Understanding Stocks

162 UNDERSTANDING STOCKS
Mistake #4:You Bet All Your Money
on Only One or Two Stocks
One of the problems with investing directly in the stock market is that
most people don’t have enough money to maintain a properly diversified
portfolio. (In general, no one stock should make up more than 10
percent of your portfolio.) Although diversification limits your
upside gains, it also protects you in case one of your investments does
badly.
If you can’t afford to buy more than one or two stocks, you have
several choices. First, you can buy mutual funds, especially index
funds, which allow you to buy the entire market for a fraction of what
it would cost if you bought each stock in the index. Second, you can
hire a certified investment adviser to manage your portfolio and help
you to diversify.
If you feel that you must bet all your money on only one or two
stocks, then buy stocks in conservative companies with low P/Es (less
than 10) that pump up their returns with quarterly dividends. You want
stocks in companies that are so good that they will be profitable for
years.
The Exceptions
If you are a short-term trader (or perhaps a gambler), making big bets
on one or two stocks can pay off big. For example, some traders focus
on one stock, perhaps an exchange-traded fund (ETF) like QQQ, Diamonds
(DIA), or SPDRs. When you become an expert on only one
investment, you have a better idea of when to buy and sell it. Obviously,
this strategy is better suited to traders than to investors.
It is also true that if you bet all your money on one stock and you
win, you can make a small fortune. However, using this strategy is
more akin to gambling than to investing. Although the odds are better
than in Las Vegas, it is still risky to bet everything on one investment.
To protect yourself, you might be better off betting all your money on a
successful mutual fund than on one stock.