The number one question to ask because in these troubled times (see GM) any company can go out of business at any moment. And there is no comfort in bigness (see GM). Investing in stocks is risky (see GM). If you can't afford to lose money you invest, then don't invest. It's better to save that money until you have enough to be able to invest with some of it so that the loss of the funds, or a partial loss, won't affect your lifestyle.
2. Have I done enough research on a stock to buy it?
Most investors will research a stock by looking at a few data points, then pull the trigger. Or they'll hear a recommendation from a screaming head on television and decide, because of the emphasis of the recommendation, that it must be the right stock to own, regardless of its risk profile. One time, at least once, but this one is well documented, a talking head on a financial show was recommending a stock at the same time his fund was selling it. He lost his job.
On the other side of this type of research is the paralysis by analysis. Some investors can never do enough digging, never find enough data points, never get comfortable with the idea of buying anything because they feel they just don't know enough. These investors aren't. They're researchers. Clearly, both of these methods are sure way to own losers or nothing at all.
Between these extremes lies the best investor. The one who does due diligence not only on a company but also on the industry, one who knows as much as is publicly available and buys only when a stock's price gets to a level where he/she is comfortable owning it. They read books on investing and understand fundamentals such as ratios of a stock, the ones that make for success. These are the successful investors, and because this takes much more work than most are willing to expend, they are few and far between.
3. Am I building a portfolio to diversify risk and build wealth?
Many investors simply buy stocks with a great deal of hope and slowly watch it fade as the price goes lower and lower until finally they sell out of desperation or complete exhaustion. Good investors don't let one stock or one industry rule the portfolio. No one stock is so significant that it will cause loss of sleep. That doesn't mean there aren't some risky investments (ones made after solid stocks are already in place). It does mean that each stock is bought with an overall picture of a portfolio being built over time that will produce capital gains and income without too much risk.
4. If I could only buy 10 stocks, would this be one of them?
This question makes you stop in your tracks. Imagine that resources were finite (which they are), and you had to carefully allocate each stock purchase. Is the stock you're considering worthy of inclusion in a portfolio that only contained 10 stocks? Is it the best in its industry? Is the industry growing? While you can buy as many stocks as you wish, if you could only buy 10, you would buy each with a great deal of deliberation and due diligence. Pretend you can only buy 10 and see how much more demanding that makes you as an investor, how much clearer it makes you think.
5. Why do I own this stock?
Another powerful question, especially for stocks that you've owned for years, have gone down in price, and are only in the portfolio because you feel there is some hope for.....something. Most stocks are bought with an eye for the future: more earnings, a special contract, FDA approval, something that will make the stock price go higher than where you bought it. If you own stocks that are what I call "catalyst" stocks, and the catalyst never happened, most likely these stocks will be dead in the water for a long time. Other investors bought the stock for the same reason and when the event didn't happen, they sold. They most likely won't be back to buy again in the hope that something good will happen. They've been burned once and since there are so many other possible investments, this stock will fade from their radar screens. Other investors who didn't buy the stock before the disappointment will most likely not go near it either since the company didn't deliver. That only leaves you and few others holding onto a stock that will need a new catalyst or fantastic earnings to motivate buyers to come back into it.
Stocks that are bought with a good earnings stream that stop due to higher interest rates or a slowing economy (sound familiar) suffer the same fate. When earnings stop growing, investors bale. If you don't, you'll feel very lonely as the stock price continually goes lower.
Take a hard look at each stock you own. Why is it in your portfolio? Does it still belong? If it's not earning its keep by going up in price or paying a good dividend, then it better have a great bit of news pending or better earnings on the near horizon or it's going to continue to disappoint. Get rid of your losers, take the losses and move on. Your new stocks (that you've researched well) will make you forget as they climb up each quarter with good earnings. Your losers will quickly fade in your memory, to the point that you won't remember their symbols.
Ted Allrich is the founder of The Online Investor, chairman of the board of Bank of Internet USA, as well as the author of the book "Comfort Zone Investing: Build Wealth and Sleep Well at Night." In this weekly column, he'll offer advice to investors who are just getting started.