dow Jones include the Dow Jones Transportation Average and the Dow Jones Utility Average. The DITA is an average of 20 stocks in the transit business.

“It’s a useful indicator of future economic activity. When the transportation average is well, it means there will be good economic activity,” Gogela said. The DIUA is an average of the 15 largest utilities in the country and is usually a reliable barometer of interest rate activity.

The Standard and Poor’s 500, or S&P 500, measures the changes in the aggregate value of 500 stocks since 1941-1943. Those three years established the foundation for comparison. The S&P has 379 industrial stocks, 37 utilities, 74 financials and 10 transportation issues.

The difference between the S&P and the Dow is that the S&P “is a broader index,” Gogela said. “It looks at a cross-section of the market. It’s probably better representative of the market than the Dow.” The S&P represents 74 percent of the market value of all stocks traded on the NYSE.

The National Association of Security Dealers Automated Quotation System, also known as the Nasdaq Composite Index, is the horse coming up on the inside.

Established in 1971, Nasdaq has grown in popularity due to its easy-to-use stock market. More than 5,400 companies are listed.

“Basically, it represents a cross-section of companies that trade what used to be called over-the-counter stocks,” Gogela explained.

OTC stocks are generally traded through a computer and telephone network rather than on the floor of an exchange. Many high-tech stocks are traded over-the-counter, such as Microsoft and Dell, and the Nasdaq is generally thought of as a barometer of how well high-tech and Internet stocks in general are performing.

There’s no real trick to the stock market, but when it comes to investing your hard-earned money, it helps to keep a few simple dictums in mind.

“Do your homework, devise a strategy and set goals,” Gogela said. “If you know what you’re trying to do, then you know how to proceed, and then you can construct a portfolio.”

For the novice, a portfolio is a combined holding of several different stocks, bonds, real estate holdings or commodities. The purpose of a portfolio is to increase diversification. The idea is that if you have holdings in several different areas, you won’t get hurt if one of them goes belly-up.

“You must diversify,” Gogela said. “Don’t put all of your eggs in one basket. Some people do, and they make money at it, but it’s very rare.”

Don’t believe that if you put your money into an industry titan that you’ll be safe. Gogela can rattle off a list of companies that were pillars of American industry suddenly laid low — PanAm, Penn Central Railroad, Montgomery Ward & Co.

“Penn Central Railroad, at one time was the largest railroad in the country,” Gogela said. “But they had too much debt.”

Where you are in life and what you want to do generally determine what kind of investment strategy you’ll want to take. If your investments are for retirement and/or for the kids’ education, you probably want the “buy-and-hold” strategy. It’s not flashy, but it’s like the tortoise in the race with the hare.

The idea is to keep your money in the market for the long haul. The long-term capital-gains tax on profits are generally favorable, and you can pay less attention to long-term investments than a more complicated active trading strategy.

If you’re young or find the whole business of investing incomprehensible, if not downright boring, one of the best bets is a mutual fund.

Mutual funds are varied, and some are more risky than others. However, an investment company operates all funds. For a management fee, the fund’s managers will invest your money in stocks, bonds, futures or whatever they deem appropriate. Funds sold by stockbrokers are called Load Funds because you pay a sales charge and get advice from the broker on the best time to sell or buy more shares. No-load funds don’t come with the sales charge or the advice.

The upshot of all this is that the managers take care of the day-to-day business of the fund and make decisions based on their expertise. Also, a little money goes a long way.

“If you’re young, you don’t have the chunk of money it takes to buy several different stocks,´ said Tom Hisey of LPL Financial Services. “You probably have $100 or so every month. Individual stock buying doesn’t lend itself to that.”

With a mutual fund, a young couple can invest small amounts and build themselves a stake that they can later take to a stockbroker. “After a few years, you’ve socked away $10,000 or $20,000 so now you can buy several stocks for a portfolio,” Hisey said. “Some will go right, and some will go wrong.”

If you’re older, your focus changes. “When you reach this age, you have to start saving like a maniac,” Hisey said. “Hopefully, you don’t have much debt and your home is paid for. You also have to be more conservative. If you’re young and you lose $10,000 investing, well, hopefully you’ll have learned something. When you’re older, you don’t have to the time to recover from those kinds of mistakes.”

So let’s say you’re at the point where you have a tidy little sum stashed away and you want to establish a portfolio. In order to do that, you have to pick a stockbroker and you have to have some idea of what stocks or what kind of stocks you want to buy.

Hisey recommends talking to people you know. Find someone whose judgement you respect and see who they use. You can also contact the National Association of Securities Dealers or the Society of Financial Planners in Denver to inquire about a broker you’re considering.

“It’s like the Better Business Bureau,” Hisey said. “If you find one complaint, well, you can’t make everybody happy. But if you find someone with five or six complaints over a few years, ehhh.”

You must also decide what kind of arrangement you want with a broker. You usually have a choice between a flat fee or a commission basis. You want a broker to be compensated fairly so he’ll be interested in you as a client. However, if you have a broker on a commission basis, that broker will get paid every time he makes a trade. You don’t want him making trades that do nothing but earn him commissions. You can check the stock-picking ability of firms in the Wall Street Journal, which runs just such a feature every quarter.

The final hitches are picking stocks and monitoring your portfolio’s progress. Gogela advises that you read investment periodicals, business newspapers and magazines before you start selecting stocks. “Just be careful of Internet information,” Gogela said. “A lot of it is suspect.”

What you don’t want to do is make an impulse buy. “Don’t take one yardstick and apply it to one stock,” Hisey said. Let’s say you bought a microwave oven 15 years ago. In all that time, the microwave has cooked your food evenly, done everything you’ve expected of it and never broken down. You may write the company a letter telling them how much you appreciate the craftsmanship that went into that oven, but it doesn’t mean you should buy their stock.

“Stocks have personalities,” Hisey said. “You have to look at the environment that an investment has been in before you decide whether to buy it.”

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