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Author Topic: Stock Picking
IrishTD
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Per OR's request for investing threads...(and a follow-up response).

In all things financial (or at least that I've tripped across so far), my guess is that selecting specific investments is probably the trickiest part of investing. There are thousands of funds and individual stocks available for purchase and deciding which one(s) to purchase is not simple.

For now, we'll dedicate this one to the types of research one should do prior to investing in a particular stock. Or any life lessons/tricks that help.

There are a few questions that should probably be answered before narrowing down the universe of stocks into a manageable number to study. Here are some I would consider:
  • Tolerance for risk (can you stomach the drops?)
  • Time frame (more time available, a bit more risk might be manageable)
  • Goal: are you looking for income, huge price appreciation, or something in between?
  • Effort: Do you want to put in the time to study these stocks?
  • Diversification: Can you buy enough different stocks to prevent losing your entire portfolio?

Answers to these questions will direct where to go...if you're looking for income and stability, certain industries and stock types are better; if you're looking to hit a home run (price appreciation) you'll have to go a different direction. For example, utility stocks generally don't have much price change, but generally have good dividends; small businesses probably won't have dividends, but if one hits it big (say, Starbucks) you can end up incredibly well off.

In general, most of the advice I've seen says to study the company's annual report, balance sheets, and income statement. Most of time, if I'm looking at these, I want to see a company with growing revenue and growing profit. Growing market share is also a good thing (if it's shown). I also tend to look at a company's P/E ratio (both current and historic) to see if it's stock is expensive, reasonable, or cheap (as a quick guideline). The other thing I've started looking at (in analyst reports) is the fair value of the stock (another data point that I use like P/E). There are lots of other measures out there, but I generally ignore them.

Personally, my investing mindset (for stocks) has changed significantly over the last few months. As a result, I'm trying to go about three ways with my portfolio as shown below (disclaimer: this excludes retirement monies which are in a few mutual funds of different asset classes).

My first direction, and what I would consider the cornerstone of my portfolio, is own stock in large companies that aren't going anywhere anytime soon (GE, Pepsi, Johnson and Johnson). Currently, I don't see myself selling any of these soon because each continues to grow (albeit slowly) and keeps raising their dividends. While I probably won't get wildly rich off any of them (at least not soon), the odds of losing any significant money on them are minimal. Citigroup would have been part of this group, but they decided to get too complex for their own good. Another reason for selecting these types of stocks is that they fit the Buffet maxim of buying what you know. When picking these stocks, I generally just try to buy them when they're cheap (close to 52-week lows) or on sale (below a moving average - say 50 days). Since I plan them to be long term holds, I don't worry too much about an exact purchase price.

A second direction I'd like to go is to invest in quickly growing small and mid cap stocks (or small large caps). Part of this group would exist to try and provide quick capital growth; the other part would be trying to find the next WalMart, Starbucks, etc. For the growth part, I wouldn't consider this to be day trading per se, but more short term trading. Since these stocks tend to have greater volatility, it's not impossible to make a quick few bucks (for example, I have an unrealized gain of 15% in a stock I purchased a month ago). Of course, it's just as easy to lose a few bucks as well. For these types of stocks, I generally look for stocks that are cheap (say $5-$20/share), close to 52-week lows, and generally well rated by analysts. This is also where looking at fair value can help (in general, stocks will drift towards there fair value). For the next Starbucks type of stock, I would be looking for those with outstanding growth, increasing revenue, increasing profits, increased market share, manageable debt (growing purely by borrowing money doesn't always work well) and some kind of moat. Since I haven't done much on this search, I can't offer any more guidance.

The third direction I would go (esp. if I had the money) these days is to skip individual stocks altogether and go with exchange traded funds (ETFs). These trade like stocks, but act like mutual funds (and depending on what you want to do, mutual funds may be a better choice). Using ETFs allows one to invest in sectors that they want without betting on any single stock. For example, since people in industrial nations are getting old, health care ETFs are probably going to do quite well over a longer time frame. I see these as a really good way to play a specific industry rather than trying to pick a single stock.

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OceanRunner
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Irish - what you say makes a lot of sense. DH and I are trying to get started in GE's direct buy program (for some reason, I'm having issues with electronically signing up). Do you have any preference for J&J over PG - they seem like pretty similar companies to me with similar longterm outlooks? We're thinking of investing in GE monthly through the direct buy program and adding in some J&J or PG as the base of our portfolio.

I really want to find some good small cap type stocks for growth, but I'm having a rough time finding something I feel good about. If y'all would allow me to just ramble for a minute, and then maybe someone can help me with perspective?

One of the issues that bothers me right now, I guess, is that I want to buy stocks that I understand, which leaves me inclined towards stocks like Buffalo Wild Wings, Chipotle, American Eagle and Coach -- but the two restaurants' stock seems overpriced right now when so many other stocks are on "sale", and the two latter ones seem like... well, they aren't going to grow any more anytime soon. Where's discretionary spending going? Nowhere...

One of my friends bought Apple at $133 a few months ago, and of course it's closer to $190 now. But the S&P reports on it have a forecast price on it of $200, so having missed it at $130-ish, buying it now seems like a bad idea.

I feel like now is a great time to get in the market, but I'm having a rough time sorting out all the conflicting info I read. Thoughts? How does one find good small cap stocks in the first place? What kind of small- and mid-cap stocks are likely to continue to grow through our current economic woes, or are good investments now for post-recession?

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IrishTD
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The direct buy (DRIP) programs can be quite nice for accumulating stock cheap. My wife did that with a couple of companies and I enjoy the lack of fees (for the most part) associated with it.

As for JNJ vs. PG, you probably can't go wrong either way. Personally, I'd probably lean a bit more towards JNJ for now since it has a higher yield and has increased it's dividend by a greater amount (on average) over the last 10 years (about 11% annual increase for PG and 14.3% for JNJ). I also like the demographic advantage of JNJ (baby boomers want health products); of course, the rise of the middle class in other countries will probably help both (I'd guess PG more though). However, the research reports I just looked at (I have an etrade account), suggest that PG is probably going to grow quicker, so there might be greater stock price appreciation there. And both of their P/E ratios are about 85% of their five year average right now. All that in mind, flip a coin and pick one -- or, look at it this way, if you spend a lot with one and not the other, get some of your money back via dividends [Smile] (that's why I have pepsi and not coke)

*****
As for small and mid-cap stocks, personally, I'm leaning towards ETFs for the most part. I don't want to spend the time to research a lot of 'em and will just take the regular growth instead (if you're planning on doing regular investments, you'd probably be better off with a mutual fund though).

I think for finding them, some of what you have to look for are seriously growing revenues and earnings (profit). Of course, low debt and reasonable stock price help too along with them being a business that is unique (or in a quickly growing market). You can find stock screeners out there to help find 'em. I'm cheap, but Motley Fool does offer some investing newsletters for a couple hundred dollars annually that seem to do well. They offer some free trials, so doing a one month freebie might help ya find some ideas.

The companies you list in your third paragraph suffer greatly from being cyclical in nature as well (well, many companies are, so no big surprise). Discretionary spending will eventually pick back up a bit, but probably not anytime soon.

My guess is that those that keep growing through this rough time are those that are unaffected by consumer spending (maybe industrial manufacturing suppliers) or on the lowest rung of consumer spending (little walmarts); international exposure is probably helpful as well (esp. as more of india and china hit the middle class). Post-recession I'd be looking at those that offer the 'little luxuries of life' or along the lines of Chipotle/BW3s (cheap casual dining)...basically, as people have more money in their pocket they'll increase their standard of living a bit. Other thing I'd be looking at these days is any kind of energy related company (we're gonna need more across the world).

As for Apple, I goofed a long time ago not getting it at just above $110. It's kind of a fad stock prone to huge swings these days -- I'm guessing it'll be below $150 again before too long. I just wonder how the recent slowdown is going to affect it. Also, (and I've not looked into this) have they been able to sell many iPods and stuff overseas (particularly Asia)? Plus, a tech company with a growing bullseye could be a bit risky (I wish I was playing the swings tho!)

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OceanRunner
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I know Apple has a contract with cellular carries in 10 other countries to sell the iPhone... read about that the other day. Not sure about the iPod, though.

I do hope it goes below $150 again soon. It is interesting to watch it swing back and forth...

EFTs are interesting. I'll have to do some more research - I saw some on Vanguard a while back that looked interesting.

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Paladine
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What do you think about Google? A friend of mine's strongly suggested that I look into putting some money into it.
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IrishTD
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Google is one I'm just not sure about. Part of me thinks that they could be a huge growth story (still) and it's worth getting in at any price (although cheap is good [Smile] ) Part of me thinks that internet advertising growth will eventually slow and so one of Google's big revenue streams will take a hit. However, they do seem to be expanding into the IT services markets (places keep outsourcing email and search to google) and have recently just entered the health records market.

Their market cap puts them in the top 25 of world wide companies and they probably have the lowest revenue of any of 'em (i found a yahoo screener to give me the list). And their P/E is about 40, which is pretty high. These factors would make me think that the stock may trade in a narrowish band for awhile (especially as their growth starts to slow a bit...).

If the stock price came down a bit (say under $500/share), I'd probably be pretty tempted (if I had the cash) to take a chance on it. It's going to take some huge swings though, especially each earnings season. My guess is that it'll keep growing and someone is going to have to come up with something special to really take a massive chunk out of Google (Microsoft and Yahoo ain't gonna be it).

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kenmeer livermaile
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I think google will rise in value for some time. It is the preeminent network for facilitating access via knowledge. It is THE catalogue.
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JoshuaD
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Can you explain how options work in some detail? I'm clueless on those.
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munga
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[Smile]

Simple rules on that:

Bull Siht San Francisco = Buy Spot Sell Future

(you believe the value of the item on the market will be going up)

SS are Bad Fcukers = Sell Spot Buy Future

(you believe that value of the item on the market will be going down)

Most people understand the first (everyone knows how to buy something and hope it will increase in value, to be sold later at a profit) but very few appreciate how to protect themselves when they anticipate the market going down, or Selling the Spot = "today's price/sold today" by wagering both directions and this is the beast we often call "hedging" or creating equal risk on both sides to equal a null risk, which is why hedged contracts are considered so valuable, but it also means you are "selling" as in not speculating as in not going to make a killing, by KNOWING which way the market will be valuing something as in the case when 1 insider trading (which is THE status of the market usually, and why New Yorkers are so full of arrogance, they really DO have the market figured out because all items are marked by NEW YORK's exchanges- stock and mercantile) and 2 you happen to really know what your item of interest is really capable of doing to the market.

[ May 30, 2008, 03:06 PM: Message edited by: munga ]

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IrishTD
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Don't know much about options...actually, anything. Sorry for the delay.
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The Drake
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Options, or derivatives, can be simple - but strategies based on them can be massively complex.

The biggest difference is that options not only have a price, but also a date on which they expire and become worthless if not exercised.

You can write options against stock you own or stock you don't own. You can buy options to purchase at a particular price.

The long call is the easiest option to understand. Somebody offers an option contract to buy stock at $30 expiring in three months. The current stock price is $28, so the option is considered "out of the money" or worthless if the stock doesn't rise during the three month contract. The contract itself might cost $3 per share. So you'll need the stock to rise above $33 before you make money.

The advantage here is leverage. Let's say the above stock rises to $40. If you buy the stock outright, you will have $28 per share tied up, and realize a gain of $12 per share. That's a nice profit of just below 45%.

But if you bought the options, you'd only tie up $3 per share, and you'd make $7 per share - over 200%. But there is no reward without risk. If the stock remains motionless for three months, the option play will lose 100%, while the stock play will lose nothing.

One of the more intruiging possibilities is writing covered call options on stock you own. In this case, you are the seller of the contract in the above scenario. If the stock does not rise, you pocket $3 per share of the stock that you own. If the stock rises to $40, you must sell your shares at $30. In either case you make money - although you miss out on the gains from the stock you would otherwise own.

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IrishTD
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Don't know if anyone else has noticed, but Google is under $500 now thanks to an earnings miss....methinks it was about $560 or so when we were first talking about it here.
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scifibum
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I think google's p/e is high but not scarily so for a new company that's been as strong as they have. sadly i have no money to invest. I wish I'd invested back at $200, or $300, or $400...
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The Drake
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Google is now available at nearly $300. It's your big chance!
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Paladine
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Really think it's a good buy, Drake?
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IrishTD
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I do (even at the $370 of today). Making boatloads of cash, minimal debt (essentially none), finding ways to expand revenue (into services) beyond search/ads/etc...and i'd bet that there is serious money to be made on services (email outsourcing, for example).
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The Drake
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I'm waiting for another downbounce, then buying a 30-60 day option contract. I wouldn't want to risk the amount necessary to buy and hold in a straight up long position.
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The Drake
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Will be interesting to see what happens with Google's earning report Thursday. Most analysts are expecting that Q3 should be unaffected by the craziness and will provide a nice boost.

I've got one options contract as of this morning.

quote:
BY THE NUMBERS: Analysts surveyed by Thomson Reuters expect Google to report income of $4.79 per share on $4.05 billion in revenue.

ANALYST TAKE: RBC Capital Markets analyst Ross Sandler suspects Google's third-quarter results will miss Wall Street estimates. "Our (third-quarter) checks suggest that search is holding up better than other forms of online advertising; however, no company is immune to cyclical factors," Sandler wrote in a research note last week.

UBS (nyse: UBS - news - people ) analyst Benjamin Schachter has similar concerns, but believes Google won't fare as poorly as the recent sell-off in its stock implies. "We believe that expectations are low enough where the stock can work from here," Schachter wrote in a note distributed last week.

WHAT'S AHEAD: The first mobile phone powered by software designed by a team led by Google is scheduled to hit stores Oct. 22. Although Google isn't charging for its "Android" software, the company is counting on the system in the "G1" phone to attract more mobile traffic to its search engine and generate more ad revenue.


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The Drake
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Google update:

They have jumped back to about $350-$380 in late trading on positive earnings news. The options I bought at $15 were down to $10 this morning and up to $20 at the close. Gotta love those swings...

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Paladine
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In somewhat related news, I've been thinking about waiting for the dollar to strengthen a little bit and then moving most of my money into either foreign currency or precious metals (kind of torn between gold and platinum). I think we're going to continue spending money we don't have under either McCain or Obama. We're not going to tax our way out of it and people are going to be less willing to lend us money as they realize they're going to be paid back in Monopoly money, so our only alternative will be to continue to print.

The reason I'm posting this here is that I'd like to know what some of our more learned members think of gold (which obviously needs to continue to come down a bit before I'd consider it).

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The Drake
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I moved some of my holdings into yen and Tokyo Exchange stocks like Mitsubishi. The yen was doing fine against the dollar until the Japanese prime minister announced his support for the dollar.

Don't know too much about precious metals. If you are looking for safe havens, it probably can't go too wrong especially as a hedge against loss of value in currency and stock.

You may want to look at stock in the companies that mine gold, copper, and other resources. Their profits tend to follow the direct sales of the metals.

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IrishTD
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I would also think about food based commodities or stocks...we all need to eat!

Potash Corporation of Saskatchewan Inc. is an integrated fertilizer and related industrial and feed products company -- symbol POT -- could be one worth looking at. It's at ~$70 now ($60-$240 in the last 52 weeks) and just reported that it earned more in the last quarter (about $1.25B in Canadian) than all of last year. Only downside to this one (and really the only reason I know about it) is that it is heavily talked about.

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OceanRunner
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I thought GE stock would have been seriously buoyed by Warren Buffet buying it (although I tend not to want to copy the Buffet's moves, since the difference between what he does and what a small investor should be doing is so different). But it was so underpriced, I had to buy some.
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IrishTD
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quote:
although I tend not to want to copy the Buffet's moves, since the difference between what he does and what a small investor should be doing is so different
Care to expand on this comment? I'd be interested to know why copying Buffet isn't an advisable strategy (in your opinion).
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mytreeisempty
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I don't know if this deserves it's own thread or not (I will happily post one), but here it goes...

Say I have $10,000 USD that I want to put into a retirement fund.

How do I invest this money to ensure that my golden years are actually bright and shiny?

Let's assume that I have no prior knowledge of sound stock owning and investment practices. (which is very close to the truth.)

How and where do I want to put my money?

I will happily discuss further details, if they are required.

Thanks!

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IrishTD
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I'd put it into a Roth IRA ($5K/year max investment unless over 50, then $6K/year) and invest it in a highly rated target retirement fund. However, given the way the market swings these days, I'd probably do it this way.

1) Find mutual fund company (or brokerage) that has target retirement fund I want to be invested in.

2) Find a money market or similar fund at some company (or another if you use a brokerage rather than go straight through a fund company).

3) Invest yearly max into a Roth IRA and buy into the money market fund (avoid the tax man [Smile] ). Your Roth IRA contribution can be marked for 2008 all the way through April 15, 2009. Put rest into online savings account.

4) Set up automated withdrawls from money market fund to purchase target retirement date fund (depending on target date fund requirements, you may have to make a large initial purchase, say $2.5K first).

5) On first business day of 2009, make 2009 annual contribution to Roth IRA from savings account. Probably best to put it into money market account. If you're under 50, you'll probably have a few bucks left over (interest earned on the $5K). Enjoy a pizza or beer.

As for the automated investments from the money market into the target retirement fund, it's certainly not required; however, it would let you dollar cost average (more shares when prices are low, fewer when high) a bit. I would probably target having the money market fund empty by the end of 2009 or 2010.

The nice thing with the target retirement date funds is that you can pretty much just open it and let it go. The fund stays pretty balanced and gets more conservative as you get closer to the target date. For example, the Vanguard 2010 fund has lost only ~21% from Jan. 1 through yesterday while the 2045 fund has lost ~32% in that same time frame.

The one comment I should make about Roth IRAs is that there are some income requirements that must be met (i.e. you have to have earned income and can't have earned too much)...you should be able to find those online pretty easily.

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mytreeisempty
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Let's say that my employer matches 3% of what I put in if we use a retirement company. That leaves us with the choice of how we want to allocate our funds. What are some guidelines for picking how much goes into the following categories:

Fixed
Large-Cap
Mid/Small-Cap
International
Short-Term

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IrishTD
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So is this like getting a $10K bonus with an extra 3% on top of it, or is this money that you would be putting into a 401(k) or similar?

As for picking fund categories (and amounts to put in each), several questions come up:
1) How much time do you want to spend doing research (both now and on an annual basis)?
2) How much effort do you want to expend on managing your fund(s)?
3) How soon is this money needed?
4) What's your risk tolerance?
5) Is this a one time thing (i.e. a bonus) or is this likely to be an annual event?

Answers to these might help some [Smile]

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mytreeisempty
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Thanks Irish for your help!

Whatever I contribute monthly, the employer adds 3%. Let's forget about the 10k, and say I was starting from scratch.

1) Considering that I haven't put any in so far, enough to where I feel comfortable about making my own decisions. So that means I don't really know yet.

2)I don't have a definite answer yet, but enough effort to where I would want to see results because of this effort.

3)This money would be for when I retire in let's say 2038.

4)I would say somewhere between low and medium.

5)A monthly paycheck deduction.

Again, thanks for your help!

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IrishTD
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If you're not sure how much time/effort you want to expend on managing your funds, I'd really look at the various blend funds that are out there. A blend fund is generally considered a blend of other mutual funds. With these, you generally get a decently balanced mix of the different asset classes (such as your 9a post on 11/7). You could also use these blend funds to guide your division up (if they are unavailable to you).

The first type, the target retirement date funds basically vary the stock/bond mix as you get closer to the target date (become more conservative) and are designed to keep you from having to manage anything. For example, the Vanguard 2040 Fund is a mix of a total stock market index fund (~72%), a bond index fund (~10%), Europe stock index fund (~10%), a Pacific stock index fund (~5%), and an emerging markets index fund (~4%). Similar funds from other companies will probably have a similar stock/bond mix, but might have a different balance of funds (for example, more in international stock indexes).

Another option would be to find a blend fund that is "risk managed" for lack of a better phrase. You'll generally find three to five blend funds in this category and they tend to range along the lines of conservative (income), conservative/moderate growth, moderate/aggressive growth. The more aggressive, the more in stock (and the less in bonds/cash). Again, going back to Vanguard they have 4 options (Life Strategy is what they call them)...the most conservative targets a mix of 20% stock/60% bond/20% cash (or similar) (right now it's about 30% stock/50% bond/20% cash). Their most aggressive ranges from 65%-90% stock and the rest bond (is about 90% stock today).

***

You might also want to look at sites like fool.com (and others) to help you out!

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mytreeisempty
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Hey, thanks for the help!

Is there any other websites out there or books (gasp!) that would give me a good start to a solid understanding of sound investing principles?

Is it kind of like learning a foreign language where you want to completely immerse yourself in a culture, or do you want the information to slowly trickle in?

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IrishTD
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I know there are some good ones out there (for investing principles), but for a lot of the basics, Motley Fool (fool.com) is pretty good. I also recall seeing some book recommendations on there, but can't think of/find them right now.
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mytreeisempty
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Thanks for the help!
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The Drake
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Haven't been checking here regularly, as I just got laid off two weeks ago, and missed the entire discussion.

Irish has a pretty good handle on what you want to do. Don't overlook the value of an ETF, or exchange-traded fund, instead of the traditional mutual funds. We can continue to use vanguard as an example, they have a nice comparison table.

The biggest advantage in today's volatile market is the ability to bail out of a fund and move to another. Mutual funds only trade at end-of-day, and you have little idea what the price is when you buy or sell.

The book, "A Random Walk Down Wall Street" is great for beginning investors.

In today's bear (down) market, however, you may look to something other than riding the indices into the side of the mountain. ProShares ETFs allow you to anticipate a falling index of various types. The market is down, but your retirement grows.

For instance, the Short S&P 500 (NYSE:SH) has risen 15% in two weeks as the market has been crashing.

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