Since mid-March, the S&P 500 is up almost 58% and the Dow Jones Industrial Average is up almost as much. If you opened your retirement savings at the end of the first quarter this year and looked at the numbers with a cringe, it’s likely that if you looked at the numbers right now, you’d feel significantly better.

Why the big rebound? To put it simply, the greater world finally realized that the only thing we had to fear was fear itself. The economy didn’t collapse. Instead, we just find ourselves in the middle of – and perhaps moving towards the later stages of – a rather strong recession.

Naturally, as the economy begins to slowly come out of a recession, the stock market goes gangbusters. Companies are beginning to reawaken and slowly increase production, a radically different picture than the massive cost cutting of the past year. Unemployment is somewhat stable – it might go up a little more, but it’s no longer on the rocket ship that it once was.

In short, we’re getting through this and we see sunlight at the end of the tunnel.

What does this mean for you and me, as small individual investors? Does this mean we should convert all of our investments into stocks and ride the rocket ship?

To put it simply, no, it doesn’t.

Hedging your long-term investments on what you think the stock market (or any investment market) is going to do in the short term is called market timing, and it’s never a good idea.

My philosophy is simple, and it’s one that was taught to me by many, many wise investment writers and investment books: unless you’re a day trader or spend a significant amount of time daily studying the stock market, you’re a long term investor, and long term investors have nothing to gain from trying to time the market.

Simply put, the vagaries and complexities and huge sums dealt with on the stock market each and every day, with so much insider information floating around and individuals playing all kinds of manipulative gains, plus the total uncertainty of day-to-day world events (if you recall, for example, 9/11 was wholly unexpected), makes it a very unsafe place for the typical person trying to save for retirement or for another long term goal. Instead, their reward is to simply look at the stock market as a long term place to put their money for a long term investment with a payoff date more than ten years down the road.

It’s all about your goals and your risk tolerance. It has nothing to do with what’s going on today, tomorrow, or next week.

Don’t let yourself be swayed by huge positive returns in the short term – or huge negative returns in the short term, either. Just stay the course with what you’re doing. If you find that the stress of such swings makes you nervous, redirect your future contributions to something with lower risk, like bonds.

Otherwise, just let things ride. Tomorrow might bring a huge unexpected event that we can’t see coming – or that some CEO is keeping under wraps for now. Given time, the stock market will correct itself from that, but over the short term, it’s basically little more than gambling unless you have the time and resources to devote yourself to truly careful study – or you’re investing with a small sliver of your portfolio that’s there solely to play around with.

One aspect of buy-and-hold investing in low-cost index funds that has always attracted me is that there is an extremely low time cost. Once you have the initial investments in place, there is virtually no time cost at all. All you have to do is invest maybe half an hour a year rebalancing the investments – and that’s it.

That strategy pretty much matches the stock market. In fact, if you choose to just invest in the Vanguard 500, it almost exactly matches the ups and downs of the S&P 500 stock index.

Let’s look at the other side of the coin. Let’s say you’re following normal stock picking advice. You have a portfolio of 20 individual stocks (so that no piece of your portfolio is more than 5% of your total investment – diversification, after all). You devote an hour a week to studying each stock in detail, so you know what’s going on with that company. You also devote five hours a week to finding new, worthwhile companies to invest in, potentially replacing the slots in your portfolio.

You’re able to invest $10,000 a year – and we’re not worried about brokerage fees at all. What’s your earnings per hour doing all that research?

Let’s say all that work manages to beat the Vanguard 500 by 1% per year. Historically, VFINX has returned 9.56% per year since its inception (remember, that number includes dividends and stock price increases and decreases, and it does include 2008), so we’ll use that number as an annual return baseline.

Over a ten year period, VFINX would turn your $10,000 a year into a sum total of $170,968.66. Meanwhile, that portfolio that beats the S&P 500 by 1% would turn $10,000 a year into a sum total of $181,005.77. Your extra effort of 25 hours a week for ten years has earned you $10,037.11 during that period – an hourly wage of $0.77. Ouch.

“Come on!” you say. “Stocks are a long term investment!” So let’s look at the thirty year mark. Over a thirty year period, VFINX would turn your $10,000 a year into a sum total of $1,061,590.42. Similarly, your 1% better investment portfolio, with 25 hours a week over ten years invested in it, will turn that annual $10,000 into $1,347,885.59. Your extra effort of 25 hours a week for thirty years has earned you $286,295.18 – an hourly wage of $7.34. Congratulations, your investing expertise has earned you minimum wage.

“Come on!” you say. “I can do better than 1% over the S&P 500 every year for thirty years!” (Of course, if you actually believe that, I have a bridge to sell you.) So let’s make it 2% – you beat the S&P 500 by 2% every year for thirty years. Your extra effort for 25 hours a week for thirty years earns you an hourly wage of $16.60.

If you have the intellectual ability to do enough rigorous analysis to beat the market by 2% year in and year out, you can most certainly be earning more than $16.60 an hour with your time.

But what if you can invest more than $10,000 a year? If you’re in that group, where you’re able to invest significantly more than $10,000 a year in whatever you want and you’re sure you can beat the market consistently over the long haul, by all means, choose the route that’s right for you. However, I argue the statement above still holds – with those kinds of resources and intellectual acumen, you likely have better ways to earn money.

Here’s the take-home message: individual stock investing, done with adequate research, is a lot of work. Unless you have a very large amount to invest, the extra work is simply not worth it in terms of the extra income per hour.

Now, that’s not to say that you shouldn’t dabble in individual stock investing. I see nothing wrong with taking a sliver of your investments and playing the market, so to speak. However, recognize that such investments are largely a gamble unless you do adequate research. And, if you do adequate research, you have to blow away the overall market to make it worth your time.

My conclusion is simple. If you’re an individual investor without a ton of money to invest, it’s simply not worth your time to chase individual stocks. The time that’s required to adequately study individual stocks and build a truly diverse portfolio will make the gains small enough per hour of your work that you might as well do something else with your time, like build your skill set for your career, improve your health, or start your own side business.

Instead, just invest in a very broad index fund and ride the market at a low price with little time investment of your own. Better yet, do it with a balanced portfolio – don’t put it all into stocks, so that you can ride through the down markets with less worry and smaller losses.

Ada writes in:

Like you, I think the stock market is near the bottom right now and will go up greatly in the next three to five years. I have some extra cash (about $10K) but I don’t know exactly what to do with it to get on board. How would you do it?

In fact, I’m already doing it. My wife and I made the decision to start investing much of our long-term savings for a home into stocks because we both feel that the market is at the bottom right now and is poised for a big rebound in the next five to ten years.

So, what are we doing?

What Are We Investing In?
Most of our investment is going into index funds. For those unaware, index funds are a way to invest in a lot of stocks at once at a cheap price. A given index fund is usually governed by a simple rule – all stocks in the S&P 500, for example. Index funds have long been lauded as a great way to easily diversify at a very cheap cost.

We’re investing all of our money equally into two funds – the Vanguard Total Stock Market Index (which basically covers all domestic stocks) and the Vanguard Total International Stock Index (which broadly covers all international markets). In other words, the money is as diverse as we can make it.

At the same time, there are a number of individual companies that my wife and I particularly believe in for one reason or another (Apple being one, for example). While we both recognize that individual stock investing is a risky proposition, we also know that our investment choices reflect the things we believe in.

So, we’re allocating a small portion of our overall investment into a diversity of individual stocks – 20, to be exact. Each month, we’re automatically investing a small amount into each of these twenty stocks. Our investment amount in individual stocks is about 25% of the amount we’re putting into index funds.

Who Are We Investing With?
Our index fund investments are handled by Vanguard. We’ve trusted them for years – they’re known for their low-cost index funds and their reliability, which is exactly what we want. They’re also managing my Roth IRA, which they’ve done quite well.

Our individual stocks are being managed by Sharebuilder, which we decided on after a fair amount of hand-wringing. Their automatic investment plans were simple and reasonably priced (without any of the factors that made us nervous about the few brokers that undercut Sharebuilder in price), plus we weren’t restricted in our investment choices (as many of the companies we wanted to invest in didn’t have direct plans for investing). Since we’re planning on just doing automatic investing until the time comes that we actually need the money and then we’ll sell all of it (no market timing here), the actual management of the money for tax purposes will be pretty straightforward, too.

Isn’t This Risky?
Undoubtedly it is. That’s why we’re not putting any of our emergency fund, any of our retirement, or any of our short-term saving goals at risk. The money we’re investing here is money that we will only tap in the long term (ten or fifteen years or so) for the place in the country we’ve always dreamed of. Ideally, the stock market will help take us there a bit quicker than we might be able to otherwise, but if it doesn’t work, we’ve not really risked anything that affects our day-to-day lives, then or now.

Also, this plan merely reflects what we’re doing. You might want to be more conservative with your own savings for long term goals like this, and you certainly wouldn’t want to do anything like this with money you will need to rely on in the future.

We’re only able to start doing things like this because we’ve cut our spending drastically over time and we live by a mantra of spending less than we earn. Because of that, we can now make choices like this, paving the way to our dreams.

A few days ago, I had the opportunity to sit down with a fellow in his early sixties who has already retired. He had been self-employed his entire life. I told him about The Simple Dollar and I asked him, if he didn’t mind, if he would tell me about how he had invested for retirement.

What he told me boiled down to four principles.

I spend way less than I earn. By this, he meant he had enough saved up at age fifty to walk away from his work, but he kept at it for several more years so that he could build up even more savings. He wanted the investments to return substantially more each year than he would spend.

I keep a years’ worth of living expenses in cash and CDs. This isn’t just an emergency fund, but it helps him do okay through the ups and downs of his other investments. If they don’t return as well as he’d like for a quarter or two, things aren’t disastrous – he still has a lot of breathing room.

I roll the excess back into my investments. Whenever he starts to build up way more than a year’s worth of savings, he rolls it into more investments. He keeps pretty careful track of his spending and thus has a strong estimate of the year to come. If the amount in cash and CDs gets over fifteen months worth of living expenses or so, he cuts it down to twelve months worth and puts that difference into his investments. And what are they?

All of the rest of my money is in stocks which pay a good dividend. All he does is buy stocks in companies he believes in over the long haul that pays good dividends. He rattled off quite a number of stocks, but the four I remembered were GE, AT&T, Verizon, and Bank of America.

So how does that work? Let’s take a look at AT&T (Google Finance). As I write this, a share of AT&T is at 24.83 and has a dividend of 0.40. What that means is that every three months, for each share of AT&T that a person holds, AT&T pays that person $0.40.

So, let’s say that over time, our friend has bought 1,000 shares of AT&T – at today’s market prices, that would have cost him just short of $25,000. This means that every three months this year, AT&T is directly going to pay him $400. Over the course of a year, that would have added up to $1,600. And if that dividend holds, over ten years, the investment would pay out $16,000.

Obviously, the board of directors of a company can choose to raise or lower a company’s dividends – here’s a recent history of AT&T dividends. That’s why our friend chooses to buy only stable companies that have a long history of paying good dividends.

What about the stock price? Aren’t stocks tanking? For the most part, our friend doesn’t care about the stock price. All he cares about is the dividend – as long as it stays reasonable, it doesn’t matter to him how much or how little the stock can sell for. He intends to hold it for a very, very long time.

In fact, he’s actually ecstatic about the low prices on many stocks. He’s about to buy more of his dividend-earning stocks and given the low market, he can get more shares for his dollar right now.

Is this a good investing strategy for me? Provided that you’re willing to have a diverse selection of dividend-paying stocks (more than 10 with no more than 20% of your money in any individual company or any sector) and you’re willing to pay attention to it so you don’t end up holding a company as it falls down the Enron drain, this strategy can work. It’s often discussed in investing books as “dividend investing” and can work very well for you, not only as a retirement plan, but as a way to build steady income.

Do you want to know more? My friend strongly recommended that I read The Ultimate Dividend Playbook, a book produced by Morningstar that covers dividend investing in detail. I can certainly say I’m intrigued, and I’ve added the book to my to-be-read pile.

This is the second in a weekly series of articles providing a chapter-by-chapter in-depth “book club” reading of Benjamin Graham’s investing classic The Intelligent Investor. Warren Buffett describes this book: “I read the first edition of this book early in 1950, when I was nineteen. I thought then that it was by far the best book about investing ever written. I still think it is.” I’m reading from the 2003 HarperBusiness Essentials paperback edition. This entry covers the first chapter, which is on pages 18 to 34, and the Jason Zweig commentary, on pages 35 to 46.

I have a friend who keeps cajoling me that I should become a day trader. “Come on!” he says. “You could write the stuff for The Simple Dollar while daytrading! It’s easy as pie!”

So one day I asked him to explain to me what he was doing. He offered up a bunch of explanations that basically amounted to technical analysis using a bunch of online tools.

Then I asked the $64,000 question: “Do you actually know anything about the companies whose stocks you’re buying and selling?” He responds, “Not too much, but I don’t need to.”

My friend is a speculator. That’s fine – it works for him. But it only works because he devotes his life to figuring out small inefficiencies in the market. He’s really passionate about finding them.

For most of us, though, we don’t have the time, patience, or interest to engage in that minutiae. We are investors.

Chapter 1 – Investment Versus Speculation: Results to Be Expected by the Intelligent Investor
Graham gets down to business. In only the second paragraph of the chapter, he specifies the difference between investors and speculators:

An investment operation is one which, upon thorough analysis promises safety of principal and an adequate return. Operations not meeting these requirements are speculative.

In Graham’s view, an investment is something that you’ve analyzed carefully. You know exactly what you’re buying. You know it’s stable for the long haul. You also know that it will give you an adequate return, either through an increase in share value or through healthy dividends for the price you pay.

The ones that scream “BUY! BUY! BUY! WE’RE ALL GETTING RICH!” when the stock market is high and then scream “SELL! SELL! WE’RE ALL GOING BANKRUPT!” when the market is low are speculators. The people that look for undervalued companies no matter what the market is doing, buy them, then only sell them if they actually need the money or if they’re not undervalued any more, those people are investors.

Graham argues that one of the biggest dangers for investors is that they’re speculating when they believe they’re investing. They buy a stock, for instance, based on a hot tip that, if true, might make it a good investment. Or they purchase a mutual fund based on a television ad or magazine ad, without really doing the due diligence to see whether it’s a quality investment based on sound principles that ensures quite a bit of safety in the investment and some sort of decent return.

Furthermore, Graham states that the only way you can be an investor (and not a speculator) that beats the market is by having an investment philosophy that’s based on sound logic that’s not popular on Wall Street at the moment.

I immediately thought of Jim Cramer’s comment on Graham during the peak of the 2000 stock market bubble, which Zweig mentioned in his commentary in the introduction:

In February 2000, hedge-fund manager James J. Cramer proclaimed that Internet-related companies “are the only ones worth owning right now.” These “winners of the new world,” as he called them, “are the only ones that are going higher consistently in good days and bad.” Cramer even took a potshot at Graham: “You have to throw out all of the matrices and formulas and texts that existed before the Web … If we used any of what Graham and Dodd teach us, we wouldn’t have a dime under management.”

[...]

By year-end 2002, [...] a $10,000 investment spread equally across Cramer’s picks would have lost 94%, leaving you with a grand total of $597.44.

Interestingly, most of the internet stocks during the dot com bubble wouldn’t have passed the Graham test. Not even close. Score one for the unpopular method.

So, what can we learn here? Don’t invest without knowing what you’re buying. Study it very carefully before you buy. If you want to speculate, that’s fine, but don’t speculate with any money you’ll actually need for the future.

Commentary on Chapter 1
Zweig does a good job of boiling down Graham’s view on what investment is, summarizing it in three points:

* you must thoroughly analyze a company, and the soundness of the underlying businesses, before you buy its stock;
* you must deliberately protect yourself against serious losses;
* you must aspire to “adequate,” not extraordinary, performance.

If you want an absurd return that’s going to blow away the market over the short term, value investing probably isn’t for you. Having said that, though, Graham’s principles are intended to avoid huge losses as well. That’s because the entire idea is to seek out undervalued companies – ones that, for some reason, the market has overlooked. Maybe they’re boring. Maybe they have an undeserved bad reputation.

Zweig makes that point again a bit later:

If they beat the market over any period, no matter how dangerous or dumb their tactics, people boasted that they were “right.” But the intelligent investor has no interest in being temporarily right.

In short, investing fads are a joke. Just a few weeks ago, I scathed the book Millionaire by Thirty because it was just that – an investing fad with short term success that the author tried to parlay into this great investing strategy that was timeless. It wasn’t. Zweig points out at least a dozen more similar investing fads or shortcut formulas, all of which worked over the short term, and none of which work over the long term.

What does work, then? Knowing in detail what you’re investing in. Is it a good, stable, safe company? Is it undervalued? Does it pay solid dividends? Those are where the real values are at. They’re not glamorous, but if you can find them, you’ll always do well, no matter how the market changes.

Next Friday, we’ll look at Chapter 2: The Investor and Inflation.

Over the last three or four days, I’ve received a bunch of emails from readers asking me why I’m not talking breathlessly about the chaos at Freddie Mac, Fannie Mae, and IndyMac. I’ve read dozens of long explanations of why this is disastrous and why it’s the worst thing people have ever seen, and I’ve read many, many people shouting that they should completely get out of all investments right now and put their cash in a little green box buried in their back yard (or some similar crazy scheme).

Here’s my take: I think there’s almost nothing to worry about, and if you’re actively selling any broad investments right now, you’re actually making a giant mistake.

Here are five reasons why you shouldn’t be panicking right now.

One: Panics happen every few years
Right now, we’re having panics in the banking and housing sectors. A few years ago, corporate accounting was destroying everything. Remember the tech sector collapse of half a decade ago? The savings and loan failures before that?

These booms and busts happen for one reason and one reason alone: most investors are sheep. They follow whatever has been hot lately, and they run away whenever there’s a bad sign. These processes are rarely rational – in the 1630s, people bet their entire life fortunes on tulips.

It took only a glance at housing prices over the last decade or so to see that there was a big bubble going on. This bubble turned out to be mixed in with the banking industry which was funding this bubble. Now we’re seeing that bubble collapse. In a few years, when all of those ARMs adjust, people will be running around yelling “PANIC” about some other sector.

Two: The talking heads shouting “PANIC!” make money from “PANIC!”
If you run out right now and sell your stock, guess who makes money? That’s right, brokers and fund managers. These people want churn. They want you to buy and sell so they can make profit on the buying and the selling. The people who are on CNBC and TheStreet.com shouting “PANIC!”

If I was a broker or an investment manager and I knew that if I shouted “PANIC!” I could make myself a mint, I’d be tempted to shout “PANIC!” I probably wouldn’t do that because it would actually not help my clients, but there are other philosophies out there. Some believe that alerting their clients to “PANIC!” can help them avoid losses. Others could actually care less about the clients and just want to profit.

There’s big money to be made in “PANIC!”

Three: Stocks are not short term investments
Unless you’re day trading (and thus making an effective career out of very short term movements), stock investments should never be short term investments. The stock market is extremely volatile over the short term – annual losses of 20% or more in stock investments are somewhat regular occurrences.

So why invest in stocks? Over the long run, the gains exceed the losses over the stock market as a whole. Here’s a quote from David Swenson, the author of the excellent book Unconventional Success:

To the extent that history provides a guide, the long-term returns for stocks encourage investors to own stocks. Jeremy Siegel’s two hundred years of data show U.S. stocks earning 8.3 percent per annum, while Roger Ibbotson’s seventy-eight years of data show stocks earning 10.4 percent per annum. No other asset class possesses such an impressive record of long-term performance.

The stock market returns very well on average. The only problem is that it’s an average of some very nice positive numbers and some very painful negative numbers – that’s the nature of an open market.

Why should one believe the stock market is going to go up in value? THIS IS THE END! Stocks will continue to go up in value over the long term for one simple reason: worker productivity. Companies over time will earn more money per employee because each employee is able to produce more value. As long as humans are innovative creatures, coming up with new technologies and ideas, then companies that implement those ideas will increase in value.

Four: Down markets are never a time to sell
At some point, the stock market will return to its previous level – there has never been a twenty year period of loss in the overall stock market.

Since the stock market is down this year, and we believe that the stock market will eventually match the previous high, now is not the time to sell. Now is the time to buy.

Let’s look at it visually using the S&P 500 from about 2000 to about 2007:

Obviously, it’s great to sell at the top – you’ll make a killing. The problem is that one never knows exactly where the top is. The market will start to drift downward and many people will think it a normal fluctuation. After a while, the talking heads on CNBC and other financial papers will begin to notice that it’s going downward and start shouting “BEAR! BEAR!” to get people to “SELL! SELL!” so they can make a profit on transaction costs. Most people still don’t move right away – it takes a little while for the “panic” to build.

Eventually (as marked above), it becomes conventional wisdom that things are disastrous – that’s where we’re at now, well into the down trend. Now, if we believe that at some point in the future things will eventually return to their original level and we can clearly see that things are way down from their original level … why would you sell? Instead, it looks like a time to buy to me.

Five: If this event is making you worried about losing everything, then you’re not appropriately diversified.
My last point is for those people who have a ton of money in the damaged sectors right now. If you’re afraid that you’re going to be losing “everything” in this down situation, then the problem isn’t the stock market. It’s your investment strategy.

Diversification is what saves you from a bubble blowing up in a particular sector. Many advisors suggest having 5% of your total assets or less in any one sector simply to a void this. That way, even if one sector loses everything, you lose at most 5% of your money – a 20% drop in one sector means only an overall 1% loss for you.

In other words, don’t put all of your eggs in one basket and you won’t panic quite so much when a basket falls to the floor.

Throughout all of this tumult, I’ve lost a fair amount of money in my retirement account. Right now, I’m contributing significantly more money per week than I was three months ago. And I feel fine. I hope you do, too.

In the reader mailbag yesterday, I alluded to the idea that I would only buy individual stocks from companies that I was strongly familiar with and whose products I used myself and not only trusted, but that I found enough value in that I would laud them to others. In other words, I’m a big believer in “buy what you know.”

Unsurprisingly, several people wrote to me asking what stocks I was referring to, and so I’ve decided to list out the seven-stock portfolio I’ve been keeping my eye on for the last several months. These are the seven stocks I would invest my money in if I were going to invest in individual stocks. At some point, I will pull the trigger and do this, likely using a buy and hold strategy and allowing all of the stocks together to comprise about 10% of my overall investments, but I’m going to assemble a strong index fund portfolio first.

Here are the seven single stocks I’d buy, likely in equal amounts. I’d buy and hold each of these unless something dramatically changed about the company – in particular, if I lost confidence in the company’s products. Together, the companies are a diverse portfolio (all are in different industries) with a few traits in common – all of them have strong products that provide value to me personally, all are financially stable and have clear plans for the future, and most of them are among the most ethical companies – three appear on Ethisphere’s list of the world’s most ethical companies in 2008.

This is not investing advice. I’m merely listing the companies I would invest in and why, in hopes that you might understand my decision-making process and perhaps add something to your own decision-making process when it comes to stock investing. I’m also not looking to day trade – I want to buy and hold over a long period of time. I also tend to lean more towards companies who behave ethically while producing products I believe in instead of the investment that will quickly maximize my buck.

Here goes.

Herman Miller (MLHR)
If I were to invest my stock in one company, it would be Herman Miller. Herman Miller is a furniture manufacturer that focuses on office chairs, and they do superb and environmentally friendly work. I own one of their Aeron chairs, and it’s simply one of the most elegantly and superbly constructed items I’ve ever owned. I was introduced to their chairs in the workplace and was so genuinely impressed that I eventually purchased one of my own – and I began carefully following the company as well. Their chairs are ecologically sound as is their factory and they’re one of the most admired companies in America, placing at the top of Fortune’s list of admired furniture companies for the past eighteen years. Their business model is stable and the business is steadily expanding, so I’m on board for the long haul.

ING Groep (ING)
For those of you who have heard me talk positively about both ING Direct and Sharebuilder on this site, this shouldn’t come as a surprise. I’ve used many different online banks and found ING Direct to be by far the most usable, and aside from Vanguard, I’ve had the easiest time with Sharebuilder for brokerage needs. The business is growing rapidly while their stock price has held largely steady, indicating to me that the company is on very solid ground financially for the long haul. A happy customer plus a solid financial standing equals a company I’ll bet on for the long haul.

Apple (AAPL)
If there’s a “bet” on this list, it’s on Apple, who produce computer products that I rely on every day. As I type this, I’m using a Mac and I’d hesitate to say that I’d ever want to go back to using a PC ever again. It’s stable, incredibly user friendly, and reliable. Their product design all around is impeccable and their sales are growing like gangbusters. The biggest reason this feels like a bet to me is that I feel like more than almost every other company, the strength of Apple is tied to its leader, Steve Jobs. I follow Apple pretty closely and I just don’t see anyone waiting in the wings, which is worrisome because of the “cult of personality” leadership at Apple. If Steve goes, I fear Apple may stumble, which is a worry over the long haul. But for now, I’m incredibly pleased with their product and their company is clearly on the right track.

Honda (HMC)
I have a lot of faith in both Honda and Toyota as car manufacturers, and all of my research has pointed me towards them as the source for my next car purchase and my experience with both companies as a driver has been very positive. I give Honda the nod over Toyota (since I don’t want to invest in two car manufacturers) because I generally believe they’re thinking more long term and their product lines are more diverse. Honda’s revenue is heading upwards and they’re recognized for their business ethics.

Costco (COST)
If there were a Costco fairly close to me (the nearest one is in West Des Moines, simply too far away), I would happily be a regular customer. I am a frequent customer of Sam’s Club in my area and I prefer Costco for product selection and employee treatment reasons. Warehouse shopping is a concept I strongly support, especially when it’s paired with ethical treatment of employees and strong prices. As with the other companies on this list, their profits and revenues are steadily marching upwards while maintaining the ethical standards they’ve become known for.

UPS (UPS)
I like UPS because they work. I’ve had dozens of packages delivered to my home without a missed delivery (as compared to FedEx, which has an atrocious 0-for-2 record since my move) and occasional earlier than expected deliveries, plus I’ve never had any issues with shipping with them, either. Given their role as a large-scale delivery company, they’re heavily involved in improving fuel economy and moving towards green solutions with their GreenFleet, plus they’re committed to high ethical standards as part of their business model. Couple that with their steadily improving financial success and it’s clear why I’d buy and hold this company.

General Mills (GIS)
My final pick is probably surprising to some given my commitment to fresh foods, but their commitment to health-conscious food production in that they’ve switched to whole grains for all of their cereals (plus my son’s incessant love for Cheerios) has slowly won me over, as has their commitment to ethical business practices. I’ve been satisfied with their products as a customer, and their financial record is strong, which all adds up to a strong picture of the company as a whole, strong enough for me to pick the stock for buying and holding.

Steve wrote in with a good question recently:

What does it actually mean to own a stock? Do you own a piece of that company? Are you just gambling that you think a company’s value will go up or down? I guess I don’t really understand the stock market.

Steve asks a good question, so let’s take a simple walk through what exactly a stock is, what owning one means, and why a person would want to own a share of stock in a company.

What is a stock? The word “stock” refers to a share of ownership in a particular company. If you own a stock, you’re an owner of some very small fraction of that company. Take, for example, Exxon. Exxon has 5.28 billion shares of stock outstanding, meaning that they have divided ownership of their company into 5.28 billion pieces. Owning a single share of Exxon stock means that you own 0.0000000189% of Exxon. That’s a very tiny fraction, but Exxon is a huge company, so that little fraction has some value.

How much value does that one share have? Right now, that one share of Exxon stock is worth $90.70 (as of this writing). Shares of Exxon are traded on an open market, meaning buyers and sellers can both make offers and sales only occur when buyer and seller agree on a price, so that $90.70 is literally the dollar amount that someone recently agreed to sell a share of Exxon stock for and someone else agreed to buy it for. In other words, that’s the value that the public estimates a single share of Exxon stock to be worth.

Right now, Exxon’s stock is worth 90.70 per share, and thus with 5.28 billion shares outstanding, that means Exxon has a market capitalization of $479.23 billion. Market capitalization is the estimate of the total value of the company based on the number of shares out there and the value that the market places on each share.

Why would you want to own a share of Exxon? There are several reasons.

First, stocks pay dividends. Exxon pays an annual dividend of $1.60 per share. A dividend is a piece of the company’s profit that a company pays out to each shareholder. With 5.28 billion shares outstanding, Exxon paid out $8.448 billion in dividends total over the last year, meaning each shareholder got $1.60. That $8.448 billion is Exxon profit that they chose not to reinvest in the company and instead pay out to shareholders.

You also own a piece of whatever would be earned if the company decided to close up shop. Exxon has a book value per share of $23.31. That means if Exxon decided to quit the business and just sell all of their assets, the shareholders would get $23.31 per share. While that wouldn’t recoup the value of the stock purchase (it’s currently $90.70 per share), it is something.

Adding the two together and one can see that a share of stock does have some cash value. It generates dividends for you while the company is in business and has some value when the company goes out of business and sells off their assets.

Larger shareholders also usually gain some voting rights when it comes to making decisions about the company. Obviously, with Exxon, an individual shareholder owns such a small portion of the company that if they allowed each such holder to have voting rights, nothing would get done with the company. Thus, there’s usually some threshold that people have to cross before they have voting rights and get to participate in corporate decision making. With some companies, that comes in the form of special voting shares – only some shares allow you to actually vote. In other companies, if you own a small amount, you vote by proxy – you basically assign someone else to vote on your behalf.

So what does that value add up to? At the moment, $90.70. The stock market is basically a free-for-all of trading where buyers and sellers can quote whatever prices they want. The “value” of a stock is whatever the buyer and seller agree on as a fair price and the $90.70 value is a recently agreed-upon value between an individual buyer and an individual seller. Other buyers and sellers then use this as a thumbnail when deciding the value of the next trade – if Exxon has good news, then it might go up to $92. If something bad happens, it might go down to $88. If things are neutral, it’ll fluctuate a bit, but stay near that value.

The chaos you see on the floor of stock exchanges is basically the chaos of tons of these trades happening at once, with people running around trying to make it happen. Much of the activity happens electronically, too.

Thus, when you buy a stock, you’re buying a piece of a company. That piece pays you dividends and also indicates ownership of a small sliver of the assets of the company. This obviously has a value, and the stronger the company is (or is predicted to become), the more value it has. Ideally, you hope to re-sell it at a higher value than you bought it for – that requires the company to demonstrate that for whatever reason it’s stronger than it was before – but in the interim, you can collect dividends and wait until you’re ready to sell it. That decision point – when to sell – is the topic of countless investment books.

If I want to buy a stock, what’s the process? In its simplest form, you basically state a price you’re willing to buy a stock for and then seek out someone willing to sell it to you at that price – this is called a “limit order.” You can also issue a “market order,” which means you’ll buy the stock at whatever price the market is currently selling it for.

Most individual stock buyers and sellers go through a stockbroker. A stockbroker is an organization that actually participates in those exchanges (it’s rather expensive to get a seat on a stock exchange). An individual, like yourself, goes to a stockbroker and pays them a fee to use their resources to get that stock for you. They might own it themselves and be willing to sell it to you, or they might have to go buy it from someone else. Either way, your fee pays for this service (and their profit margin).

Alternatively, you can buy stocks directly from individual companies. This saves on the broker fees, but it means you deal with only one company at a time and it’s also somewhat difficult to sell the shares back to the company.

In a nutshell, brokers are much more convenient for both buying and selling, but they charge a fee for the service.

So what’s a mutual fund? A mutual fund is just a collection of stocks. A typical mutual fund has their stocks chosen by a fund manager and the fees with that fund go to pay the fund manager’s salary (and the salaries of anyone working for the manager). An index fund is a mutual fund without an active manager – it operates based on a clearly-specified set of rules that do not require active intervention. Thus, the fees for an index fund are much lower. Some people prefer having an actual person manage the fund; as for me, I’ll take the index fund almost every time.

Good luck, Steve. Once you have this basic info in hand, there’s an almost infinite amount of material to learn about the stock market.