Large-capitalization (large-cap) stocks. The name tells the story.
Since investors tend to set values for stocks relative to earnings,
companies with massive profits can sport enormous market
capitalizations. Stocks of large companies tend to be less volatile, and
investors often consider them safer than smaller stocks.
Small-cap stocks. Stocks of smaller companies have historically
delivered higher returns than stocks of large companies—again, at the
cost of higher risk. What constitutes a small-cap stock? It depends on
who you ask, as there is no market consensus on where lies the cutoff
point between small and large. A commonly cited dividing line is $3
billion, with anything smaller classified as a small-cap.
Because of their different risk-return profiles, investors should treat
large-cap and small-cap stocks as separate asset classes. In general, you
should own a blend of large-cap and small-cap stocks in the equity portion
of your portfolio. Sure, you could stuff the portfolio with only large-caps or
stick to just small-caps, but you might end up with a lower rate of return
(the large-cap option) or higher risk (the small-cap option) than you desire.
U.S. stocks. Because economic trends vary from country to country, at
times U.S. stocks will thrive while the rest of the world limps along, and
vice versa. As a rule, investors consider U.S. stocks safer than foreign
stocks. This belief stems, at least in part, from the size and liquidity of
the stock market and that U.S. accounting rules require greater
disclosure of financial data than most other countries.
Foreign stocks. Many investors purchase foreign stocks to diversify
their portfolios. In Chapter 10, you’ll learn more about diversification.
For now, just realize that you can reduce portfolio volatility and thus
reduce risk by blending assets that don’t move in the same direction all
the time. In addition, you can sometimes boost returns by purchasing
stocks of companies in emerging markets like China and India, where
the economies grow far faster than in the United States. Of course,
those emerging-market stocks come with—you guessed it—more risk.
Variety. With the stocks of more than 5,000 companies trading on
U.S. exchanges, investors can buy into almost any business they
Flexibility. Stocks trade all day long, which allows investors to buy
and sell at specific levels and attempt to play short-term price
moves. (The risky strategy of timing intraday fluctuations is called
day trading. Even professionals make plenty of mistakes day
trading, and beginners shouldn’t mess with it.)
High returns. Stocks tend to outperform bonds and other incomeoriented investments.
Volatility. Stock prices fluctuate more than bond prices. However,
investors must accept that risk if they wish to tap into stocks’
potentially excellent returns.
Complex analysis. Stock analysis involves looking at a number of
statistics, gauging trends, and estimating future growth rates. It
takes time and effort, which might explain, at least in part, the
popularity of mutual funds.
Vigilance required. Because stock prices can change so quickly,
and because they often respond sharply to news about the company
or the market, investors must pay close attention to them.
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