When I graduated from college and got my first job, I was earning almost twice what my father was. If I'd had a clue, I would have started investing my extra money instead of spending it. Don't get me wrong, I had a great time in those days. I threw lots of parties, I had great seats for all the concerts I wanted to see, I had a cool car and nice clothes. But if I'd given up a third of that stuff and bought stock in Microsoft or Cisco or Home Depot (all companies I was familiar with), I'd now be a millionaire several times over.
After a year or two at my job, I started having my taxes done by an accountant. One of the first things he told me was that I should be putting as much as I could into an IRA every year. I bought into the fund he recommended, Franklin Utilities, which has been a so-so performer, but at about 7 % it's done better than if it was in a savings account at a bank. Later, my work started offering a 401(k) program, so I started contributing to that instead of the IRAs.
For years, that was my investment strategy. Contribute as much as possible to the 401(k) and choose the most conservative option of what it was invested in. I had worked hard for my money and I didn't want to lose it in stocks. At this point, my perception was that you have to invest for retirement, but you should keep the money as safe as possible.
My 401(k)'s grew for a while, but mostly from the money I was contributing. Meanwhile I noticed that several more agressive funds were making 20% a year or better, while I was only getting 7% a year. As I have a math degree, I was already aware of the power of compounding interest, so I decided I needed to start getting more agressive. I jumped into some of the funds with better records, like Fidelity Growth & Income and Seligman Communications. Now my money was growing a bit faster, so I was happy with that for a while.
I probably would have stuck with that strategy all the way to retirement and been perfectly happy with my return, but then something else happened that changed my mind. I signed up for the employee stock purchase plan at my work. The first time the plan dumped some stock in my lap, I had the option to sell it right away for an immediate 15% gain, or I could hold the stock. I thought the company was doing well at the time, so I held onto it for a month.
After one month, I sold the stock for a 30% profit. Once again I was thinking, "Man, I've been settling for 20% a year when I just made 30% in only a month." That piqued my interest, and I started watching the stock prices of companies that I thought were good companies. Obviously I realized that I couldn't expect to make 30% in a month on all my stocks, but I wanted to get an idea of whether I could make more, or if I was more likely to lose my shirt.
It turned out that I was able to pick some winners, some mediocre performers and a loser or two. The only problem with that is that the market was so bullish that I probably could have accomplished the same level of success by throwing darts at the stock tables. About this time I started hearing about online brokerages that charged $20 or less for a trade instead of the $50 to $100 range I had heard about. I decided to go ahead and risk some actual money, so I transferred $10,000 into a brokerage account.
My first thought was to buy stock in a big company with a proven track record that I really believed in (my conservative side was still peeking through), so I bought a bunch of Disney stock. At the time, Disney stock was $106 a share, so a bunch was only 90 shares. Somehow that didn't feel impressive to me, so I decided to read up on how to choose good stocks. I figured it'd be safe in Disney in the mean time, so I left it there (good decision #1).
My next step was to go out and get a bunch of books on how to evaluate stocks to choose the best ones. It turns out there are several different camps about what makes a good stock. I don't think any of them has the definitive answer, else everyone would be folowing those methods and none of the other theories would get any press. I think each of them lends some useful knowledge for a particular strategy of investing.
At one end of the spectrum, you have conservative or "value" investors, who argue that a good stock should pay dividends, and should have a low price to earnings ratio and a low book to earnings value. I'd put Benjamin Graham and Warren Buffet in this school. The goal here is to find good solid companies that are under-priced. The "Dogs of the Dow" method is sort of a quick and easy strategy that falls into this camp.
In the middle of the risk road, there were the "growth" investors, like William O'Neil and Peter Lynch. To this group, dividends weren't nearly as important, or even p/e to some extent. This strategy is to look for stocks that seem likely to go up in price quickly, either in the short or long term. Some of the most important factors they look for in a company are earnings growth and small market capitalization. The theory here is that since the company is making good money, it'll eventually become popular, and when it does, the small number of shares will make it rise very quickly.
Of course there are some things that both growth and value investors look for. For example, it's best to avoid companies that have a lot of debt. Also, all of the investors mentioned above prefer not to buy stock in a company until it's profitable. This is a confusing concept at first, but you can be losing money as a company and still have earnings growth. If you lost 10 million last year and only lost 1 million this year, that's quite big earnings growth. The smart people all say to wait until a company is profitable for a couple of years (or at least a couple of quarters) before buying.
My one problem with this notion is that all the big moon shot stocks that go from 50 cents a share to $50 a share in a couple of years go up in price to $10 or $15 a share before they become profitable. Thus if you wait with the smart people, your rocket ride isn't nearly as far. On the other hand, most stocks worth less than $5 a share end up worth $0 in the long run, so it's probably better to stick with the companies that have proven themselves.
In several of the books I read, they talked about stock options. These are essentially side bets about whether a particular stock is going to go up or down a certain amount by a certain time. The bad thing about options is that they expire in a short period of time, so if the stock doesn't go up (or down) as quick as you thought, you lose the whole investment. The good thing about them is that you get great leverage.
For example, I bought 90 shares of Disney for $106 a share because I thought it would go up in the next couple of months. Ignoring commissions, that's $9,540 of my money tied up. I could just as easily have bought a call option for Disney in May at 120. Basically, this would have said that I had the option to buy 100 shares of Disney any time before the 3rd week in May for $120 a share. At the time, these cost something like $37.50. Thus if it went up to $125 a share by that time, I could have bought the 100 shares at $120 and sold them at $125, thus giving me $500 profit on a $37.50 investment. On the other hand, if Disney stayed where it was, or went down in price, then I'd lose the $37.50.
That sounds like a really good deal, and not much risk, but the truth of the matter is that most options expire without being called in, so you have to be really careful about what stocks you pick and how much you say they'll change in price. After being a little leery at first, I tried a couple of option plays and actually won on one or two, and lost on a few. The thing is that once in a while you can really win big on options. In the previous example, if you'd have bought 100 options instead of just 1, you'd have risked $3,750, but if it had gone up to $500, you'd have won $500,000. Thus, if you make one great play and four or five lousy plays, you can still come out ahead. You can also lose all your money very quickly, so I'm still up in the air about whether I'll continue to use options plays as an investment strategy.
You can also sell (or "write") call options on stock that you own at least 100 shares of (one option for each 100 shares). This means someone is paying you for the right to buy the stock within some specific time (usually the next few months) for some specific price. This is OK if you're planning on holding the stock, but you wouldn't mind selling (e.g. you're not too concerned about short term capital gains). It could be a bummer if the stock really takes off or plummets, but at least you'll have a modest gain if it goes up or the premium price and the stock if it goes down.
Option strategies, and several other fairly risky strategies are championed by Wade Cook as a way of making big bucks, but I'm undecided yet as to whether they can be used consistently to make money, or whether they are something left to a once in a while high-risk investment when I feel I've got a sure-thing bet. At this point, my view is that they're like Vegas, but with better odds, and much better odds if you're really up to date on the market and the company that you're buying options on. If I really would like to buy the stock RIGHT NOW, but I can't afford it, options might be a good idea.
This is actually the far end of the investment risk spectrum that I've gone to so far. Beyond my current level of risk are futures and options on futures. Futures are sort of like options, in that you're betting that the value of some commodity (like corn or gold or yen) will go up or down over time. Options on futures get even weirder, as they're sorta like a side bet on a side bet. They sound really risky to me now, but who knows. If I do really well in stocks and on options, I may give them a try some day.