Are your goals long term or short term? Answering this question is important because individual stocks can be either great or horrible choices, depending on the term. Generally, the term can be short, intermediate, or long. The following sections outline what kinds of stocks are most appropriate for each term length.
Investing in stocks becomes less risky as the necessary time frame lengthens. Stock prices tend to fluctuate on a daily basis, but they do have a tendency to trend up or down over an extended period of time. Even if you invest in a stock that goes down in the short term, you're likely to see it rise and even go above your investment if you have the patience to wait it out and let the stock price appreciate.
Looking at the short term
Short term generally means one year or less, although some people say that short term means two years or less. You get the point.
All of us have short-term goals. Some are modest, such as setting aside money for a vacation next month or paying for medical bills. Other short-term goals are more ambitious, such as accruing funds for a down payment for a new home purchase within six months. Whatever the expense or purchase, you need a predictable accumulation of cash soon. If this sounds like your situation, stay away from the stock market!
Because stocks can be so unpredictable in the short term, they're a bad choice for short-term considerations. Short-term stock investing is very unpredictable, and your short-term goals are better served with stable, interest-bearing investments (like bank CDs) instead.
During the raging bull market of the late 1990s, investors watched as some high-profile stocks went up 20 to 50 percent in a matter of months. Hey, who needs a savings account earning measly #&*@$ interest when stocks grow like that! Of course, when the bear market hit in 2000 and those same stocks fell 50 to 70 percent, all of a sudden, a savings account earning a measly #&*@$ interest rate didn't seem so bad.
Stocks, even the best ones, will fluctuate in the short term. No one can really predict the price movement accurately, so stocks are not appropriate for any financial goal that you need to reach within one year.
Considering intermediate-term goals
Intermediate term refers to your financial goals that need to be reached within five years. If, for example, you need to accumulate funds to put money down for investment real estate property four years from now, some growth-oriented investments may be suitable.
Although some stocks may be appropriate for a two- or three-year period, not all stocks are good intermediate-term investments. There are different types and categories of stocks. Some stocks are fairly stable and hold their value well, such as the stock of much larger or established companies. Other stocks have prices that go all over the place, such as the stocks of untested companies that are just starting out and haven't been in existence long enough to develop a consistent track record.
If you plan to invest in the stock market to meet intermediate-term goals, large, established companies or dividend-paying companies in much-needed industries (like food and beverage or electric utilities, for instance) are good choices for you. Dividends are payments made to an owner (unlike interest, which is payment to a creditor). Dividends are a great form of income, and companies that issue dividends tend to have more stable stock prices as well.
Investing for the long term
Stock investing is best suited for making money over a long period of time. When you measure stocks against other investments in terms of five or (preferably) ten or more years, they excel. Even investors who bought stocks in the depths of the Great Depression saw profitable growth in their stock portfolios over a ten-year period.
In fact, if you take any ten-year period over the past 75 years, you'll see that stocks beat out other financial investments (such as bonds or bank investments) in every single ten-year period when measured by total return (taking into account reinvesting and compounding of capital gains and dividends)! As you can see, long term is where stocks shine. Of course, it doesn't stop there. You still have to do your homework and choose stocks wisely because, even in good times, you can lose money if you invest in companies that go out of business.
Because there are many different types and categories of stocks, virtually any investor with a long-term perspective should add stocks to his investment portfolio. Whether you're saving for a young child's college fund or for future retirement goals, carefully selected stocks have proven to be a superior long-term investment.