No one likes to be told that in order to succeed he must put his nose to the grindstone, but that's exactly what smart investors must do if they are to stand a chance of making a profit. An amateur, wanting to avoid gambling in stock, must do some studying. The main ideas for reducing the risks are mentioned below:
1. Avoid Egotism. Realizing that there are several million stockholders in this country, admit to yourself that probably quite a lot of these people are just as smart as you are. Be satisfied with results a little better than average.
2. Avoid prophets, especially the positive ones. The stock market reflects events and rumors from all over the world, and no man or any group of men can be sure of what is going to happen, or when.
3. Don't borrow on stock; the price might drop and wipe you out.
4. Diversify. Don't put all of your capital into one investment, or into just one type. Put part of your savings into common stock, the other part into fixed-price items cashable at any time without loss of dollar value. Own stock in a good many corporations. The larger the number, the better the chance of getting average results. And for real diversification, the companies should be in several different industries. For instance, pick a steel manufacturer, an oil refiner, an electric-power company, an electronics manufacturer, a railroad, a department-store chain, and so on.
5. Check its marketability. Before you buy, make sure that you can sell or redeem it easily and promptly.
6. Choose skilled management. Find out how to pick a manager of proved competence.
7. Adopt rules on timing of your buying and selling stock. The time of action is a major risk in owning stock. After you buy, maybe the price drops; and after you sell, perhaps the price rises. Maintain a standard ratio between the current market value of your stock and your reserve. Also, buy and sell stock only in small installments, never moving a large portion of your capital within a short time. By spreading installments over many years, you obtain a fair average price per share.
8. Review periodically. Don't put stock away and forget it. At regular intervals, as for example after the close of each year, check back to see how well your stock has performed during the past five or ten years in comparison to other stock you might buy.
A reader's reaction to these ways of reducing risk may be: "Those are nice ideas, provided a man has considerable capital, but they are impractical with only small savings. A broker's charge is a high percentage on a small transaction; so a little investor cannot afford to make a large number of small purchases and sales. Also, the fee for first-class advice is too high for an ordinary investor to pay."
This reader's complaint is valid, provided he insists on owning stock in the customary old way that is, being a direct owner of stock in corporations engaged in manufacturing, mining, transportation, retailing, and so on. But the mutual funds, the open-end type of investment companies, make it quite practical for a man with only small savings to use every one of the ideas listed above for lowering the risk of owning stock.
It is possible to own stock at a low risk to oneself, but as always the lesser the risk the lesser the profit. It is up to the individual to decide how many and what kinds of risks he wishes to take, and determine the amount of loss he's willing to absorb from there. The rule still applies, however, that the smart investor will diversify.