3 Things I Must Know Before Buying a Stock

Through investing, stock market appreciation can help my money grow. But what I invest in could have a huge effect on how well and how fast.

And if I don’t make the right choices, it could even put me further away from my goals instead of closer. That’s why I take my time when picking my investments and must know these three things before I buy anything.

Image source: Getty Images.

1. It fits in with my risk tolerances

Before I buy a stock, I must know if it aligns with my risk tolerances. Buying a holding like Netflix (NASDAQ: NFLX) is exciting in a year like 2020 when it earned 67%, but not so much in a year like 2011 when it lost 61%. And investing in it means taking the bad years along with the good.

If I can’t, it could affect my overall rate of return. If I’m constantly buying my stocks when they’re performing well, then I’m probably purchasing them at high prices. And if I’m selling them when they’re doing poorly, this could be at prices that are lower than I bought them for. This could lead to returns that don’t match up with what the stock has done over the long term.

This is why I’ll buy an investment with less risk and an overall lower rate of return if it matches up better with my appetite for risk than a stock that could perform better. Giving up the upside potential might be difficult, but if my ability to stay invested increases, I could have a better chance of accumulating wealth over the years.

2. It’s something I see myself holding long-term

There may be times when I buy a stock and only hold it for a short while. But for the most part, when I purchase an investment, I do so with the intention of keeping it for the long term. Over short periods of time, a stock may experience a low level of growth, or I may invest at the beginning of a down period, such as 2000 to 2010 when the S&P 500 only earned an average rate of return of 3.5%. But over the long term, my investments should have positive growth, and over the last 30 years, this index has earned an average rate of return of 10.4%.

I also don’t have time for short-term trading. If an investment I buy has a trading pattern that varies greatly, I may miss out on selling when it’s trading at a high — like shares of Sorrento Therapeutics (NASDAQ: SRNE), which over the last year have traded as low as $3.82 and as high as $19.39. If I missed this high price on Aug. 10, I would’ve only experienced lower trading prices since then.

The only investments I can really set and forget are index funds or ETFs. Making sure I rebalance these holdings when my allocations get skewed is important. But choosing more passive investments like this makes it so that I need less daily management of my accounts than I would if I owned stock with a lot of volatility.

3. I understand what I’m investing in

I don’t need an expert-level understanding of how a company operates. But I should know how it makes its money. Which product lines generate the most profit for it? Are there any new and exciting ventures that could change the way they grow for the better? Old products that are headed toward obsolesence that could make the company perform worse?

When I buy a mutual fund or index fund, I should know what types of companies it invests in. What is the asset allocation of the fund? Are the companies inside of it large, small, or international? The risk level for each of these is different, and the mix of these companies inside of my investment could affect my rate of return.

I also should know how long the fund manager has been managing this fund and how much it has earned on average in the past. Knowing this type of information helps me project what I could experience going forward. While past performance doesn’t guarantee future performance, it can be a good guideline if nothing changes.

If my investment objectives are not aligned with my goals, it could make meeting them harder. That’s why doing my research and finding the right securities is so important. Increasing my understanding of what I’m investing in will also help me feel more comfortable in what I’m doing and help me set realistic expectations for long-term success.

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Diane Mtetwa owns shares of Sorrento Therapeutics. The Motley Fool owns shares of and recommends Netflix. The Motley Fool has a disclosure policy.

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