Of all the major asset classes, stocks have consistently delivered the highest return over the longest period of time. It is critical for you to understand basic information about stocks if you want to achieve better returns than those yielded by long-term bonds and cash. This section will give you a basic understanding of how and why stocks perform the way they do. This section will also help you understand why you should consider stocks or stock mutual funds when building your portfolio.

Before I begin the discussion of stocks, I reiterate three important principles of successful investing discussed earlier which have implications for investing in stocks. First, Principle 3: Stay Diversified. Diversification is your best defense against risk. When investing in stocks, do not invest in individual stocks but in portfolios’ of stocks. Investing is risky and uncertain: minimize risk by diversifying your stock holdings by investing in index funds, ETFs, or diversified mutual funds. 

Second, Principle 6: use caution if you are investing in individual assets. The fastest way to get rich and poor, depending on your luck, is investing in individual stocks. If you must invest in individual assets (and this is not a given), know what you are investing in. Do your homework. Spend time learning about the company, its financial statements, its management, its short- and long-term strategy, its domestic and global industry, and its competition. Note that I emphasize that this section on Stock Basics is not sufficient background information to enable you to invest wisely in individual assets. I strongly recommend that you invest in index or mutual funds that have many hundreds of individual assets instead of investing in individual stocks.

Finally, Principle 8: Do Not Waste Too Much Time and Energy Trying to Beat the Market. It is very difficult, expensive, and time-consuming to beat the market (to gain returns in excess of the returns on the major asset classes). While it may be possible to beat the market on a short-term basis, it is very difficult to consistently beat the market on a long-term basis. This section on Stock Basics advocates education and learning by investing in index and mutual funds, rather than investing in individual stocks.