Money Matters: When should someone consider investing in stocks?

For the general public, there are several common investment securities: mutual funds, four types of annuities, certificates of deposit, REITs, stocks, and bonds to name a few. The most common are stocks, bonds, and mutual funds. The question is often raised, "Should I be in stocks rather than mutual funds?" While the answer should be based upon your individual
objectives, risks, and several other key factors; I will try to provide a general answer.

This topic was the result of a recent meeting with a new client. While I was pleased to be meeting with him, I was a little surprised he was still willing to work with an advisor. After changing jobs in the late 90's, he rolled his 401-k to a broker and began investing in stocks. If you recall the time, the market was moving up with vigor partially due to the impact the millennium bug was having on our economy. His account almost doubled in a short time, but then came 2000, 2001, and 2002. With his account now worth less than when he started, he changed brokers. The new broker continued the investing in stocks but did not reverse the trend, and thus the account continued to shrink.

By the time he reached my office, he had been with yet another broker and now held positions in only four stocks. After reviewing the stocks, he had one with a positive return and the other three all had been trending lower with one having had two major drops in price during the last six months, and yet his current broker failed to stop the bleeding in the account.

This example is not intended to scare anyone from investing in stocks, but it does raise at least two significant points. The first, "Is your account large enough to properly diversify, if stocks are used rather than mutual funds?" I prefer to have the account value at more than $100,000 before investing in stocks; and even then, I generally blend mutual funds with the use of stocks. If you invest solely in stocks, most likely you are in nothing but the US economy. While foreign stocks do trade on our US markets as American Depository Receipts, most individuals do not add very many foreign stocks to their portfolio. Not doing so reduces the allocation and may hurt the overall performance.

You might ask why $100,000 is my limit. If you review professionally managed portfolios, you will notice that only a small number of positions actually equal 1 percent of the portfolio or higher. Most positions constitute less than 1 percent of the amount being managed. They do this for diversification purposes, and they understand regardless of the research and advance preparation some of their selections will drop in value significantly after the purchase and there is little you can do except try to minimize the damage. This is done by keeping the percentage of each holding small when compared to the overall portfolio value. Thus, one percent of $100,000 is only $1,000 and when most stocks trade over $10 per share, buying 100 share round lots can still result in taking a higher percentage position than you might otherwise consider. Any account value with less than $100,000, the impact one stock may have on the portfolio can be so damaging that it could require years to recover the losses.

The second point pertains to the management of the account. Will the advisor actually manage the account and follow the holdings, or are they too busy selling other services to actually manage their existing client accounts? You should ask any broker or advisor how will they track your account and how will they handle a holding that is no longer performing or is now losing money. A broker in a major wire house may have hundreds of clients if not more. And if you have a position that is unique to your account, will the broker still be aware of the moves of that holding or is it up to you to watch the position. If the advisor truly manages the accounts and is not just a salesperson, then you may be in good hands. However, this is an area you should ask and find out how the advisor manages their client accounts.

Stocks are great tools to use to grow your portfolio, but they come with all types of risks. If you are not prepared, you may end up with less than you started. Find an advisor that truly manages the accounts, has the tools to do so, and is not just focused on another sale.

Would you like a response to a financial question? Send your question to Doug Horn, 115 W. Broadway, Maryville TN 37801. Be sure to mark your envelope Money Matters.

Doug Horn, CFP, is an area financial planner with more than 24 years financial experience and founder of Quality Financial Concepts, located in downtown Maryville on Broadway.

Doug Horn, CFP, Registered Investment Advisor in Tennessee and Texas and Registered Principal, Branch Office of and Securities offered through CUE Financial, Member NASD, SIPC.

© 2007 All rights reserved. This material may not be published, broadcast, rewritten or redistributed.

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