Stock investment for greenhorns

May 25, 2014 10:06 AM

My mom wants to invest $5K (which she could afford to lose) in possibly high-return, but also possibly high-risk, sectors of the stock market. She's asked me to do the research and manage the investment. I'm interested, but I don't know much about investing in stocks, so I want to proceed cautiously. How do I educate myself about this field? What are some specific sectors to research? What red flags should I be looking for? What about the practicalities, e.g. choosing an online broker? Or is this just a bad idea?

My mom has pretty comfortable retirement savings; losing this $5K wouldn't hurt her significantly, and she's aware this might happen. (If it did, our relationship wouldn't suffer.) She's more of a risk taker than I am; if it was me, I'd probably just put it into a Vanguard index or something of the kind, but she wants to place educated bets on emerging sectors that have a good chance of high growth in the next few years. Her initial ideas were "internet of things"-related technology and medical cannabis; the former seems more promising to me than the latter, but I don't actually know how to judge. Assuming that this is a good idea at all: what are some possible fields of this kind to check out? What sources can I use for research, both on general sectors and specific stocks? How do I learn to evaluate specific stocks, especially in newer markets where companies may be smaller and younger than elsewhere? What are good and bad signs to look for? What are some common beginner mistakes? About how many different stocks does it make sense to invest in given a total of $5K? How do I choose an online broker?

I'm definitely interested in doing this, partly as a learning experience for myself, but feel free to tell me it's a terrible idea. (Even if it is, knowing my mom she's probably going to go ahead and do it anyway, so if you think this is the case, please suggest some ways of damage control!)

posted by zeri to Work & Money (25 answers total)

Best answer: Investing in high risk investments if one has a high risk tolerance and can afford it isn't a bad idea, but asking someone who knows very little about stocks to choose the investments probably is.

If I were me, I would recommend to her that she invest the money into an investment TYPE that is relatively less risky and volatile, like an index fund, but have it be an index fund that invests in 100% stocks (inherently higher risk) and that is aimed towards investors with high risk tolerance. Then the index fund manager is the one who chooses the specific stocks that the fund is invested in, and the pressure's off you - in the meantime you could work on your investment savvy, and at some point in the future if and when you feel comfortable with it, you could offer to help her purchase some other types of investments on your advice.
posted by treehorn+bunny at 10:18 AM on May 25, 2014

Having only $5K to invest is also a good reason to go for an index fund. You can't afford to diversify much with such a small investment otherwise, which ups the risk of losing most or all of the money substantially.
posted by treehorn+bunny at 10:19 AM on May 25, 2014 [1 favorite]

feel free to tell me it's a terrible idea

This is a really terrible idea.

Professional equity analysts are paid vast sums of money to do this kind of work full-time. They're very smart people recruited from top schools. They've studied thousands of hours for certifications like the CFA, and then they spend huge amounts of time studying individual companies and sectors in detail. And they still get things wrong a lot of the time.

I used to work for an investment firm with one of the best track records in the business, and even our analysts were only able to pick winning stocks about 60% of the time. As an amateur you really don't stand a chance.
posted by ripley_ at 10:20 AM on May 25, 2014 [1 favorite]

There is no way to judge. You are essentially gambling, which is fine because both you and mom seem to understand that. Stick to what you know - there are more ways to hit a home run than emerging technology. Pick a sector you feel like you understand better than the average Joe, and do some research to find a promising company. Somebody is going to make a mint on the next Chipolte.

An alternative approach would be a sector specific mutual fund. I'm sure there is a solar power or emerging energy fund out there that is pretty high risk. Of course, with niche funds like that the fees are going to to be high.
posted by COD at 10:22 AM on May 25, 2014

Best answer: The American Association of Individual Investors (aaii.com) is a good place to get general information about investing. They are an ubiased, non-profit organization

Their Shadow Stock porfolio

http://www.aaii.com/model-portfolios/stock-historical-returns?adv=yes

made 61% in 2013.

Worth a look.

G
posted by gnossos at 10:24 AM on May 25, 2014 [4 favorites]

Best answer: with niche funds like that the fees are going to to be high.

agree with this. That's why I was thinking something like this Vanguard fund - one of their highest risk/most aggressive funds, but it's Vanguard so the expense ratio is still quite low, and the only fee would be the $20 for all accounts under $10K. Minimum investment $3K.
posted by treehorn+bunny at 10:35 AM on May 25, 2014 [4 favorites]

Best answer: Whatever you do, do not do not do not invest that money into penny stocks (like the cannabis stocks). Stay away from any stock not listed on the NYSE or NASDAQ.

Giving somebody with no financial experience some money and asking them to invest it in high-risk stocks is like giving somebody some money, asking them to read a few dentistry manuals, then do a root canal at home. Investing is hard. I know they tell you even the professionals can't beat the market, but what they don't tell you is how easy it is to vastly underperform the market and lose your money.

Also, make sure that your expectations are aligned. Even if you made a 30% return in one year, which would be an excellent result, you would barely make $1,500 on that investment. You probably already realize this, but 2013 was an absolutely incredible year for stocks. It is very rare for the entire market to be up that much in one year. Not saying it can't happen again, but just temper your expectations.

Now to actually answer your questions, I'd suggest you look at ETF's rather than single stocks. You could start with the S&P sector ETF's (e.g. XLK tech, XLV healthcare, etc.) or consider IWM (smallcaps) or QQQ(Nasdaq). They also have tons of esoteric ETF's that cover all sorts of various niche sectors, but always be aware of the fees. Do not invest in any ETF you do not understand, especially the ones that are actually running a dynamic strategy rather than just holding stocks.

As for financial news websites I honestly feel like they do more harm than good, especially for people who are just starting out. But you could look at Barron's for investment ideas, and FT or Bloomberg.com for general market news.

Finally, always remember: are you an investor, or are you a trader? If the former, then don't get caught up in trying to time the market. Volatility is not the same thing as risk.
posted by pravit at 10:37 AM on May 25, 2014 [4 favorites]

Also: Confidence kills. If you are lucky enough to do well on your initial investment, do not be fooled into thinking you have the Midas touch. Some of the worst losses come when it feels the best.
posted by pravit at 10:44 AM on May 25, 2014

Bad idea to invest the money in high-risk investments. Before you do anything else, please read A Random Walk Down Wall Street: The Time-Tested Strategy for Successful Investing, by Burton Malkiel. He explains, in thorough detail, why it's not possible to beat the market (at least, not without getting lucky). My advice is to follow the advice in the book.
posted by alex1965 at 10:45 AM on May 25, 2014 [1 favorite]

Here is some data on the performance of individual investors in the American stock market.

In short, they do about as well as the market* before trading costs, and they significantly underperform when you take trading costs into account. These are the kinds of results you can expect.
posted by ripley_ at 10:51 AM on May 25, 2014

My mom wants to invest $5K (which she could afford to lose) in possibly high-return, but also possibly high-risk, sectors of the stock market. She's asked me to do the research and manage the investment. I'm interested, but I don't know much about investing in stocks, so I want to proceed cautiously.

You shouldn't be doing it, then. Tell her to invest it in an index fund. Or if she wants to gamble, let her gamble on her own.
posted by empath at 10:56 AM on May 25, 2014

You are essentially gambling, which is fine because both you and mom seem to understand that.

And if you're going to gamble, then you might as well fly yourselves to Vegas and bet the remainder on a horse or the winner of the World Cup, the latter of which will give you a month's worth of entertainment. This isn't meant to be flippant: I honestly believe there are better places than the stock market for high-risk, high-return speculation.

Otherwise, go for a lowish-fee sector ETF.
posted by holgate at 10:56 AM on May 25, 2014

I would go for a small cap index fund. Small caps aren't as massively inflated right now as large caps, but they're still a huge and diverse group so you won't be biased towards any particular sector. Overall just a little bit riskier and slightly higher return, but not enough to be a really dumb idea.
posted by miyabo at 11:58 AM on May 25, 2014

Small caps are relative to history very expensive when compared to large.
posted by JPD at 12:13 PM on May 25, 2014 [1 favorite]

If you really mean very high risk (like you could double your money or lose it all), I wouldn't advise to engage in this type of gambling unless she's just doing it for entertainment and she really doesn't care if she loses the money. If that's what she wants to do, you could just pick a random stock. Picking one stock is always risky, you don't know if it will go up or down, and by a lot or a little, so if it's risk you want, you could do that. Or you could do the same with a non-random stock. Just pick some company for whatever reason you want and see what happens.

If on the other hand she wants risk in the sense of having all this money in the stock market, then a low fee total market index fund from Vanguard or Fidelity would allow you to do that.

Someone else posted this comment:

Then the index fund manager is the one who chooses the specific stocks that the fund is invested in.

That's incorrect because components of the index are picked but not stocks in the fund are not (that's the whole point of using the index). The stocks in an index such as the S&P 500 are chosen somehow (by committee, rules, or whatever) but funds sold to consumers/investors by companies such as Vanguard and Fidelity to mirror that index are not actively managed. That is to say, Vanguard and Fidelity are not picking stocks, they are just mirroring the index, and that's why their fees are low. It's important to understand the distinction between an actively managed mutual fund (where stocks are picked by fund managers) and an index fund (where they are not).
posted by Dansaman at 12:45 PM on May 25, 2014

I want to agree, in all seriousness, that if you and she are both totally okay with gambling this money, you ought to spend it on gambling it in a way that's really entertaining, because you can get way more entertainment out of $5k than a bunch of stressful stock-picking.
posted by Sequence at 12:55 PM on May 25, 2014

zeri: "She's more of a risk taker than I am; if it was me, I'd probably just put it into a Vanguard index or something of the kind"

So, there is a middle ground, that doesn't involve you picking stocks in ecigs or whatever bullshit: leveraged ETFs. These Exchange Traded Funds typically buys and sells options to create a portfolio that doubles the return of the underlying thing. This includes negative returns, so if S&P 500 loses 30 percent in the next year, your portfolio loses 60 percent. I'm not sure what happens when losses reach 50 percent. I mean, what happens, in addition to the world war such an event might trigger.

Example: Barclay's 2x Leveraged S&P 500 (BUXC). Over the past year the S&P 500 was up 15 percent. Over the past year BUXC was up 30 percent. For this, you pay a fairly large .75 percent. If you believe in reversion to the mean, S&P 500 has doubled in the past five years, for a return of almost 15 percent annually, and this is far above the average inflation adjusted returns. There's plenty of global economic factors that suggest that 2014 will not have similar returns. VIX had a big spike in February when protesters marched on the Ukrainian Parliment. Imagine what happens if US economic sanctions are applied to more than just Putin's best friends.

Of course, if global economic factors are against an 'all sectors' investment strategy, they're also against whatever sector specific method you choose.
posted by pwnguin at 2:22 PM on May 25, 2014 [1 favorite]

Be very careful with leveraged products.

Most leveraged ETF products give you daily leverage, so in other words if the underlying is up 1% on a given day, you would be up 2% on that day (and vice versa). However, consider the case in which the underlying goes from 100 to 95 to 100, unchanged over 2 days. The daily changes are -5% and 5.26%. The 2x levered ETF would go from 100 to 90 to 99.47, resulting in a 2 day loss.

What pwnguin is describing is not a daily leveraged product, but a note that promises the owner a leveraged payout over a certain period. It is equivalent to borrowing $5,000 from your broker on margin, and investing a total of $10,000 into the market. If you think this sounds imprudent, then why would you do it just because it was packaged into a shiny ETN? (and why do you need an ETN to do it?)

You should always be aware of your claims and/or liabilities in any scenario - and if you don't understand them, don't buy the product. In the case of that product, if its value drops to $10, they close the whole thing and give you the $10 per share (it is currently worth ~$273 per share). It is the same as if you borrowed the $5,000, invested $10,000 total, the value of your investment dropped to a bit over $5,000, and the broker liquidated everything to pay back your debt and gave you back some change.

That particular product represents the net value of someone who had $100 back when it was issued in 2009, borrowed $100, then invested the $200 in the S&P. For various boring math reasons, due to when the borrowing starts, it does not actually give you a 2x return over whatever period you hold it - it only gives a 2x overall return since the 2009 initiation until whenever they redeem the securities. So if you had bought on Dec 31 2012 and sold it on Dec 31 2013, you would have gotten only a 51% return even though the S&P was up 31%.

The other small detail to note is that it is an ETN(an exchange traded note), meaning it is actually a debt instrument issued by Barclays and traded on an exchange like a stock. If Barclays were to go bankrupt, you would likely lose all your money even if the 2x leveraged investment would not have gone bust. This actually happened to people who owned Lehman notes in 2008.
posted by pravit at 3:42 PM on May 25, 2014 [1 favorite]

Response by poster: Very helpful answers! Please keep them coming.

Looks like there's something of a consensus that trying to pick individual stocks is a bad idea, so I'm thinking one or more of the higher-risk index funds that have been mentioned might be the way to go. But I still want to start learning how to evaluate specific stocks. As an example, here's one of the stocks she's asked me to research. What are some of the main things to look out for in that particular case? What are the first questions I should be asking, red flags to watch for, etc.?
posted by zeri at 3:58 PM on May 25, 2014

For one, it is an illiquid penny stock trading on the OTC markets...
posted by pravit at 4:07 PM on May 25, 2014 [1 favorite]

Pop in an emerging markets ETF like vanguard VWO.
posted by jpe at 4:44 PM on May 25, 2014 [1 favorite]

I still want to start learning how to evaluate specific stocks

Start studying for the CFA or something similar. Or, more likely, start with one of the more basic courses like the CFA's Claritas certificate. It will take hundreds of hours, but realistically you're not going to find an easier way.

You're looking for an easy way to do this, and there isn't one. I'm sorry.
posted by ripley_ at 6:39 PM on May 25, 2014 [1 favorite]

Back when I was interested in this sort of thing, I used to read The Motley Fool's articles - and I am pretty much an amateur in terms of finance, it was geared towards that.

This "How To Value Stocks" page has a compilation of articles you may find interesting for further reading.
posted by treehorn+bunny at 9:26 PM on May 25, 2014

For one, it is an illiquid penny stock trading on the OTC markets...

Which reminds me of a similar "tip" that we got from an older relative (who I'll not name) that was a large bust. No liquidity, obviously in the pump-and-dump zone, lots of stock being sold cheaply to investors and probably some of it cashed out to suckers.

When traders and brokers want to gamble, they go to Belmont Park and use the money they make from amateurs who throw money at individual stocks.
posted by holgate at 9:51 PM on May 25, 2014

Go with Vanguard international index ETFs.

1. ETFs are like mutual funds, but traded like stocks (in smaller chunks) and usually without minimums.
2. Index ETF and especially ones from Vanguard have very low expense rations. That means you are not paying anybody to actively manage your money. Index means your money is just put into a "basket" that follows some pre-set index (like S&P 500).
3. Index funds perform as a well or better than people who actively pick stocks.
4. International ETFs are higher risk and higher reward than domestic, which is what you are looking for.
posted by soyiuz at 10:26 PM on May 25, 2014