Chances are, you probably already know you need to start investing.
The problem? It can be overwhelming to figure out what makes “good” investments.
One of the scariest aspects of investing is trying to pick the “right” stock. You don’t want to make a mistake that costs you a substantial amount of financial losses.
While there is no way to completely protect against losses when you invest, there are things you can do to limit your risk and find good investments for your portfolio.
What are good investments?
When most of us think of investing, our minds immediately go to stock picking.
Most of us probably start out trying to figure out which stock is going to be “winner.” However, you don’t actually need to get involved with investing in individual stocks to be successful.
Before you get into stock picking, consider the possibility of investing in index mutual funds. The best part? You don’t have to worry about jargon and finding the “right” investment when you own a broad swath of the market.
With an index fund, you own a piece of everything on a specific index. This might be a collection of bonds, a collection of stocks, or some other collection of assets.
Essentially, one of the easiest ways to start investing and keep pace with market growth is to consider an all-market fund.
You don’t end up with sexy returns when you follow this strategy, but you do have a better chance of gains over time. Plus, you get instant diversification because you are invested in a wide variety of assets.
Overall, the stock market has never had more losses than gains in any 25-year period. It may see losses in a year, or struggle over a five-year period, but over time the trend is toward gains.
So if you don’t want to mess with picking stocks, indexing can be a viable strategy.
But if you still want to look for good investments by choosing individual stocks or putting money into other assets, here are five signs to look for before diving in.
1. Start with the fundamentals
When choosing individual stocks, it helps to look at a company’s fundamentals.
The fundamentals of a company are the items that can indicate its health. These characteristics are unrelated to trading patterns and price fluctuations.
Some fundamentals to consider include:
- Cash flow: positive cash flow indicates a company can settle debts, pay expenses, return money to shareholders, and reinvest.
- Return on assets: how a company uses its assets to generate income.
- Management: whether a company’s management has provided good leadership and growth.
Because fundamentals can vary from company to company, it’s important to compare those fundamentals with other companies in the same industry or sector. A company with solid fundamentals is likely to weather storms in the market or in the economy.
2. Long-term viability
How likely is the investment to stick around? Could you see yourself staying in for at least five to 10 years?Good investments have long-term viability.
Ultimately, you want to feel good about keeping the investment long-term and feel good about reinvesting dividends if that’s an option.
Your best results over time come from sticking with something long-term and taking advantage of gains over time. Consider digging into the company’s business model and profit margins. And, the history of the company as well.
This idea also works with other assets. What’s the long-term viability of real estate in your area? If you want to own rentals, you need to consider whether or not you think the rental market will remain strong for the long-term.
Do you think oil and gold prices can go up over time? Study it out to see if your investment has long-term viability.
Take a look at the earnings from an investment standpoint. It’s important to consider stability and growth when trying to find good investments.
Does the investment provide relatively consistent earnings? This means that the company sees regular growth in earnings over time.
Although there may be years of larger or smaller earnings, as well as some losses in some years, over time you want to see general consistency in profit earnings.
A word of caution, though. Earnings that are too consistent, such as 10 percent on the nose each year, are suspect. Every investment has down times. Clockwork consistency is usually a sign of a scam.
Look at the quality of the earnings as well. At the end of the day, you want to make sure that the earnings make sense.
Declining revenues and increasing costs in concurrence with high earnings are unsustainable. It means the earnings aren’t high quality and probably won’t last. Avoid investments that can’t sustain earnings and growth.
4. Consistent dividend growth
When a company has the ability to pay out a portion of its earnings back to shareholders, that’s usually a good sign. If a company consistently increases its dividends, that is often a sign of health.
Looking for good investments using dividends as a sign isn’t about high yield. Instead, look for a company with a mid-range yield that increases regularly. Something on the list of dividend aristocrats is a good place to start.
I don’t invest much in individual stocks, but when I do, I usually start with the dividend aristocrats list. These are companies that raise their dividends each year — even in years when the stock market is down.
While it’s not the only list to consider, it’s a good indication that a company is fairly healthy and a reasonably good investment if it’s listed there.
5. Helps you meet your goals
Finally, good investments help you reach your goals. An investment that might be otherwise good in someone else’s portfolio might not be right for you. You have your own goals, timeframe, and risk profile.
When evaluating an investment, look at the potential returns, historical returns, and fundamentals to see how it fits into your long-term goals.
Is the investment likely to grow at a rate to help you grow your portfolio and help you reach your retirement goals? Can you sleep at night placing money in this investment?
At the end of the day, you need to be comfortable with your investments and reasonably confident that they will help you reach your goals.
Other things to consider
Once you really get into investing and choosing assets, there are a number of data points you can use to evaluate an investment. As you dig in, you’ll discover jargony things like PEG, P/E ratio, technical analysis, and price-to-book.
Remember, start out with the simple investments and simple strategies. Once you get started and build a solid foundation, you can try more complex strategies and add other assets to your portfolio.
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