Wednesday, October 6, 2010

Some Advice for New or Young Stock Pickers

After watching Citrix Systems and VMware drop 14% and 9% respectively, I thought would give some advice for newer or young stock pickers. Investing in individual stocks is a lot different than throwing money into your 401k, mutual fund or ETF. Many mutual funds and ETFs come with some sort of prepackaged diversification, shielding you from the volatile movements of specific stocks.

When I first started investing in individual stocks, I went towards what I knew and this was technology. I was almost 100% technology at the time and the movements were extremely volatile. Over time I have adjusted my portfolio to where I am much more balanced with Coke (KO), Kraft (KFT), and Johnson & Johnson (JNJ) being some of my largest holdings. Not only are the returns still good, but its helped cushion the blow of some of the more volatile days in the market.

I know a lot of young investors are given advice to take on risk because they're young. They can make up losses over time. But a loss is a loss, and as people drift into high fliers or momentum stocks, losses can pour in a lot quicker. Would you have sold VMware today when it dropped 9%? What happens if VMware continues to drop? These are very important questions that need to be asked BEFORE starting your position.

STEC was one of those stocks a lot of people chased in 2009 that had a lot of good momentum going. STEC sells solid state disks to companies like EMC. These hard drives are much faster than typical drives seen in a personal computer, and STEC saw a large spike in orders in 2009. It was a highly visible stock, and not too hard to understand their product.

In late 2009, the company reported a slowdown in orders. The stock fell and it didn't stop. Chasing that stock burned a lot of investors, and a lot didn't get out early enough. STEC was a highly speculative stock and had been priced on extremely high growth rates. Once investors realized those growth rates had stalled, and even reversed, the stock saw a major correction. You may feel the stock has nowhere to go but up. But a stock that goes up fast will fall just as fast if the company doesn't deliver.

I would recommend new or young stock pickers to start slow and be patient. You may be able to lose money, but those losses can add up over time. Even the smallest of losses will make it that much harder to get back to even. Take a look at my article on long-term investing, and you'll see that you don't even need momentum stocks to beat the market.

This is not a knock on Citrix or VMware as they have had incredible returns for the year, and are very well run companies with strong fundamentals behind them. Just make sure you don't have all your eggs in one basket, and be prepared to adapt quickly if those fundamentals change. The movements in Citrix and VMware today are examples of how quickly things can change for stocks that have had a great run.

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