How to pick stocks in four simple steps

In the last ten years, the stock market proved to be a very difficult place to invest and make money. This has lead many investors into looking at different stock market strategies. There are more alternatives and options than even publicly traded companies to invest into. So it is not surprise that the average investor can become overwhelmed and face many problems along the way to retirement.

The common problems with most investment approaches is human emotions, there is lack of complete transparency, poor diversification, no disciplined approach, and not being properly rebalanced. These problems can lead to investments that underperform and often have very high expenses. Instead of feeling overwhelmed, here is how to help avoid this problems using formula based investing.

The first step is to create a filter for choosing the investments. Just like a good filter in a furnace removes bacteria and viruses you breathe, a filter can be applied to investments to remove things you don’t want. Here is an example of how a filter could work on the S&P 500 Index. This index is the largest index in the United States and usually when the S&P 500 index is doing well, the whole US is doing well.

Step #1 in the filter is to remove any company in the index that has a negative net income. This will remove all of the currently unprofitable companies. Step #2; take the stocks that are left and rank them most profitable to least profitable. Then eliminate the bottom half. Step #3; since the stock market is simply an auction, we want stocks that are actively being traded. Rank the stocks based upon momentum, most traded to least traded and eliminate the bottom half of the group. Finally in Step #4, purchase an equal dollar amount of the stocks that passed through the filter. In this example, we created a four step filter process to identify what we want in our investments. Now, we know what to buy.

Diversification is important in creating an investment account. Just because there was a group of stocks that made it through the filter, doesn’t mean we should put all of our money on that one group of stocks. At the same time, owning a lot of different investments does not mean an investor is actually properly diversified. True diversification means investing the correct amount into large, medium, small, and international stocks. It can also mean investing a into growth and value stocks. Adjusting the diversification is like adjusting the thermostats on your furnace for how warn you want your house to be.

Proper rebalancing and determining when to sell an investment can be the hardest step in the process. I, Nolan, remember when my furnace stopped working last year. I had just gotten home from a trip, when I noticed how cold it was. The circuit breaker was tripped on my furnace and every time I turned the circuit back on, it tripped again. So I called in a local repair man. And to my embarrassment, it was because I haven’t changed my filter in a long time. The circuit was protecting us. This same type of protection can be applied to investments to automate the selling process. First, when a filter is used on your investments, we recommend updating the filter every 90 days. Stocks that don’t make it through the filter get sold automatically, this removes human emotions. Also, be sure to put a circuit breaker on the investment account. The way that can be done is to use specific shut off points when a problem occurs. Then you can fix the problem before it gets worse.

We just completed updating our list of stocks that pass our filter. There are currently 120 stocks that make our A+ list. There are several companies on the list that have a major presence right here in our local community and some on the list you may have never expected to make the grade. To get a complete list of those stocks and to learn more about how use investment filters, go to www.RetirementGuysRadio.com and click on the Freedom Formula.

Send your questions to letters@toledofreepress.com or for more information about The Retirement Guys, tune in every Saturday at 1 PM on 1370 WSPD or visit www.retirementguysradio.com . Securities are offered through NEXT Financial Group Inc. Member FINRA / SIPC. The Retirement Guys are not an affiliate of NEXT Financial Group. Their office is located at 1700 Woodlands Drive, Suite 100, Maumee, OH 43537.

This entry was posted on Friday, January 8th, 2010 at 12:00 am and is filed under Retirement Guys. Toledo Business Link .

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