Basic Online Investing Principles

You can’t help but be interested in hearing what the analyst
du jour has to say about how to make a killing in the stock
market. But avoid the impulse to allow a piece of news or an
opinion to send you scampering to your computer to buy or
sell stocks.

Online investors may occasionally guess right about the
movement of a particular stock and succeed in buying low
and selling high over a short time period. Bear in mind, however,
that the vast majority of investors who try to use the
Internet to anticipate the stock market on a day-to-day basis
(the beat-the-market approach) lose money in the long run.
A day-to-day trading approach is also more time-consuming
and stressful.

You should, instead, according to the NAIC, focus on using
your computer to find investments that you reasonably
expect to double in value over a five-year period. The NAIC
recommends that you stick to the following four basic online
investing principles.

Principle #1: Invest online systematically
Online investing should never be done on impulse. Snap
decisions can be a real danger, because after you establish an
account, you can buy or sell any stock in less than 60 seconds.
And thousands of Web sites offer you hot tips and
advise you to purchase something that is currently “undervalued”
or “about to take off.”

The NAIC recommends that you invest “regular sums
of money once a month in common stock” rather than
taking the beat-the-market approach. This systematic
approach encourages discipline. More importantly,
systematic investing increases your odds of making a profit
through the benefit of dollar cost averaging.
Dollar cost averaging presumes that the market goes up and
down over day-to-day and month-to-month periods. But
over a period of several years, dollar cost averaging assumes
that the trend is upward. The assumption that the market (as
a whole, not necessarily stock by stock) is likely to rise in
value over longer time periods is borne out by the past performance
of the stock market.

If you purchase large amounts of stock in a particular month
and the market goes down two months later, you’ve lost
money. (And you’ve agonized over your big purchase and the
stock’s subsequent decline.) However, if you systematically
purchase a small amount of stock each month, you can actually
benefit from declines in the market. In the months when
stock prices are down, you buy at a lower price, which, barring
fundamental problems at the company, is a bargain.
By making a commitment to buy, you don’t need to stay
glued to your computer screen, biting your nails over when
to buy and when to sell. Instead, you systematically identify
good stocks and make regular purchases each month without
worrying about short-term fluctuations.

Principle #2: Diversify your online
investments
Fortunes are made and lost on the principle of diversification.
Diversification means that you invest in different types
of industries and types of investments instead of just one.
This principle is especially important in the fast-paced environment
of online investing.

Diversification, according to the NAIC, “spreads both risk
and opportunity.” For example, if your technology stocks
suddenly take a nosedive due to the outbreak of an insidious
global computer virus, you’ll be glad you haven’t risked everything
and chose to diversify your stock portfolio to include
manufacturing, retail, and other types of stocks. If the entire
stock market is affected by the computer virus, you benefit
even further if you’ve diversified to include bonds in your
portfolio as well.

Principle #3: Reinvest your online profits
You can accelerate the process of building your wealth without
increasing the time and effort you spend online. Reinvesting
your dividends, interest, and the profit you derive
from selling an investment compounds your earnings. Compounding
occurs when you earn profits on your profits, and
it makes your assets grow exponentially.

Principle #4: Select online investments
for long-term growth
Day trading is a strategy where investors try to profit from shortterm
daily fluctuations in the stock market. According to USA
Today, only one out of every five day traders makes money.
Financial experts agree that you should focus on long-term
growth potential. You probably see the wisdom in purchasing
only those stocks that you believe have the potential to
double in value over the next five years.
The problem is that when you’re investing online, it’s easy to
become influenced by temporary market fluctuations as
opposed to the long-term growth indicators on which you
need to focus. Continuous quotes scrolling across your screen
showing your stock going down can make even the most
committed investor jittery about staying the course. The next
section of this chapter gives you a few pointers on how to
research the long-term potential of a stock.
Focusing on purchasing investments that you intend to hold
for a year or more provides important tax benefits as well. If
you hold an investment for 12 months or longer before you
sell it, the profits are taxed at favorable capital gains rates.
Capital gains rates are substantially lower than regular tax
rates