If you have specific goals in mind, and those goals are five or more years away, then you should be invested in stocks, stock mutual funds or both.
Yes, there are risks associated with stocks -- you could be up one day and down the next. But over the long haul you'll earn more money with stocks -- riding out the highs and lows -- than you would with any other investment.
You also can reduce your exposure to market downturns by investing in a variety of stocks. And as your savings goals approach, you can turn down risk even more by shifting some of your money out of stocks and into bonds or a money market mutual fund. But remember, there is a downside to investing too conservatively as well: Inflation may outpace your returns.
If you're investing for retirement, use our risk worksheet to help you determine the percentage of stocks you should hold in your portfolio.
Scout Out the Best Prospects
Stocks come in two principal varieties: common stock and preferred stock. Both represent an ownership share in the company that issues them.
Preferred stock, because it gives investors first crack at a company's dividends, is generally bought for the income it produces.
Nevertheless, common stocks are where the action is. When people talk about stocks they are almost always referring to common stocks. There are several categories of common stocks to fit investors' goals:
Growth stocks have good prospects for growing faster than the economy or the stock market in general. Investors buy them because of their good record of earnings growth and the expectation that they will continue generating capital gains over the long haul.
Blue-chip stocks are a more loosely defined universe, including solid performers that could also be classified as growth stocks. Investors with an eye on the long term and little tolerance for risk buy these stocks for their undeniable high quality. They tend to generate decent dividend income, some growth and, above all, safety and reliability.
Income stocks pay relatively high dividends. Not all common stocks pay dividends. So those that have a long history of regular dividends set themselves apart. This category is favored by retirees and others in need of a relatively high level of income from their stocks.
Cyclical stocks' fortunes tend to rise and fall with those of the economy at large, prospering when the business cycle is on the upswing, suffering in recessions. Cyclical industries include airlines, steel, chemicals and home building.
Defensive stocks are theoretically insulated from the business cycle because people go right on buying their products and services in bad times as well as good. Utility companies fit here, as do companies that sell food, beverages and drugs.
Speculative stocks don't pass the usual tests of quality but for some reason or another attract investors anyway. They may be unproven young companies ("emerging growth" stocks). They may be erratic or down-at-the-heels old companies exhibiting some sort of spark, such as the promise of an imminent technological breakthrough or brilliant new chief executive.
Buyers of speculative stocks have hopes of making a killing but almost never do. Most speculative stocks don't do well, so it takes big gains in a few to offset your losses in many.