Institutional investors are entities that pool together funds on behalf of others, and invest those funds in a variety of different financial instruments and asset classes. Institutional investors control a significant amount of all financial assets in the United States, and exert considerable influence in all markets.
TUTORIAL: Advanced Financial Statement Analysis
Influence
This influence has grown over time and can be confirmed by examining the concentration of ownership by institutional investors in the equity of the top 50 publicly traded corporations. The average institutional ownership in these companies was about 64% at the end of 2009, compared to 49% at the end of 1987. As the size and importance of institutions continues to grow, so does their relative holdings and influence on the financial markets.
Advantages
Institutional investors are generally considered to be more proficient at investing due to the assumed professional nature of operations and greater access to companies and managements because of size. These advantages may have eroded over the years as information has become more transparent and accessible, and regulation has limited the amount and method of disclosure by public companies. (These vehicles have gotten a bad rap in the press. Find out whether they deserve it. See Are Derivatives Safe For Retail Investors?)
Types of Institutional Investors
Institutional investors include public and private pension funds, insurance companies, savings institutions, closed- and open-end investment companies, and foundations.
By the Numbers
Institutional investors controlled $25.3 trillion, or 17.4% of all U.S. financial assets as of 12/31/2009, according to the Conference Board. This percentage has been declining over the last decade and peaked in 1999 at 21.5% of total assets. The gradual percentage decline arises due to the massive value increases in total outstanding assets which are available for investment purposes.
Asset Allocation
Institutional investors invested these assets in a variety of classes, the standard allocation is approximately 40% of assets to equity and 40% to fixed income. Another 20% of total assets were allocated to real estate, cash and other areas. However, these figures drastically vary from institution to institution. Equities have experienced the fastest growth over the last generation, and in 1980 only 18% of all institutional assets were invested in equities. (Your portfolio's asset mix is a key factor in whether it's profitable. Find out how to get this delicate balance right. Refer to 6 Asset Allocation Strategies That Work.)
Pension Funds
Pension funds are the largest part of the institutional investment community and control over $10 trillion, or approximately 40% of all professionally managed assets. Pension funds receive payments from individuals and sponsors, either public or private, and promise to pay a retirement benefit in the future to the beneficiaries of the fund.
The large pension fund in the United States, California Public Employees' Retirement System (CalPERS), reported total assets of $239 billion at as of 2011. Although pension funds have significant risk and liquidity constraints, they are often able to allocate a small portion of their portfolios to investments which are not easily accessible to retail investors such as private equity and hedge funds.
Most pension fund operational requirements are discussed in the Employee Retirement Income Security Act (ERISA) passed in 1974. This law established the accountability of the fiduciaries of pension funds and set minimum standards on disclosure, funding, vesting and other important components of these funds.
Investment Companies
Investment companies are the second largest institutional investment class and provide professional services to banks and individuals looking to invest their funds.
Most investment companies are either closed- or open-end mutual funds, with open end funds continually issuing new shares as it receives funds from investors. Closed end funds issue a fixed number of shares and typically trade on an exchange.
Open end funds have the majority of assets within this group, and have experienced rapid growth over the last few decades as investing in the equity market became more popular. In 1980, investment companies comprised only 2.9% of all institutional assets, but this share more than tripled to 9.4% by 1990, and reached 28.4% by the end of 2009. However, with the rapid growth of ETFs many investors are now turning away from mutual funds.
The Massachusetts Investors Trust came into existence in the 1920s and is generally recognized as the first open-end mutual fund to operate in the United States. Others quickly followed and by 1929 there were 19 more open-end mutual funds and nearly 700 closed-end funds in the United States.
Investment companies are regulated primarily under the Investment Company Act of 1940, and also come under other securities laws in force in the United States. (Flying high one day but not the next - see the stories behind some spectacular meltdowns. Check out Massive Hedge Fund Failures.)
Insurance Companies
Insurance companies are also part of the institutional investment community and controlled almost the same amount of funds as investment firms. These organizations, which include property and casualty insurers and life insurance companies, take in premiums to protect policy holders from various types of risk. The premiums are then invested by the insurance companies to provide a source of future claims and a profit.
Savings Institutions
Savings institutions control over $1 trillion in assets. These organizations have seen a huge drop in assets over the last generation, with the percentage of assets held by savings institutions declining from 32.6% in 1980 to only 4.9% in 2009.
Foundations
Foundations are the smallest institutional investor as they are typically funded for pure altruistic purposes. These organizations are typically created by wealthy families or companies and are dedicated to a specific public purpose.
The largest foundation in the United States is the Bill and Melinda Gates Foundation, which held $36.7 billion in assets at the end of 2010. Foundations are usually created for the purpose of improving the quality of public services such as accessibility to education funding, healthcare and research grants.
Conclusion
Institutional investors remain an important part of the investment world despite a flat share of all financial assets over the last decade, and still have considerable impact on all markets and asset classes.
http://www.investopedia.com/articles/financial-theory/11/introduction-institutional-investing.asp?partner=YahooEA#axzz1Z4IQRtp8
Monday, September 26, 2011
Evaluate Investments With SWOT Analysis
SWOT analysis can be a useful tool in evaluating and monitoring equity investments. Standing for "strengths, weaknesses, opportunities and threats," SWOT analysis was reportedly developed by Albert Humphrey in the 1960s and has become a staple concept in business management and investment evaluation. (To understand the qualities that make for a great company, investors must dig deep into "soft" metrics. Check out Qualitative Analysis: What Makes A Company Great?)
TUTORIAL: Behavioral Finance
Most commonly used as a business planning tool, SWOT analysis can be used to evaluate products, divisions, companies and entire markets. It can also be used as an investment tool; giving an investor a handy snapshot of the potential advantages or disadvantages of a company's current positioning.
The Components of SWOT
Although the concepts that make up a SWOT analysis seem straightforward, diligence and attention to detail are important. More than is generally the case with company and stock evaluation methods, SWOT analysis is a great example where the quality of results will never be better than the quality of the inputs.
It is also worth noting that, broadly speaking, strengths and weaknesses should reflect "what is" today, while opportunities and threats are more about what could happen in the future.
Strengths
Strengths are characteristics that give the subject a meaningful advantage or form the basis of above-average performance potential. In many cases, a subject's strengths will be the basis of its competitive advantage. Not only do strengths consider what a company does well, but why or how it does it well.
In the case of a mining company, for instance, a valuable mineral asset in a politically stable country may be listed as a strength, while a major consumer company may have some of its greatest strengths in the value of its brands. It is important to note that above-average revenue growth or superior margins are not in and of themselves strengths – it is the popularity of the products or the relative efficiency of its manufacturing process that represent the real strengths.
Weaknesses
In a SWOT analysis, weaknesses are vulnerabilities to the company's competitive position and/or opportunity to earn positive economic returns. Common weaknesses could include a unionized labor force, products that are essentially regarded as commodities, or the requirement to comply with expensive or elaborate regulatory regimes to sell its goods/services.
Weaknesses can also refer to how the company is integrated and affected by economic conditions. An economic environment heavily burdened with competition, for example, would be considered a potential weakness of the firm.
Opportunities
Opportunities represent scenarios or options where the company can meaningfully improve itself. The introduction of a significant product can be an opportunity, as well as a restructuring or acquisition. It is important to note, though, that "better margins" or "better sales" are not in themselves opportunities; generally more specificity is in order (the details of how the company will improve those margins or sales).
Another type of opportunity presents itself from an untapped customer demographic. For example, if an independent pizza restaurant on the west side of the side introduces a delivery service, it has the opportunity to expand its customer base beyond only those living in the neighborhood.
Threats
The threats portion of a SWOT analysis should answer the question "what could change for the worse?" with a particular company. Like opportunities, threats may be prospective or even theoretical, but they should offer more specificity than "something might go wrong." Increased government regulation, a failure to secure approval/acceptance for a major new product, or the introduction of a rival product/service would all represent meaningful threats to a company's competitive standing and economic returns.
Limitations
There are key limitations that users of SWOT analysis should understand. To start, it totally ignores valuation and other significant fundamental metrics like return on capital, margins, cost of capital and so on. Although there is no rule out there that an investor cannot opt to include fundamental details as strengths or weaknesses in evaluating a stock's prospects as an investment, these analyses work best when the user explores why and how company earns a certain return on capital.
SWOT analysis also does not tend to offer much scope or scale to the size or significance of various opportunities and threats. It stands to reason that the creator of a SWOT analysis would not bother with non-material opportunities or threats, but it is nevertheless important to try to quantify the impact of these items on a company's returns.
The largest limitation of SWOT analysis is that it is subjective and self-directed. The entire process relies solely on the creator's knowledge and judgment, and there is an inherent potential for bias. In the case of a biotech, for instance, a bull may well see an experimental therapy as a major opportunity while a bear will see a weakness or threat in the vast amounts of money that are to spent developing a doomed therapy. Likewise, an optimist may well see an emerging brand as a major asset (a strength), while the bear sees little value in a brand and major threats from competition from more established brands/companies.
Usefulness
On balance, SWOT analysis is best used by investors as a way of crystallizing and quantifying the thought process that goes into an investment decision. The entire process can, and should, make an investor think more deeply about the weaknesses of and threats to a company, while also helping to tease out what is really important and distinctive about one company versus its rivals.
SWOT analysis also works best when it is done consistently. By using it on a regular basis and keeping track of the information, SWOT analysis can allow for better comparisons across industry participants and more frequent use can also help limit some of the dangers of bias and selective (or incomplete) analysis.
Investors can look at SWOT analysis as a good screening tool for potentially interesting ideas that merit further research. Likewise, investors may find that SWOT analysis provides a useful means of tracking current holdings and comparing the development and evolution of those companies to the original purchase theses. (These five qualitative measures allow investors to draw conclusions about a corporation that are not apparent on the balance sheet. Check out Using Porter's 5 Forces To Analyze Stocks.)
Conclusions
A SWOT analysis will not tell an investor what price is fair for a stock, or if a stock is presently undervalued. What SWOT analysis does do, however, is force some discipline and systematic thinking into the investment evaluation process. A careful and thoughtful analysis should bring into focus the balance of a company's advantages and vulnerabilities, and also give the investor a benchmark to evaluate the company in future years. (Knowing what the company's financial statements mean will help you to anaylze your investments.
http://www.investopedia.com/articles/financial-theory/SWOT-analysis-primer.asp?partner=YahooEA#axzz1Z4IQRtp8
TUTORIAL: Behavioral Finance
Most commonly used as a business planning tool, SWOT analysis can be used to evaluate products, divisions, companies and entire markets. It can also be used as an investment tool; giving an investor a handy snapshot of the potential advantages or disadvantages of a company's current positioning.
The Components of SWOT
Although the concepts that make up a SWOT analysis seem straightforward, diligence and attention to detail are important. More than is generally the case with company and stock evaluation methods, SWOT analysis is a great example where the quality of results will never be better than the quality of the inputs.
It is also worth noting that, broadly speaking, strengths and weaknesses should reflect "what is" today, while opportunities and threats are more about what could happen in the future.
Strengths
Strengths are characteristics that give the subject a meaningful advantage or form the basis of above-average performance potential. In many cases, a subject's strengths will be the basis of its competitive advantage. Not only do strengths consider what a company does well, but why or how it does it well.
In the case of a mining company, for instance, a valuable mineral asset in a politically stable country may be listed as a strength, while a major consumer company may have some of its greatest strengths in the value of its brands. It is important to note that above-average revenue growth or superior margins are not in and of themselves strengths – it is the popularity of the products or the relative efficiency of its manufacturing process that represent the real strengths.
Weaknesses
In a SWOT analysis, weaknesses are vulnerabilities to the company's competitive position and/or opportunity to earn positive economic returns. Common weaknesses could include a unionized labor force, products that are essentially regarded as commodities, or the requirement to comply with expensive or elaborate regulatory regimes to sell its goods/services.
Weaknesses can also refer to how the company is integrated and affected by economic conditions. An economic environment heavily burdened with competition, for example, would be considered a potential weakness of the firm.
Opportunities
Opportunities represent scenarios or options where the company can meaningfully improve itself. The introduction of a significant product can be an opportunity, as well as a restructuring or acquisition. It is important to note, though, that "better margins" or "better sales" are not in themselves opportunities; generally more specificity is in order (the details of how the company will improve those margins or sales).
Another type of opportunity presents itself from an untapped customer demographic. For example, if an independent pizza restaurant on the west side of the side introduces a delivery service, it has the opportunity to expand its customer base beyond only those living in the neighborhood.
Threats
The threats portion of a SWOT analysis should answer the question "what could change for the worse?" with a particular company. Like opportunities, threats may be prospective or even theoretical, but they should offer more specificity than "something might go wrong." Increased government regulation, a failure to secure approval/acceptance for a major new product, or the introduction of a rival product/service would all represent meaningful threats to a company's competitive standing and economic returns.
Limitations
There are key limitations that users of SWOT analysis should understand. To start, it totally ignores valuation and other significant fundamental metrics like return on capital, margins, cost of capital and so on. Although there is no rule out there that an investor cannot opt to include fundamental details as strengths or weaknesses in evaluating a stock's prospects as an investment, these analyses work best when the user explores why and how company earns a certain return on capital.
SWOT analysis also does not tend to offer much scope or scale to the size or significance of various opportunities and threats. It stands to reason that the creator of a SWOT analysis would not bother with non-material opportunities or threats, but it is nevertheless important to try to quantify the impact of these items on a company's returns.
The largest limitation of SWOT analysis is that it is subjective and self-directed. The entire process relies solely on the creator's knowledge and judgment, and there is an inherent potential for bias. In the case of a biotech, for instance, a bull may well see an experimental therapy as a major opportunity while a bear will see a weakness or threat in the vast amounts of money that are to spent developing a doomed therapy. Likewise, an optimist may well see an emerging brand as a major asset (a strength), while the bear sees little value in a brand and major threats from competition from more established brands/companies.
Usefulness
On balance, SWOT analysis is best used by investors as a way of crystallizing and quantifying the thought process that goes into an investment decision. The entire process can, and should, make an investor think more deeply about the weaknesses of and threats to a company, while also helping to tease out what is really important and distinctive about one company versus its rivals.
SWOT analysis also works best when it is done consistently. By using it on a regular basis and keeping track of the information, SWOT analysis can allow for better comparisons across industry participants and more frequent use can also help limit some of the dangers of bias and selective (or incomplete) analysis.
Investors can look at SWOT analysis as a good screening tool for potentially interesting ideas that merit further research. Likewise, investors may find that SWOT analysis provides a useful means of tracking current holdings and comparing the development and evolution of those companies to the original purchase theses. (These five qualitative measures allow investors to draw conclusions about a corporation that are not apparent on the balance sheet. Check out Using Porter's 5 Forces To Analyze Stocks.)
Conclusions
A SWOT analysis will not tell an investor what price is fair for a stock, or if a stock is presently undervalued. What SWOT analysis does do, however, is force some discipline and systematic thinking into the investment evaluation process. A careful and thoughtful analysis should bring into focus the balance of a company's advantages and vulnerabilities, and also give the investor a benchmark to evaluate the company in future years. (Knowing what the company's financial statements mean will help you to anaylze your investments.
http://www.investopedia.com/articles/financial-theory/SWOT-analysis-primer.asp?partner=YahooEA#axzz1Z4IQRtp8
Genetic Algorithms Forecast Financial Markets
Burton suggested in his book, "A Random Walk Down Wall Street", (1973) that, "A blindfolded monkey throwing darts at a newspaper's financial pages could select a portfolio that would do just as well as one carefully selected by experts." While evolution may have made man no more intelligent at picking stocks, Charles Darwin's theory has quite effective when applied more directly. (To help you pick stocks, check out How To Pick A Stock.)
TUTORIAL: Stock-Picking Strategies
What Are Genetic Algorithms?
Genetic algorithms (GAs) are problem solving methods (or heuristics) that mimic the process of natural evolution. Unlike artificial neural networks (ANNs), designed to function like neurons in the brain, these algorithms utilize the concepts of natural selection to determine the best solution for a problem. As a result, GAs are commonly used as optimizers that adjust parameters to minimize or maximize some feedback measure, which can then be used independently or in the construction of an ANN.
In the financial markets, genetic algorithms are most commonly used to find the best combination values of parameters in a trading rule, and they can be built into ANN models designed to pick stocks and identify trades. Several studies have demonstrated that these methods can prove effective, including "Genetic Algorithms: Genesis of Stock Evaluation" (2004) by Rama, and "The Applications of Genetic Algorithms in Stock Market Data Mining Optimization" (2004) by Lin, Cao, Wang, Zhang. (To learn more about ANN, see Neural Networks: Forecasting Profits.)
How Genetic Algorithms Work
Genetic algorithms are created mathematically using vectors, which are quantities that have direction and magnitude. Parameters for each trading rule are represented with a one-dimensional vector that can be thought of as a chromosome in genetic terms. Meanwhile, the values used in each parameter can be thought of as genes, which are then modified using natural selection.
For example, a trading rule may involve the use of parameters like Moving Average Convergence-Divergence (MACD), Exponential Moving Average (EMA) and Stochastics. A genetic algorithm would then input values into these parameters with the goal of maximizing net profit. Over time, small changes are introduced and those that make a desirably impact are retained for the next generation.
There are three types of genetic operations that can then be performed:
•Crossovers represent the reproduction and biological crossover seen in biology, whereby a child takes on certain characteristics of its parents.
•Mutations represent biological mutation and are used to maintain genetic diversity from one generation of a population to the next by introducing random small changes.
•Selections are the stage at which individual genomes are chosen from a population for later breeding (recombination or crossover).
These three operators are then used in a five-step process:
1.Initialize a random population, where each chromosome is n-length, with n being the number of parameters. That is, a random number of parameters are established with n elements each.
2.Select the chromosomes, or parameters, that increase desirable results (presumably net profit).
3.Apply mutation or crossover operators to the selected parents and generate an offspring.
4.Recombine the offspring and the current population to form a new population with the selection operator.
5.Repeat steps two to four.
Over time, this process will result in increasingly favorable chromosomes (or, parameters) for use in a trading rule. The process is then terminated when a stopping criteria is met, which can include running time, fitness, number of generations or other criteria. (For more on MACD, read Trading The MACD Divergence.)
Using Genetic Algorithms in Trading
While genetic algorithms are primarily used by institutional quantitative traders, individual traders can harness the power of genetic algorithms - without a degree in advanced mathematics - using several software packages on the market. These solutions range from standalone software packages geared towards the financial markets to Microsoft Excel add-ons that can facilitate more hands-on analysis.
When using these applications, traders can define a set of parameters that are then optimized using a genetic algorithm and a set of historical data. Some applications can optimize which parameters are used and the values for them, while others are primarily focused on simply optimizing the values for a given set of parameters. (To learn more about these program derived strategies, see The Power Of Program Trades.)
Important Optimization Tips and Tricks
Curve fitting (over fitting), designing a trading system around historical data rather than identifying repeatable behavior, represents a potential risk for traders using genetic algorithms. Any trading system using GAs should be forward-tested on paper before live usage.
Choosing parameters is an important part of the process, and traders should seek out parameters that correlate to changes in the price of a given security. For example, try out different indicators and see if any seem to correlate with major market turns.
The Bottom Line
Genetic algorithms are unique ways to solve complex problems by harnessing the power of nature. By applying these methods to predicting securities prices, traders can optimize trading rules by identifying the best values to use for each parameter for a given security. However, these algorithms are not the Holy Grail, and traders should be careful to choose the right parameters and not curve fit (over fit).
http://www.investopedia.com/articles/financial-theory/11/using-genetic-algorithms-forecast-financial-markets.asp?partner=YahooEA#axzz1Z4IQRtp8
TUTORIAL: Stock-Picking Strategies
What Are Genetic Algorithms?
Genetic algorithms (GAs) are problem solving methods (or heuristics) that mimic the process of natural evolution. Unlike artificial neural networks (ANNs), designed to function like neurons in the brain, these algorithms utilize the concepts of natural selection to determine the best solution for a problem. As a result, GAs are commonly used as optimizers that adjust parameters to minimize or maximize some feedback measure, which can then be used independently or in the construction of an ANN.
In the financial markets, genetic algorithms are most commonly used to find the best combination values of parameters in a trading rule, and they can be built into ANN models designed to pick stocks and identify trades. Several studies have demonstrated that these methods can prove effective, including "Genetic Algorithms: Genesis of Stock Evaluation" (2004) by Rama, and "The Applications of Genetic Algorithms in Stock Market Data Mining Optimization" (2004) by Lin, Cao, Wang, Zhang. (To learn more about ANN, see Neural Networks: Forecasting Profits.)
How Genetic Algorithms Work
Genetic algorithms are created mathematically using vectors, which are quantities that have direction and magnitude. Parameters for each trading rule are represented with a one-dimensional vector that can be thought of as a chromosome in genetic terms. Meanwhile, the values used in each parameter can be thought of as genes, which are then modified using natural selection.
For example, a trading rule may involve the use of parameters like Moving Average Convergence-Divergence (MACD), Exponential Moving Average (EMA) and Stochastics. A genetic algorithm would then input values into these parameters with the goal of maximizing net profit. Over time, small changes are introduced and those that make a desirably impact are retained for the next generation.
There are three types of genetic operations that can then be performed:
•Crossovers represent the reproduction and biological crossover seen in biology, whereby a child takes on certain characteristics of its parents.
•Mutations represent biological mutation and are used to maintain genetic diversity from one generation of a population to the next by introducing random small changes.
•Selections are the stage at which individual genomes are chosen from a population for later breeding (recombination or crossover).
These three operators are then used in a five-step process:
1.Initialize a random population, where each chromosome is n-length, with n being the number of parameters. That is, a random number of parameters are established with n elements each.
2.Select the chromosomes, or parameters, that increase desirable results (presumably net profit).
3.Apply mutation or crossover operators to the selected parents and generate an offspring.
4.Recombine the offspring and the current population to form a new population with the selection operator.
5.Repeat steps two to four.
Over time, this process will result in increasingly favorable chromosomes (or, parameters) for use in a trading rule. The process is then terminated when a stopping criteria is met, which can include running time, fitness, number of generations or other criteria. (For more on MACD, read Trading The MACD Divergence.)
Using Genetic Algorithms in Trading
While genetic algorithms are primarily used by institutional quantitative traders, individual traders can harness the power of genetic algorithms - without a degree in advanced mathematics - using several software packages on the market. These solutions range from standalone software packages geared towards the financial markets to Microsoft Excel add-ons that can facilitate more hands-on analysis.
When using these applications, traders can define a set of parameters that are then optimized using a genetic algorithm and a set of historical data. Some applications can optimize which parameters are used and the values for them, while others are primarily focused on simply optimizing the values for a given set of parameters. (To learn more about these program derived strategies, see The Power Of Program Trades.)
Important Optimization Tips and Tricks
Curve fitting (over fitting), designing a trading system around historical data rather than identifying repeatable behavior, represents a potential risk for traders using genetic algorithms. Any trading system using GAs should be forward-tested on paper before live usage.
Choosing parameters is an important part of the process, and traders should seek out parameters that correlate to changes in the price of a given security. For example, try out different indicators and see if any seem to correlate with major market turns.
The Bottom Line
Genetic algorithms are unique ways to solve complex problems by harnessing the power of nature. By applying these methods to predicting securities prices, traders can optimize trading rules by identifying the best values to use for each parameter for a given security. However, these algorithms are not the Holy Grail, and traders should be careful to choose the right parameters and not curve fit (over fit).
http://www.investopedia.com/articles/financial-theory/11/using-genetic-algorithms-forecast-financial-markets.asp?partner=YahooEA#axzz1Z4IQRtp8
Getting Started In Stocks
So you've decided to invest in the stock market. Congratulations! In his 2005 book "The Future for Investors," Jeremy Siegel showed that, in the long run, investing in stocks has handily outperformed investing in bonds, Treasury bills, gold or cash. In the short term, one or another asset may outperform stocks, but overall stocks have historically been the winning path.
Tutorial: Stock Basics
But there are so many ways to invest in stocks. Individual stocks, mutual funds, index funds, ETFs, domestic, foreign - how can you decide what is right for you? This article will address several issues that you, as a new (or not-so-new) investor, might want to consider so that you can rest more easily while letting your money grow.
Risk Taker, Risk Averse or in the Middle?
You may be eager to get started so that you, too, can make those fabulous returns you hear so much about, but slow down and take a moment to contemplate some simple questions. The time spent now to consider the following will save you money down the road.
What kind of person are you? Are you a risk taker, willing to throw money at a chance to make a lot of money, or would you prefer a more "sure" thing? What would be your likely response to a 10% drop in a single stock in one day or a 35% drop over the course of a few weeks? Would you sell it all in a panic?
The answers to these and similar questions will lead you to consider different types of equity investments, such as mutual or index funds versus individual stocks. If you are naturally not someone who takes risks, and feel uncomfortable doing so but still want to invest in stocks, the best bet for you might be mutual funds or index funds. This is because they are well diversified and contain many different stocks. This reduces risk - and doesn't require individual stock research. (For more insight, read Personalizing Risk Tolerance, Mutual Fund Basics and The Lowdown On Index Funds.)
Have much time and interest do you have for investing?
Should you invest in funds, stocks or both? The answer depends on how much time you wish to devote to this endeavor. Careful selection of mutual or index funds would let you invest your money, leaving the hard work of picking stocks to the fund manager. Index funds are even simpler in that they move up or down according to the type of company, industry or market they are designed to track.
Individual stock investing is the most time consuming as it requires you to make judgments about management, earnings and future prospects. As an investor, you are attempting to distinguish between a money-making stock and financial disaster. You need to know what they do, how they make their money, the risks, the future prospects and much more.
Therefore, ask yourself how much time you have to devote to this enterprise. Are you willing to spend a couple of hours a week, or more, reading about different companies, or is your life just too busy to carve out that time? Investing in individual stocks is a skill, which, like any other, takes time to develop. (For more on this research, read Introduction To Fundamental Analysis.)
Eggs in One Basket
It is best that you not be exposed to only one type of asset. For instance, don't put all of your money in small biotech companies. Yes, the potential gain can be quite high, but what will happen to your investment if the Food and Drug Administration starts rejecting a higher percentage of new drugs? Your entire portfolio would be negatively impacted. (For related reading, see The Ups And Downs Of Biotechnology.)
It is better to be diversified across several different sectors such as real estate (a real estate investment trust is one possibility), consumer goods, commodities, insurance, etc., rather than focusing on one or two or three, as above. Consider diversifying across asset classes, as well, by keeping some money in bonds and cash, rather than being 100% invested in stocks. How much to have in these different sectors and classes is up to you, but being invested more broadly lessens the risk of losing it all at any one time. (For more insight, check out Introduction To Diversification.)
A Portfolio for Beginners
If you are just starting out, think seriously about investing most of your money in a couple of index funds, such as one tracking the broad market (e.g. the S&P 500) and one that gives some international exposure. Maybe adding one that tracks small companies (e.g. the Russell 2000) would give your portfolio a boost.
A portfolio consisting of those three would give plenty of diversification, provide the steadier performance of large companies and be spiced up a bit with both international companies and small caps.
A Portfolio with Individual Stocks
If you are investing in individual stocks, a portfolio of 12-20 well-chosen ones will give you plenty of diversification and probably will not be too many to follow regularly. However, you will need to ensure that you fully understand each company, from their businesses to their risks. If you plan on investing in only stocks, make sure to spread the funds across different sectors such as healthcare, technology, small cap and big cap.
If you don't have the time or desire to pick as well as follow that many stocks, consider investing in a mixture of index funds and individual stocks. Another consideration, especially if starting out with limited funds, is that investing in 12-20 stocks may not be feasible, so having the majority of your money in some funds would provide the stabler returns those tend to generate while maybe half a dozen individual stocks would give your portfolio an extra kick.
Time to Invest
Once you've determined the shape of your portfolio, it is time to invest. Find a broker you are comfortable with, either an online broker or one with a local office or both. Call and talk with this person, if necessary. Then, fill out the paperwork, deposit some money and open an account. (To learn more, see Picking Your First Broker.)
After deciding what to buy, don't buy all at once: enter slowly. What if you invested all your money just before a market downturn? Being in the red that quickly wouldn't do much for your confidence. Plan to take several months to invest all of your money to minimize any market timing risk. Finally, remember to set aside time each week to review or catch up on the news for your investments.
Keep Adding
As your experience grows, your asset allocation decisions will probably change. You could adjust your portfolio on a regular basis, say every year or so, by selling some of one type of investment and buying more of another. You could also adjust your portfolio by adding additional funds to those areas in which you want to increase exposure. (For more on this, see A Guide To Portfolio Construction.)
These additional funds can be used to expand the number of securities you hold or can be added to existing holdings. Do this on a regular basis and before you realize it, you'll have a substantial portfolio that will help fund your retirement, pay for a second home, or meet whatever goals you set when you started you investing journey.
Conclusion
Before you jump into the stock market, spend some time thinking about what you want to accomplish and how to do that while staying within your risk tolerance levels. Also consider how much time you have to devote to investing. Doing this before committing those first dollars will go a long way toward protecting you from the emotional rollercoaster of investing first one way, then another, never really knowing why you are changing your mind. Careful thought before and during your investing career will do more to help your results than trying to chase the latest hot stock. After all, it's your money - you should know what you are doing with it and why.
http://www.investopedia.com/articles/basics/07/getting-started-stocks.asp?partner=YahooEA#axzz1Z4IQRtp8
Tutorial: Stock Basics
But there are so many ways to invest in stocks. Individual stocks, mutual funds, index funds, ETFs, domestic, foreign - how can you decide what is right for you? This article will address several issues that you, as a new (or not-so-new) investor, might want to consider so that you can rest more easily while letting your money grow.
Risk Taker, Risk Averse or in the Middle?
You may be eager to get started so that you, too, can make those fabulous returns you hear so much about, but slow down and take a moment to contemplate some simple questions. The time spent now to consider the following will save you money down the road.
What kind of person are you? Are you a risk taker, willing to throw money at a chance to make a lot of money, or would you prefer a more "sure" thing? What would be your likely response to a 10% drop in a single stock in one day or a 35% drop over the course of a few weeks? Would you sell it all in a panic?
The answers to these and similar questions will lead you to consider different types of equity investments, such as mutual or index funds versus individual stocks. If you are naturally not someone who takes risks, and feel uncomfortable doing so but still want to invest in stocks, the best bet for you might be mutual funds or index funds. This is because they are well diversified and contain many different stocks. This reduces risk - and doesn't require individual stock research. (For more insight, read Personalizing Risk Tolerance, Mutual Fund Basics and The Lowdown On Index Funds.)
Have much time and interest do you have for investing?
Should you invest in funds, stocks or both? The answer depends on how much time you wish to devote to this endeavor. Careful selection of mutual or index funds would let you invest your money, leaving the hard work of picking stocks to the fund manager. Index funds are even simpler in that they move up or down according to the type of company, industry or market they are designed to track.
Individual stock investing is the most time consuming as it requires you to make judgments about management, earnings and future prospects. As an investor, you are attempting to distinguish between a money-making stock and financial disaster. You need to know what they do, how they make their money, the risks, the future prospects and much more.
Therefore, ask yourself how much time you have to devote to this enterprise. Are you willing to spend a couple of hours a week, or more, reading about different companies, or is your life just too busy to carve out that time? Investing in individual stocks is a skill, which, like any other, takes time to develop. (For more on this research, read Introduction To Fundamental Analysis.)
Eggs in One Basket
It is best that you not be exposed to only one type of asset. For instance, don't put all of your money in small biotech companies. Yes, the potential gain can be quite high, but what will happen to your investment if the Food and Drug Administration starts rejecting a higher percentage of new drugs? Your entire portfolio would be negatively impacted. (For related reading, see The Ups And Downs Of Biotechnology.)
It is better to be diversified across several different sectors such as real estate (a real estate investment trust is one possibility), consumer goods, commodities, insurance, etc., rather than focusing on one or two or three, as above. Consider diversifying across asset classes, as well, by keeping some money in bonds and cash, rather than being 100% invested in stocks. How much to have in these different sectors and classes is up to you, but being invested more broadly lessens the risk of losing it all at any one time. (For more insight, check out Introduction To Diversification.)
A Portfolio for Beginners
If you are just starting out, think seriously about investing most of your money in a couple of index funds, such as one tracking the broad market (e.g. the S&P 500) and one that gives some international exposure. Maybe adding one that tracks small companies (e.g. the Russell 2000) would give your portfolio a boost.
A portfolio consisting of those three would give plenty of diversification, provide the steadier performance of large companies and be spiced up a bit with both international companies and small caps.
A Portfolio with Individual Stocks
If you are investing in individual stocks, a portfolio of 12-20 well-chosen ones will give you plenty of diversification and probably will not be too many to follow regularly. However, you will need to ensure that you fully understand each company, from their businesses to their risks. If you plan on investing in only stocks, make sure to spread the funds across different sectors such as healthcare, technology, small cap and big cap.
If you don't have the time or desire to pick as well as follow that many stocks, consider investing in a mixture of index funds and individual stocks. Another consideration, especially if starting out with limited funds, is that investing in 12-20 stocks may not be feasible, so having the majority of your money in some funds would provide the stabler returns those tend to generate while maybe half a dozen individual stocks would give your portfolio an extra kick.
Time to Invest
Once you've determined the shape of your portfolio, it is time to invest. Find a broker you are comfortable with, either an online broker or one with a local office or both. Call and talk with this person, if necessary. Then, fill out the paperwork, deposit some money and open an account. (To learn more, see Picking Your First Broker.)
After deciding what to buy, don't buy all at once: enter slowly. What if you invested all your money just before a market downturn? Being in the red that quickly wouldn't do much for your confidence. Plan to take several months to invest all of your money to minimize any market timing risk. Finally, remember to set aside time each week to review or catch up on the news for your investments.
Keep Adding
As your experience grows, your asset allocation decisions will probably change. You could adjust your portfolio on a regular basis, say every year or so, by selling some of one type of investment and buying more of another. You could also adjust your portfolio by adding additional funds to those areas in which you want to increase exposure. (For more on this, see A Guide To Portfolio Construction.)
These additional funds can be used to expand the number of securities you hold or can be added to existing holdings. Do this on a regular basis and before you realize it, you'll have a substantial portfolio that will help fund your retirement, pay for a second home, or meet whatever goals you set when you started you investing journey.
Conclusion
Before you jump into the stock market, spend some time thinking about what you want to accomplish and how to do that while staying within your risk tolerance levels. Also consider how much time you have to devote to investing. Doing this before committing those first dollars will go a long way toward protecting you from the emotional rollercoaster of investing first one way, then another, never really knowing why you are changing your mind. Careful thought before and during your investing career will do more to help your results than trying to chase the latest hot stock. After all, it's your money - you should know what you are doing with it and why.
http://www.investopedia.com/articles/basics/07/getting-started-stocks.asp?partner=YahooEA#axzz1Z4IQRtp8
Self-Taught Finance Expert
So you want to become a financial expert, but don't know where to start? Have no fear, a wealth of information is at your fingertips, and getting started is easy. From a basic introduction to personal finances to advanced security analysis, anyone interested in learning can get access to the necessary resources. (For more on a career in finance, check out Is A Career In Financial Planning In Your Future?)
TUTORIAL: Investing 101
Start By Reading
For a basic introduction to sound financial concepts, you can't do much better than "The Richest Man in Babylon." It's a tiny little book, written in an uncomplicated style. It also captures the wisdom of the ages in an easy to follow manner.
Once you've covered that, the famous "For Dummies" series provides insight into everything from budgeting to mutual funds. "Managing Your Money for Dummies," "Budgeting for Dummies" and "Mutual Funds for Dummies" are three titles that will help you expand your knowledge of basic concepts.
By the time you finish those four books, you are likely to have identified specific items that you would like to learn more about. For these inquiries, there's no better place to go for fast, easy access to information that online. Investopedia and similar sites provide access to a wealth of information that will keep you busy for weeks if not months. Investopedia's tutorials are particularly notable, as they provide an in-depth look at a wide variety of topics.
Google and other search engines let you hone in on specific topics, and many mutual fund companies and financial services firms offer a wealth of free information. A visit to their websites can reveal everything from general education on a wide array of products to economic forecasts and economic insights from professional market watchers. With a just a little effort, you can even identify and follow comments from your favorite economist, investment strategists, portfolio manager, or other expert.
The library, you local bookstore and multiple online retailers also offer literally thousands of books on every conceivable topic. From financial history and Wall Street villains to hedge fund analysis and day-trading strategies, there's a book (or ten) for every topic of interest. (For more read, Can You “Learn” The Stock Market?)
Television, Radio and Podcasts Can Help Too
Television broadcasts and/or podcasts are from a variety of experts. At the national level, Suze Orman and other gurus cover the common topics. Kramer and his peers talk stocks. At the local level, your hometown is likely to have an expert or two that you can tune into at no cost. (To read more on gurus, see Investing Quotes You Can Bank On.)
Ready to Step Up Your Game? Hit the Books Again
After you have covered the basics and want a solid overview at a more detailed level, "The Wall Street Journal Guide to Investing" is a great place to start. When you are done with that, your local library or bookstore will contain a variety of magazines covering both timely and general financial services topics. When you are ready to learn about stock research, Value Line is a great publication that provides an introduction into how you can begin to research and analyze stocks. Some libraries provide access to Value Line for free. If your local library does not, the service is available by subscription. Even if you choose not to conduct your own stock analysis, the Value Line website is worth a visit.
If you make it this far, you are clearly serious about your endeavor. Now it's time to make your quest a daily habit. Subscribing to the The Wall Street Journal will give you a daily overview of the issues impacting global business operations. The Journal also has a great "Money and Investing" section. Barron's is another fine publication read by many professionals in the financial services industry. There are many other top-quality publications dedicated to various aspects of the financial services world. Find one that matches your interests and read it. (Check out, 5 Must-Read Finance Books.)
Talk to the Experts
Once you have solid understanding of the various aspects of the financial services world, it is time to spend some time talking to the experts. Financial services professionals make a living with their expertise and can help you learn about everything from mortgages and debt management to retirement savings and estate planning. Some of these topics are covered in seminars, others in one-on-one consultations. You can even pick up a thing or two just by having an informal conversation. Talk to a professional financial advisor, talk to your banker, talk to your accountant and your attorney. Then listen and learn as they share their knowledge. (For help on locating an advisor, read Advice For Finding The Best Advisor.)
Ready for More?
If you like what you have seen and heard and are ready for more, the CFA Institute (a non-profit organization that offers “a range of educational and career resources, including the Chartered Financial Analyst (CFA) and the Certificate in Investment Performance Measurement (CIPM) designations”) provides access to the curriculum for several of their well-regarded programs for free:
•http://www.cfainstitute.org/cfaprogram/courseofstudy/Pages/study_sessions.aspx
•http://www.cfainstitute.org/cipm/courseofstudy/curriculum/Pages/index.aspx
The Certified Financial Analyst program is an extremely well regarded curriculum, and the Certificate in Investment Performance Measurement (CIPM) Program "is the investment industry's only designation dedicated to investment performance analysis and presentation." If articles with titles like Evaluating Portfolio Performance by V. Bailey, Thomas M. Richards and David E. Tierney, and "Investment Performance Measurement: Evaluating and Presenting Results," Philip Lawton and Todd Jankowski, eds. (Wiley 2009) capture your interest, the CFA institute has a reading list that you are sure to like. (For help choosing a designation, check out CPA, CFA Or CFP - Pick Your Abbreviation Carefully.)
A Life-Long Pursuit
The financial services field is constantly evolving and changing. Recent decades have seen the rise of unified managed accounts, the development of exchange traded funds, the evolution of annuities and insured investment products and a host of other developments. Change is par for the course as the industry adapts to dynamic economic conditions and changes in what investors want and how they wish to deploy their assets. In this environment, there is always something new to consider, something old to revisit and something interesting just beyond the horizon. Keeping up with the industry is an important part of a financial service professional's life, and continuing education requirements are required for many of these experts to maintain their credentials. What this means for the-self taught expert is that you will always have an opportunity to add to your body of knowledge. (To read more on new investments, see 3 Investments On The Rise In 2011.)
by Lisa Smith
http://www.investopedia.com/articles/basics/11/become-self-taught-finance-expert.asp?partner=YahooEA#axzz1Z4IQRtp8
TUTORIAL: Investing 101
Start By Reading
For a basic introduction to sound financial concepts, you can't do much better than "The Richest Man in Babylon." It's a tiny little book, written in an uncomplicated style. It also captures the wisdom of the ages in an easy to follow manner.
Once you've covered that, the famous "For Dummies" series provides insight into everything from budgeting to mutual funds. "Managing Your Money for Dummies," "Budgeting for Dummies" and "Mutual Funds for Dummies" are three titles that will help you expand your knowledge of basic concepts.
By the time you finish those four books, you are likely to have identified specific items that you would like to learn more about. For these inquiries, there's no better place to go for fast, easy access to information that online. Investopedia and similar sites provide access to a wealth of information that will keep you busy for weeks if not months. Investopedia's tutorials are particularly notable, as they provide an in-depth look at a wide variety of topics.
Google and other search engines let you hone in on specific topics, and many mutual fund companies and financial services firms offer a wealth of free information. A visit to their websites can reveal everything from general education on a wide array of products to economic forecasts and economic insights from professional market watchers. With a just a little effort, you can even identify and follow comments from your favorite economist, investment strategists, portfolio manager, or other expert.
The library, you local bookstore and multiple online retailers also offer literally thousands of books on every conceivable topic. From financial history and Wall Street villains to hedge fund analysis and day-trading strategies, there's a book (or ten) for every topic of interest. (For more read, Can You “Learn” The Stock Market?)
Television, Radio and Podcasts Can Help Too
Television broadcasts and/or podcasts are from a variety of experts. At the national level, Suze Orman and other gurus cover the common topics. Kramer and his peers talk stocks. At the local level, your hometown is likely to have an expert or two that you can tune into at no cost. (To read more on gurus, see Investing Quotes You Can Bank On.)
Ready to Step Up Your Game? Hit the Books Again
After you have covered the basics and want a solid overview at a more detailed level, "The Wall Street Journal Guide to Investing" is a great place to start. When you are done with that, your local library or bookstore will contain a variety of magazines covering both timely and general financial services topics. When you are ready to learn about stock research, Value Line is a great publication that provides an introduction into how you can begin to research and analyze stocks. Some libraries provide access to Value Line for free. If your local library does not, the service is available by subscription. Even if you choose not to conduct your own stock analysis, the Value Line website is worth a visit.
If you make it this far, you are clearly serious about your endeavor. Now it's time to make your quest a daily habit. Subscribing to the The Wall Street Journal will give you a daily overview of the issues impacting global business operations. The Journal also has a great "Money and Investing" section. Barron's is another fine publication read by many professionals in the financial services industry. There are many other top-quality publications dedicated to various aspects of the financial services world. Find one that matches your interests and read it. (Check out, 5 Must-Read Finance Books.)
Talk to the Experts
Once you have solid understanding of the various aspects of the financial services world, it is time to spend some time talking to the experts. Financial services professionals make a living with their expertise and can help you learn about everything from mortgages and debt management to retirement savings and estate planning. Some of these topics are covered in seminars, others in one-on-one consultations. You can even pick up a thing or two just by having an informal conversation. Talk to a professional financial advisor, talk to your banker, talk to your accountant and your attorney. Then listen and learn as they share their knowledge. (For help on locating an advisor, read Advice For Finding The Best Advisor.)
Ready for More?
If you like what you have seen and heard and are ready for more, the CFA Institute (a non-profit organization that offers “a range of educational and career resources, including the Chartered Financial Analyst (CFA) and the Certificate in Investment Performance Measurement (CIPM) designations”) provides access to the curriculum for several of their well-regarded programs for free:
•http://www.cfainstitute.org/cfaprogram/courseofstudy/Pages/study_sessions.aspx
•http://www.cfainstitute.org/cipm/courseofstudy/curriculum/Pages/index.aspx
The Certified Financial Analyst program is an extremely well regarded curriculum, and the Certificate in Investment Performance Measurement (CIPM) Program "is the investment industry's only designation dedicated to investment performance analysis and presentation." If articles with titles like Evaluating Portfolio Performance by V. Bailey, Thomas M. Richards and David E. Tierney, and "Investment Performance Measurement: Evaluating and Presenting Results," Philip Lawton and Todd Jankowski, eds. (Wiley 2009) capture your interest, the CFA institute has a reading list that you are sure to like. (For help choosing a designation, check out CPA, CFA Or CFP - Pick Your Abbreviation Carefully.)
A Life-Long Pursuit
The financial services field is constantly evolving and changing. Recent decades have seen the rise of unified managed accounts, the development of exchange traded funds, the evolution of annuities and insured investment products and a host of other developments. Change is par for the course as the industry adapts to dynamic economic conditions and changes in what investors want and how they wish to deploy their assets. In this environment, there is always something new to consider, something old to revisit and something interesting just beyond the horizon. Keeping up with the industry is an important part of a financial service professional's life, and continuing education requirements are required for many of these experts to maintain their credentials. What this means for the-self taught expert is that you will always have an opportunity to add to your body of knowledge. (To read more on new investments, see 3 Investments On The Rise In 2011.)
by Lisa Smith
http://www.investopedia.com/articles/basics/11/become-self-taught-finance-expert.asp?partner=YahooEA#axzz1Z4IQRtp8
Controversial Investing Theories
When it comes to investing, there is no shortage of theories on what makes the markets tick or what a particular market move means. The two largest factions on Wall Street are split along theoretical lines into adherents to an efficient market theory and those who believe the market can be beat. Although this is a fundamental split, there are many other theories that attempt to explain and influence the market - and the actions of investors in the markets. In this article, we will look at some common (and uncommon) financial theories.
Efficient Market Hypothesis
Very few people are neutral on efficient market hypothesis (EMH). You either believe in it and adhere to passive, broad market investing strategies, or you detest it and focus on picking stocks based on growth potential, undervalued assets and so on. The EMH states that the market price for shares incorporates all the known information about that stock. This means that the stock is accurately valued until a future event changes that valuation. Because the future is uncertain, an adherent to EMH is far better off owning a wide swath of stocks and profiting from the general rise of the market.
Opponents of EMH point to Warren Buffett and other investors who have consistently beat the market by finding irrational prices within the overall market.
Fifty Percent Principle
The fifty percent principle predicts that, before continuing, an observed trend will undergo a price correction of one-half to two-thirds of the change in price. This means that if a stock has been on an upward trend and gained 20%, it will fall back 10% before continuing its rise. This is an extreme example, as most times this rule is applied to the short-term trends that technical analysts and traders buy and sell on.
This correction is thought to be a natural part of the trend as it's usually caused by skittish investors taking profits early to avoid getting caught in a true reversal of the trend later on. If the correction exceeds 50% of the change in price, it's considered a sign that the trend has failed and the reversal has come prematurely.
Greater Fool Theory
The greater fool theory proposes that you can profit from investing as long as there is a greater fool than yourself to buy the investment at a higher price. This means that you could make money from an overpriced stock as long as someone else is willing to pay more to buy it from you.
Eventually you run out of fools as the market for any investment overheats. Investing according to the greater fool theory means ignoring valuations, earning reports and all the other data. Ignoring data is as risky as paying too much attention to it; so people ascribing to the greater fool theory could be left holding the short end of the stick after a market correction.
Odd Lot Theory
The odd lot theory uses the sale of odd lots – small blocks of stocks held by individual investors – as an indicator of when to buy into a stock. Investors following the odd lot theory buy in when small investors sell out. The main assumption is that small investors are usually wrong.
The odd lot theory is contrarian strategy based off a very simple form of technical analysis – measuring odd lot sales. How successful an investor or trader following the theory is depends heavily on whether or not he checks the fundamentals of companies that the theory points toward or simply buys blindly. Small investors aren't going to be right or wrong all the time, so it's important to distinguish odd lot sales that are occurring from a low-risk tolerance from odd lot sales that are due to bigger problems. Individual investors are more mobile than the big funds and thus can react to severe news faster, so odd lot sales can actually be a precursor to a wider sell-off in a failing stock instead of just a mistake on the part of small time investors.
Prospect Theory (Loss-Aversion Theory)
Prospect theory states that people's perceptions of gain and loss are skewed. That is, people are more afraid of a loss than they are encouraged by a gain. If a person is given a choice of two different prospects, they will pick the one that they think has less of chance of ending in a loss, rather than the one that offers the most gains. For example, if you offer a person two investments, one that has returned 5% each year and one that has returned 12%, lost 2.5%, and returned 6% in the same years, the person will pick the 5% investment because he puts an irrational amount of importance on the single loss, while ignoring the gains that are of a greater magnitude. In the above example, both alternatives produce the net total return after three years.
Prospect theory is important for financial professionals and investors. Although the risk/reward trade-off gives a clear picture of the amount of risk an investor has to take on to achieve the desired returns, prospect theory tells us that very few people understand emotionally what they realize intellectually. For financial professionals, the challenge is in suiting a portfolio to the client's risk profile, rather than reward desires. For the investor, the challenge is to overcome the disappointing predictions of prospect theory and become brave enough to get the returns you want.
Rational Expectations Theory
Rational expectations theory states that the players in an economy will act in a way that conforms to what can logically be expected in the future. That is, a person will invest, spend, etc. according to what he or she rationally believes will happen in the future. By doing so, that person creates a self-fulfilling prophecy that helps bring about the future event.
Although this theory has become quite important to economics, its utility is doubtful. For example, an investor thinks a stock is going to go up, and by buying it, this act actually causes the stock to go up. This same transaction can be framed outside of rational expectations theory. An investor notices that a stock is undervalued, buys it, and watches as other investors notice the same thing, thus pushing the price up to its proper market value. This highlights the main problem with rational expectations theory: it can be changed to explain everything, but it tells us nothing.
Short Interest Theory
Short interest theory posits that a high short interest is the precursor to a rise in the stock's price and, at first glance, appears to be unfounded. Common sense suggests that a stock with a high short interest – that is, a stock that many investors are short selling – is due for a correction. The reasoning goes that all those traders, thousands of professionals and individuals scrutinizing every scrap of market data, surely can't be wrong. They may be right to an extent, but the stock price may actually rise by virtue of being heavily shorted. Short sellers have to eventually cover their positions by buying the stock they've shorted. Consequently, the buying pressure created by the short sellers covering their positions will push the share price upwards.
The Bottom Line
We have covered a pretty wide range of theories, from technical trading theories like short interest and odd lot theory to economic theories like rational expectations and prospect theory. Every theory is an attempt to impose some type of consistency or some type of frame to the millions of buy and sell decisions that make the market swell and ebb on a daily basis. While it is useful to know these theories, it is also important to remember that there is no unified theory that can explain the financial world. During certain time periods, one theory seems to hold sway only to be toppled the next instant. In the financial world, change is the only true constant.
Efficient Market Hypothesis
Very few people are neutral on efficient market hypothesis (EMH). You either believe in it and adhere to passive, broad market investing strategies, or you detest it and focus on picking stocks based on growth potential, undervalued assets and so on. The EMH states that the market price for shares incorporates all the known information about that stock. This means that the stock is accurately valued until a future event changes that valuation. Because the future is uncertain, an adherent to EMH is far better off owning a wide swath of stocks and profiting from the general rise of the market.
Opponents of EMH point to Warren Buffett and other investors who have consistently beat the market by finding irrational prices within the overall market.
Fifty Percent Principle
The fifty percent principle predicts that, before continuing, an observed trend will undergo a price correction of one-half to two-thirds of the change in price. This means that if a stock has been on an upward trend and gained 20%, it will fall back 10% before continuing its rise. This is an extreme example, as most times this rule is applied to the short-term trends that technical analysts and traders buy and sell on.
This correction is thought to be a natural part of the trend as it's usually caused by skittish investors taking profits early to avoid getting caught in a true reversal of the trend later on. If the correction exceeds 50% of the change in price, it's considered a sign that the trend has failed and the reversal has come prematurely.
Greater Fool Theory
The greater fool theory proposes that you can profit from investing as long as there is a greater fool than yourself to buy the investment at a higher price. This means that you could make money from an overpriced stock as long as someone else is willing to pay more to buy it from you.
Eventually you run out of fools as the market for any investment overheats. Investing according to the greater fool theory means ignoring valuations, earning reports and all the other data. Ignoring data is as risky as paying too much attention to it; so people ascribing to the greater fool theory could be left holding the short end of the stick after a market correction.
Odd Lot Theory
The odd lot theory uses the sale of odd lots – small blocks of stocks held by individual investors – as an indicator of when to buy into a stock. Investors following the odd lot theory buy in when small investors sell out. The main assumption is that small investors are usually wrong.
The odd lot theory is contrarian strategy based off a very simple form of technical analysis – measuring odd lot sales. How successful an investor or trader following the theory is depends heavily on whether or not he checks the fundamentals of companies that the theory points toward or simply buys blindly. Small investors aren't going to be right or wrong all the time, so it's important to distinguish odd lot sales that are occurring from a low-risk tolerance from odd lot sales that are due to bigger problems. Individual investors are more mobile than the big funds and thus can react to severe news faster, so odd lot sales can actually be a precursor to a wider sell-off in a failing stock instead of just a mistake on the part of small time investors.
Prospect Theory (Loss-Aversion Theory)
Prospect theory states that people's perceptions of gain and loss are skewed. That is, people are more afraid of a loss than they are encouraged by a gain. If a person is given a choice of two different prospects, they will pick the one that they think has less of chance of ending in a loss, rather than the one that offers the most gains. For example, if you offer a person two investments, one that has returned 5% each year and one that has returned 12%, lost 2.5%, and returned 6% in the same years, the person will pick the 5% investment because he puts an irrational amount of importance on the single loss, while ignoring the gains that are of a greater magnitude. In the above example, both alternatives produce the net total return after three years.
Prospect theory is important for financial professionals and investors. Although the risk/reward trade-off gives a clear picture of the amount of risk an investor has to take on to achieve the desired returns, prospect theory tells us that very few people understand emotionally what they realize intellectually. For financial professionals, the challenge is in suiting a portfolio to the client's risk profile, rather than reward desires. For the investor, the challenge is to overcome the disappointing predictions of prospect theory and become brave enough to get the returns you want.
Rational Expectations Theory
Rational expectations theory states that the players in an economy will act in a way that conforms to what can logically be expected in the future. That is, a person will invest, spend, etc. according to what he or she rationally believes will happen in the future. By doing so, that person creates a self-fulfilling prophecy that helps bring about the future event.
Although this theory has become quite important to economics, its utility is doubtful. For example, an investor thinks a stock is going to go up, and by buying it, this act actually causes the stock to go up. This same transaction can be framed outside of rational expectations theory. An investor notices that a stock is undervalued, buys it, and watches as other investors notice the same thing, thus pushing the price up to its proper market value. This highlights the main problem with rational expectations theory: it can be changed to explain everything, but it tells us nothing.
Short Interest Theory
Short interest theory posits that a high short interest is the precursor to a rise in the stock's price and, at first glance, appears to be unfounded. Common sense suggests that a stock with a high short interest – that is, a stock that many investors are short selling – is due for a correction. The reasoning goes that all those traders, thousands of professionals and individuals scrutinizing every scrap of market data, surely can't be wrong. They may be right to an extent, but the stock price may actually rise by virtue of being heavily shorted. Short sellers have to eventually cover their positions by buying the stock they've shorted. Consequently, the buying pressure created by the short sellers covering their positions will push the share price upwards.
The Bottom Line
We have covered a pretty wide range of theories, from technical trading theories like short interest and odd lot theory to economic theories like rational expectations and prospect theory. Every theory is an attempt to impose some type of consistency or some type of frame to the millions of buy and sell decisions that make the market swell and ebb on a daily basis. While it is useful to know these theories, it is also important to remember that there is no unified theory that can explain the financial world. During certain time periods, one theory seems to hold sway only to be toppled the next instant. In the financial world, change is the only true constant.
Professional Development
It's easy to get complacent about professional development when you're employed. If you already have a job, why should you go above and beyond to improve your skills, especially if it's not required by your company?
But making an effort to help yourself grow professionally will help you succeed, both in the short term and in the long term. And if you don't learn new skills and acquire new knowledge and experience, you're likely to fall behind your peers, which could be detrimental when you look to change positions.
"If you don't [focus on professional development], you won't be marketable in your field in five years," Alexandra Levit, author of New Job, New You: A Guide to Reinventing Yourself in a Bright New Career, wrote in an email. "In this [employment] climate, you always have to be looking ahead to what is going to be required in your potential next role."
Levit recommends focusing on transferable skills that are relevant across a variety of industries and positions. That way, even if you can't use them now, they'll likely come in handy later.
Taking charge of your professional development has become even more important since the recession, because some companies no longer have the funds to help employees grow beyond their basic duties. And since employees tend to have shorter stays with companies than they did years ago, companies may not see the value in training an employee they could lose. Of course, employee-retention experts say that's exactly why companies should offer professional development: because it helps them keep and cultivate their best talent.
"Companies have less resources to do professional development because as they've cut back, everybody's down to muscle and bone," says Rusty Rueff, career and workplace expert at Glassdoor.com, a website that offers insight into careers and companies. "You have to take control of your own development ... and find ways to make it happen."
Here are 10 ways to help yourself grow professionally even without the support of your company:
1. Take a class. Just because you're no longer in school doesn't mean the classroom is off-limits. Plenty of universities offer classes for adults, often in the evening so you can attend around your job schedule. Online classes are another convenient option. Take a class on a topic that's relevant for your job, or learn about something that's totally unrelated for a change of pace. Either way, you're growing, which is the over-arching goal.
2. Teach yourself a skill. You don't always need structure or a class to learn something new. Pinpoint skills that are desirable in your line of work, and start practicing. Website-building or social-media skills are a perfect example, and they're desirable across the board. Jump into a project, and learn the ropes as you go.
3. Volunteer. "Because [nonprofit] organizations are so hungry for hands," Levit says, "you'll get the opportunity to master leadership skills you might not have the chance to practice otherwise." And, she adds, "you'll be doing it in a real-world environment, which makes the experience better than if you, for example, took coursework or training seminars."
4. Master an online tool. Even those of us who organize our lives via digital tools don't always make the most of them. The Web is full of free video tutorials on how to use networks like LinkedIn and Google+, as well as tips on organizing your Gmail life. Think about how you can increase your efficiency, and scour the Internet for resources to help you accomplish that.
5. Seek out people who are on the career path you aspire to. Ask them how they got to where they are. With a little effort on social media, Rueff says, you can easily find out who holds a certain position--or who used to hold it--and reach out to them. Especially if you stroke their ego a bit, people are often happy to talk about the path they took in their career, as well as what worked and what didn't. Learn from their successes and mistakes.
6. Shadow a colleague. Find workers within your company who do something you want to learn, and stop by their office occasionally to ask questions, Rueff suggests. You don't need an official shadowing program to accomplish this, just your own initiative. "You will learn a lot by listening and watching, and a little bit by osmosis," he says.
7. Find a mentor. Take that find-a-successful-person goal one step further and identify someone who's willing to give you guidance and advice. Even if you don't feel comfortable calling that person a mentor, having someone to run ideas by who has more experience than you can go a long way toward helping you make the right decisions. The key here is that they have to have an interest in helping you.
8. Read. Devour books and articles and blogs within your niche, but also pick reads that are outside of your normal professional box, Rueff says. "Read things that are outside of your own industry and experience, and then stop and think about, how can I relate that and apply it to my business?" he says.
9. Attend a conference. Figure out which conference is most worthwhile for people who work in your target industry and go, even if it means using vacation time. Not only will you learn new skills, you'll also make new contacts. Emily Bennington, who helps new college graduates transition from the classroom to the workplace, advises researching who's going and connecting with those people on social media before the event, so you can arrange an in-person meeting and facilitate a stronger connection.
10. Don't neglect your "soft skills." Most of us know our weaknesses, whether we need to be more organized or do a better job of meeting deadlines or simply prioritizing in a smarter way. Putting effort into improving those skills will make you more marketable no matter what field you're in, says Joseph Grenny, an organizational-development expert and co-author of Change Anything: The New Science of Personal Success.
"Don't do it for your boss," Grenny says. "You're doing this for you."
But making an effort to help yourself grow professionally will help you succeed, both in the short term and in the long term. And if you don't learn new skills and acquire new knowledge and experience, you're likely to fall behind your peers, which could be detrimental when you look to change positions.
"If you don't [focus on professional development], you won't be marketable in your field in five years," Alexandra Levit, author of New Job, New You: A Guide to Reinventing Yourself in a Bright New Career, wrote in an email. "In this [employment] climate, you always have to be looking ahead to what is going to be required in your potential next role."
Levit recommends focusing on transferable skills that are relevant across a variety of industries and positions. That way, even if you can't use them now, they'll likely come in handy later.
Taking charge of your professional development has become even more important since the recession, because some companies no longer have the funds to help employees grow beyond their basic duties. And since employees tend to have shorter stays with companies than they did years ago, companies may not see the value in training an employee they could lose. Of course, employee-retention experts say that's exactly why companies should offer professional development: because it helps them keep and cultivate their best talent.
"Companies have less resources to do professional development because as they've cut back, everybody's down to muscle and bone," says Rusty Rueff, career and workplace expert at Glassdoor.com, a website that offers insight into careers and companies. "You have to take control of your own development ... and find ways to make it happen."
Here are 10 ways to help yourself grow professionally even without the support of your company:
1. Take a class. Just because you're no longer in school doesn't mean the classroom is off-limits. Plenty of universities offer classes for adults, often in the evening so you can attend around your job schedule. Online classes are another convenient option. Take a class on a topic that's relevant for your job, or learn about something that's totally unrelated for a change of pace. Either way, you're growing, which is the over-arching goal.
2. Teach yourself a skill. You don't always need structure or a class to learn something new. Pinpoint skills that are desirable in your line of work, and start practicing. Website-building or social-media skills are a perfect example, and they're desirable across the board. Jump into a project, and learn the ropes as you go.
3. Volunteer. "Because [nonprofit] organizations are so hungry for hands," Levit says, "you'll get the opportunity to master leadership skills you might not have the chance to practice otherwise." And, she adds, "you'll be doing it in a real-world environment, which makes the experience better than if you, for example, took coursework or training seminars."
4. Master an online tool. Even those of us who organize our lives via digital tools don't always make the most of them. The Web is full of free video tutorials on how to use networks like LinkedIn and Google+, as well as tips on organizing your Gmail life. Think about how you can increase your efficiency, and scour the Internet for resources to help you accomplish that.
5. Seek out people who are on the career path you aspire to. Ask them how they got to where they are. With a little effort on social media, Rueff says, you can easily find out who holds a certain position--or who used to hold it--and reach out to them. Especially if you stroke their ego a bit, people are often happy to talk about the path they took in their career, as well as what worked and what didn't. Learn from their successes and mistakes.
6. Shadow a colleague. Find workers within your company who do something you want to learn, and stop by their office occasionally to ask questions, Rueff suggests. You don't need an official shadowing program to accomplish this, just your own initiative. "You will learn a lot by listening and watching, and a little bit by osmosis," he says.
7. Find a mentor. Take that find-a-successful-person goal one step further and identify someone who's willing to give you guidance and advice. Even if you don't feel comfortable calling that person a mentor, having someone to run ideas by who has more experience than you can go a long way toward helping you make the right decisions. The key here is that they have to have an interest in helping you.
8. Read. Devour books and articles and blogs within your niche, but also pick reads that are outside of your normal professional box, Rueff says. "Read things that are outside of your own industry and experience, and then stop and think about, how can I relate that and apply it to my business?" he says.
9. Attend a conference. Figure out which conference is most worthwhile for people who work in your target industry and go, even if it means using vacation time. Not only will you learn new skills, you'll also make new contacts. Emily Bennington, who helps new college graduates transition from the classroom to the workplace, advises researching who's going and connecting with those people on social media before the event, so you can arrange an in-person meeting and facilitate a stronger connection.
10. Don't neglect your "soft skills." Most of us know our weaknesses, whether we need to be more organized or do a better job of meeting deadlines or simply prioritizing in a smarter way. Putting effort into improving those skills will make you more marketable no matter what field you're in, says Joseph Grenny, an organizational-development expert and co-author of Change Anything: The New Science of Personal Success.
"Don't do it for your boss," Grenny says. "You're doing this for you."
Investor Mistakes
Of the mistakes made by investors, seven of them are repeat offenses. In fact, investors have been making these same mistakes since the dawn of modern markets, and will likely be repeating them for years to come. You can significantly boost your chances of investment success by becoming aware of these typical errors and taking steps to avoid them.
1. No Plan
As the old saying goes, if you don't know where you're going, any road will take you there. Solution?
Have a personal investment plan or policy that addresses the following:
Goals and objectives - Find out what you're trying to accomplish. Accumulating $100,000 for a child's college education or $2 million for retirement at age 60 are appropriate goals. Beating the market is not a goal.
Risks - What risks are relevant to you or your portfolio? If you are a 30-year-old saving for retirement, volatility isn't (or shouldn't be) a meaningful risk. On the other hand, inflation - which erodes any long-term portfolio - is a significant risk.
Appropriate benchmarks - How will you measure the success of your portfolio, its asset classes and individual funds or managers?
Asset allocation - What percentage of your total portfolio will you allocate to U.S. equities, international stocks, U.S. bonds, high-yield bonds, etc. Your asset allocation should accomplish your goals while addressing relevant risks.
Diversification - Allocating to different asset classes is the initial layer of diversification. You then need to diversify within each asset class. In U.S. stocks, for example, this means exposure to large-, mid- and small-cap stocks.
Your written plan's guidelines will help you adhere to a sound long-term policy, even when current market conditions are unsettling. Having a good plan and sticking to it is not nearly as exciting or as much fun as trying to time the markets, but it will likely be more profitable in the long term.
2. Too Short of a Time Horizon
If you are saving for retirement 30 years hence, what the stock market does this year or next shouldn't be the biggest concern. Even if you are just entering retirement at age 70, your life expectancy is likely 15 to 20 years. If you expect to leave some assets to your heirs, then your
3. Too Much Attention Given to Financial Media
There is almost nothing on financial news shows that can help you achieve your goals. Turn them off. There are few newsletters that can provide you with anything of value. Even if there were, how do you identify them in advance?
Think about it - if anyone really had profitable stock tips, trading advice or a secret formula to make big bucks, would they blab it on TV or sell it to you for $49 per month? No - they'd keep their mouth shut, make their millions and not have to sell a newsletter to make a living.
Solution? Spend less time watching financial shows on TV and reading newsletters. Spend more time creating - and sticking to - your investment plan.
4. Not Rebalancing
Rebalancing is the process of returning your portfolio to its target asset allocation as outlined in your investment plan. Rebalancing is difficult because it forces you to sell the asset class that is performing well and buy more of your worst performing asset classes. This contrarian action is very difficult for many investors.
In addition, rebalancing is unprofitable right up to that point where it pays off spectacularly (think U.S. equities in the late 1990s), and the underperforming assets start to take off.
However, a portfolio allowed to drift with market returns guarantees that asset classes will be overweighted at market peaks and underweighted at market lows - a formula for poor performance. The solution? Rebalance religiously and reap the long-term rewards.
5. Overconfidence in the Ability of Managers
From numerous studies, including Burton Malkiel's 1995 study entitled, "Returns From Investing In Equity Mutual Funds", we know that most managers will underperform their benchmarks. We also know that there's no consistent way to select - in advance - those managers that will outperform. We also know that very, very few individuals can profitably time the market over the long term. So why are so many investors confident of their abilities to time the market and select outperforming managers?
Fidelity guru Peter Lynch once observed, "There are no market timers in the 'Forbes' 400'." Investors' misplaced overconfidence in their ability to market-time and select outperforming managers leads directly to our next common investment mistake.
6. Not Enough Indexing
There is not enough time to recite many of the studies that prove that most managers and mutual funds underperform their benchmarks. Over the long-term, low-cost index funds are typically upper second-quartile performers, or better than 65-75% of actively managed funds.
Despite all the evidence in favor of indexing, the desire to invest with active managers remains strong. John Bogle, the founder of Vanguard, says it's because, "Hope springs eternal. Indexing is sort of dull. It flies in the face of the American way [that] 'I can do better.'"
Index all or a large portion (70-80%) of all your traditional asset classes. If you can't resist the excitement of pursuing the next great performer, set aside a portion (20-30%) of each asset class to allocate to active managers. This may satisfy your desire to pursue outperformance without devastating your portfolio.
7. Chasing Performance
Many investors select asset classes, strategies, managers and funds based on recent strong performance. The feeling that "I'm missing out on great returns" has probably led to more bad investment decisions than any other single factor. If a particular asset class, strategy or fund has done extremely well for three or four years, we know one thing with certainty: We should have invested three or four years ago. Now, however, the particular cycle that led to this great performance may be nearing its end. The smart money is moving out, and the dumb money is pouring in. Stick with your investment plan and rebalance, which is the polar opposite of chasing performance.
Conclusion
Investors who recognize and avoid these seven common mistakes give themselves a great advantage in meeting their investment goals. Most of the solutions above are not exciting, and they don't make great cocktail party conversation. However, they are likely to be profitable. And isn't that why we really invest?
1. No Plan
As the old saying goes, if you don't know where you're going, any road will take you there. Solution?
Have a personal investment plan or policy that addresses the following:
Goals and objectives - Find out what you're trying to accomplish. Accumulating $100,000 for a child's college education or $2 million for retirement at age 60 are appropriate goals. Beating the market is not a goal.
Risks - What risks are relevant to you or your portfolio? If you are a 30-year-old saving for retirement, volatility isn't (or shouldn't be) a meaningful risk. On the other hand, inflation - which erodes any long-term portfolio - is a significant risk.
Appropriate benchmarks - How will you measure the success of your portfolio, its asset classes and individual funds or managers?
Asset allocation - What percentage of your total portfolio will you allocate to U.S. equities, international stocks, U.S. bonds, high-yield bonds, etc. Your asset allocation should accomplish your goals while addressing relevant risks.
Diversification - Allocating to different asset classes is the initial layer of diversification. You then need to diversify within each asset class. In U.S. stocks, for example, this means exposure to large-, mid- and small-cap stocks.
Your written plan's guidelines will help you adhere to a sound long-term policy, even when current market conditions are unsettling. Having a good plan and sticking to it is not nearly as exciting or as much fun as trying to time the markets, but it will likely be more profitable in the long term.
2. Too Short of a Time Horizon
If you are saving for retirement 30 years hence, what the stock market does this year or next shouldn't be the biggest concern. Even if you are just entering retirement at age 70, your life expectancy is likely 15 to 20 years. If you expect to leave some assets to your heirs, then your
3. Too Much Attention Given to Financial Media
There is almost nothing on financial news shows that can help you achieve your goals. Turn them off. There are few newsletters that can provide you with anything of value. Even if there were, how do you identify them in advance?
Think about it - if anyone really had profitable stock tips, trading advice or a secret formula to make big bucks, would they blab it on TV or sell it to you for $49 per month? No - they'd keep their mouth shut, make their millions and not have to sell a newsletter to make a living.
Solution? Spend less time watching financial shows on TV and reading newsletters. Spend more time creating - and sticking to - your investment plan.
4. Not Rebalancing
Rebalancing is the process of returning your portfolio to its target asset allocation as outlined in your investment plan. Rebalancing is difficult because it forces you to sell the asset class that is performing well and buy more of your worst performing asset classes. This contrarian action is very difficult for many investors.
In addition, rebalancing is unprofitable right up to that point where it pays off spectacularly (think U.S. equities in the late 1990s), and the underperforming assets start to take off.
However, a portfolio allowed to drift with market returns guarantees that asset classes will be overweighted at market peaks and underweighted at market lows - a formula for poor performance. The solution? Rebalance religiously and reap the long-term rewards.
5. Overconfidence in the Ability of Managers
From numerous studies, including Burton Malkiel's 1995 study entitled, "Returns From Investing In Equity Mutual Funds", we know that most managers will underperform their benchmarks. We also know that there's no consistent way to select - in advance - those managers that will outperform. We also know that very, very few individuals can profitably time the market over the long term. So why are so many investors confident of their abilities to time the market and select outperforming managers?
Fidelity guru Peter Lynch once observed, "There are no market timers in the 'Forbes' 400'." Investors' misplaced overconfidence in their ability to market-time and select outperforming managers leads directly to our next common investment mistake.
6. Not Enough Indexing
There is not enough time to recite many of the studies that prove that most managers and mutual funds underperform their benchmarks. Over the long-term, low-cost index funds are typically upper second-quartile performers, or better than 65-75% of actively managed funds.
Despite all the evidence in favor of indexing, the desire to invest with active managers remains strong. John Bogle, the founder of Vanguard, says it's because, "Hope springs eternal. Indexing is sort of dull. It flies in the face of the American way [that] 'I can do better.'"
Index all or a large portion (70-80%) of all your traditional asset classes. If you can't resist the excitement of pursuing the next great performer, set aside a portion (20-30%) of each asset class to allocate to active managers. This may satisfy your desire to pursue outperformance without devastating your portfolio.
7. Chasing Performance
Many investors select asset classes, strategies, managers and funds based on recent strong performance. The feeling that "I'm missing out on great returns" has probably led to more bad investment decisions than any other single factor. If a particular asset class, strategy or fund has done extremely well for three or four years, we know one thing with certainty: We should have invested three or four years ago. Now, however, the particular cycle that led to this great performance may be nearing its end. The smart money is moving out, and the dumb money is pouring in. Stick with your investment plan and rebalance, which is the polar opposite of chasing performance.
Conclusion
Investors who recognize and avoid these seven common mistakes give themselves a great advantage in meeting their investment goals. Most of the solutions above are not exciting, and they don't make great cocktail party conversation. However, they are likely to be profitable. And isn't that why we really invest?
Cover Letter Kills
Many job seekers question whether or not they should send a cover letter with their resume. It's a question that's up for debate between job search professionals, and you'll receive conflicting advice everywhere.
People skip the cover letter because they think that companies don't read them and that they are a waste of time to write. While it is true that some hiring managers and recruiters won't take the time to read a cover letter, plenty of companies do consider one necessary for a candidate to receive serious consideration. Not sending a cover letter for a position could be a risky move, so if you are extremely interested in the position for which you're applying, your best bet is to include one.
Think of your cover letter (or introductory letter) as a high-level overview of your resume and an additional tool to elaborate any specific information. It provides you with the opportunity to highlight your strengths and answer any possible objections up front. Focus the content on the specific skills that the job description mentions so that the hiring manager knows right away that you fit her criteria. Once you've covered that and have gained the reader's attention, you can use it fill in any details that might not fit on or be appropriate for your resume.
For example, if you are applying for a job that requires French language skills, it might not be fitting to mention in your resume that you lived in France for a few years as a teenager with your family, but your cover letter is the perfect place to tell that story.
If you foresee any obstacles, such as in the case of applying for a job out of state, mention them in your letter. Let's say you are applying for a job in New York City and live in Utah, but plan to move to New York soon; let the company rep know so she doesn't feel like you're looking for a relocation package. If you are planning on being in the region where you are applying for jobs, make sure you include this early on in your cover letter.
Successful Cover Letters
There's no single formula for success when it comes to writing a stellar cover letter, but you can be sure that the more unique and creative your cover letter, the more attention it will get. A quick cut and paste job changing the title of the position won't cut it. The meat of the cover letter should be customized for the specific position using the job description and your knowledge of the company as a guide about what to cover in the introduction.
Relate your experience to the job description. The best cover letters should leave the reader with the desire to call you to come in for an interview before even opening your resume.
Keep the letter relatively short. It's an introduction to you and your resume, so three to five paragraphs should suffice. Resist the temptation of writing a full page (or more) to get in all of the great things about you; it's better to keep some of that for the interview.
Address your letter to the hiring manager, and if at all possible, get his or her name. A personalized letter is much better than one addressed "To Whom It May Concern."
What to Include
--Start your letter by identifying the position you are interested in and where you found it (this is unnecessary if you are applying through a job site directly). If the company is hiring for more than one position that you're interested in and qualified for, specify which ones. Only choose the positions for which you are a close enough fit. Otherwise, your search comes across as unfocused.
--Provide three outstanding reasons why you are ideal for the job. It's not enough to say, "I'm the perfect fit for this role." Instead, you should back it up with examples. Refer back to the job description to align what you focus on with the responsibilities and challenges of the position.
--Bullet points or a table to match your background to the requirements works well to highlight your three main points. They're visually easy to skim, and they show the reader where her eyes should focus. Stick to just three (maybe four) points, rather than a long list. Your resume should answer the rest.
--Don't forget your contact information! Provide both your e-mail address and your phone number, as well as any links to your portfolio or samples of your work.
And finally, don't be too stuffy. Yes, your letter should be professional, but it should also show your personality. Be relaxed in your letter, and don't be afraid to toot your own horn. Sometimes the job description can give you an idea of the company's formality. If the description is a bit off the wall and personable, respond in a similar tone. On the other hand, if the job description is very stilted and formal, a more traditional letter may appeal more to the reader.
People skip the cover letter because they think that companies don't read them and that they are a waste of time to write. While it is true that some hiring managers and recruiters won't take the time to read a cover letter, plenty of companies do consider one necessary for a candidate to receive serious consideration. Not sending a cover letter for a position could be a risky move, so if you are extremely interested in the position for which you're applying, your best bet is to include one.
Think of your cover letter (or introductory letter) as a high-level overview of your resume and an additional tool to elaborate any specific information. It provides you with the opportunity to highlight your strengths and answer any possible objections up front. Focus the content on the specific skills that the job description mentions so that the hiring manager knows right away that you fit her criteria. Once you've covered that and have gained the reader's attention, you can use it fill in any details that might not fit on or be appropriate for your resume.
For example, if you are applying for a job that requires French language skills, it might not be fitting to mention in your resume that you lived in France for a few years as a teenager with your family, but your cover letter is the perfect place to tell that story.
If you foresee any obstacles, such as in the case of applying for a job out of state, mention them in your letter. Let's say you are applying for a job in New York City and live in Utah, but plan to move to New York soon; let the company rep know so she doesn't feel like you're looking for a relocation package. If you are planning on being in the region where you are applying for jobs, make sure you include this early on in your cover letter.
Successful Cover Letters
There's no single formula for success when it comes to writing a stellar cover letter, but you can be sure that the more unique and creative your cover letter, the more attention it will get. A quick cut and paste job changing the title of the position won't cut it. The meat of the cover letter should be customized for the specific position using the job description and your knowledge of the company as a guide about what to cover in the introduction.
Relate your experience to the job description. The best cover letters should leave the reader with the desire to call you to come in for an interview before even opening your resume.
Keep the letter relatively short. It's an introduction to you and your resume, so three to five paragraphs should suffice. Resist the temptation of writing a full page (or more) to get in all of the great things about you; it's better to keep some of that for the interview.
Address your letter to the hiring manager, and if at all possible, get his or her name. A personalized letter is much better than one addressed "To Whom It May Concern."
What to Include
--Start your letter by identifying the position you are interested in and where you found it (this is unnecessary if you are applying through a job site directly). If the company is hiring for more than one position that you're interested in and qualified for, specify which ones. Only choose the positions for which you are a close enough fit. Otherwise, your search comes across as unfocused.
--Provide three outstanding reasons why you are ideal for the job. It's not enough to say, "I'm the perfect fit for this role." Instead, you should back it up with examples. Refer back to the job description to align what you focus on with the responsibilities and challenges of the position.
--Bullet points or a table to match your background to the requirements works well to highlight your three main points. They're visually easy to skim, and they show the reader where her eyes should focus. Stick to just three (maybe four) points, rather than a long list. Your resume should answer the rest.
--Don't forget your contact information! Provide both your e-mail address and your phone number, as well as any links to your portfolio or samples of your work.
And finally, don't be too stuffy. Yes, your letter should be professional, but it should also show your personality. Be relaxed in your letter, and don't be afraid to toot your own horn. Sometimes the job description can give you an idea of the company's formality. If the description is a bit off the wall and personable, respond in a similar tone. On the other hand, if the job description is very stilted and formal, a more traditional letter may appeal more to the reader.
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