Stock Market Investing - Is It For You?

Am I well suited to stock market investing?

Before embarking on a career as a stock market investor, beginners should be asking this question you should be asking yourself. I mention in my last article (How To Start Investing In The Stock Market) that before you get started, you need to be sure this is something you want to take on. In this article I will discuss some of the things you'll need to consider before deciding you're ready.

Are you emotionally ready for stock market investing?

Participating in the world's financial markets can be an emotional roller coaster ride. Anyone who's had any experience will know that prices can fluctuate wildly. And with this volatility, you need to make sure you will be able keep your head.

Imagine buying a stock, only to see it drop by 5% or even 10% the next day. What will you do? Will you panic and sell straight away? Or will you hold on secure in the knowledge that you've done your research and that over the long term the value of your shareholding will be realized?

It happens to all of us eventually. If you don't think you'll be able to sleep at night with all of this going on, direct investment may not be for you. You may be better off letting a professional manage your money. Stick with a mutual fund or something similar.

Do you have a long term investment time horizon?

Maybe I should clarify something here. I consider investment be be the act of buying stocks in quality companies at reasonable prices and holding for the long term. Short-term trading and speculation are fine - but you need to be aware of the risks. I don't consider these activities to be investment. It can be exciting but I would only employ a small amount of my capital in such endeavors.

Having got that out of the way, what I wanted to say was that you need to ask yourself how long you plan to be in the market. Are you planning to invest the money you've saved up to go on vacation at the end of the year? Or the deposit you've been saving to buy a house? If this is the case, the stock market probably isn't the right place for you. Consider cash or fixed interest investments.

You should be looking at a 3 to 5 year time frame - preferably longer. This will give you time to ride out any volatility associated with market cycles. Stock prices tend to oscillate around the intrinsic value of a company. If you invest in a company whose intrinsic value is rising over time, the stock price should eventually follow. The problem is that over the short term prices may fall short of this intrinsic value sometimes. And at other times it may even trade at a premium. You will need to give yourself sufficient time to ride out these periods of under-valuation. The last thing you want to have to do is sell out at one of the low points - especially if you think the intrinsic value of the company has increased over the period you've held it.

What is intrinsic value? This is a complex topic - beyond the scope of this article. I will write about this in more detail in a future article. But for now, let's just say that it's the true value of a company, rather than the value at which it is currently selling.

Do you have sufficient funds to invest in the stock market?

The reality is that you will need a certain amount of money before starting your stock market investment career. How much is enough? It depends. I would think about $5,000 to $10,000. But this could vary depending on how much additional money you can spare each month to add to your portfolio.

The idea is that you will need to diversify your holdings. You will need to buy stock in a number of companies to reduce the risk that a single company will under perform. If you're unlucky enough the own the next Enron, you want to make sure it's no more than about 10% to 15% of your total holdings. But there are costs associated with buying each of these holdings. You'll need to buy enough to make it worthwhile.

If you only have a small amount to invest, you may want consider fixed interest or a mutual fund until you have saved enough to take the plunge.

Are you willing to put in the time and effort to succeed in the stock market?

In order to be successful, you'll need spend a fair amount of time on your investments. You will need to spend some time getting educated before you begin. You'll need to spend the time researching the companies you intend to buy. You'll need to spent time monitoring you're holdings. This doesn't mean checking the prices everyday, but rather satisfying yourself that the fundamentals of each of your holdings remains sound from one period to the next.

While not an exhaustive list, the above questions should start beginners thinking about whether they are suited to stock market investment.