What are "small, mid and large cap" stocks?

This refers simply to smaller, medium-size and larger companies: a successful regional chain of coffee shops compared against, say, an IBM. The term "cap" means market capitalization, or the market value of a publicly-traded firm's outstanding shares.

Small caps generally range between $300 million and $2 billion; mid from $2 billion to $10 billion; and large cap up to $200 billion. (There's even a "mega cap" category for the Exxons and Wal-Marts of this world – a very select handful.)

NOTE: Investors frequently misunderstand one very important point. A higher stock price does not necessarily connote a larger or "better" company. Stock price – alone – can misrepresent a company's actual market worth.

Let's say that two large cap companies have stock prices of $29 and $22.75, respectively. But although the first company's stock price is higher, it has 1.73 billion shares outstanding. The second has 10.6 billion shares outstanding. This means that the second firm, with a lower stock price, actually has a market "cap" of $242.97 billion compared with only $50.17 billion for the first company. Thus "calculating market cap" is a critical step.

What are "value" stocks?

These are the hidden gems of the market. So-called value stocks are equities currently trading at a lower share price, often far lower, than they are worth. In other words, they have a lower price-to-book value. Value stocks trade lower for any number of reasons: the company may have had a disappointing quarter, a product recall, even a legal issue.

But where others see short-term problems … the long-term value investor sees earnings potential.

In searching for value stocks, how can you tell the difference between an overlooked diamond in the rough … and costume jewelry? Investment professionals study what are called fundamentals: price-to-earnings, dividends, sales, and many other quantitative factors.

Value investing is definitely not for the part-timer. Various evaluation methodologies can be arcane and complex. But for the well-advised long-term investor, value stocks are a key portfolio component.

What are "growth" stocks?

As the name indicates, these are shares of companies whose earnings and revenues are rapidly (sometimes spectacularly) outpacing others in a particular industry sector. Growth stocks generally have a higher price-to-book value.

Successful investments in growth stocks requires getting "on board" early enough to benefit from the stock-price appreciation because often these companies do not pay dividends, choosing instead to put their profits into continued expansion.

When growth stocks do hit a speed bump, they are severely punished by the market. Missing a quarterly earnings forecast even by a few pennies can result in a sharp drop in share price.

Are there any absolute truths in investing?

More than you might think:

Markets and economies are not predictable.

Despite the tens of thousands of stock "experts," innumerable publications devoted to the "hot" picks for a given year or quarter, and despite even the occasional legendary "oracle," extensive research overwhelmingly shows it is impossible to improve on well-educated guesswork in forecasting the performance of stocks, sectors and even national economies. Witness the virtual overnight Argentine meltdown, the sudden collapse of the Soviet Union … many other examples.

Sometimes even the best and brightest economists cannot compete with the element of random chance. For example, one study found that Federal Reserve analysts did significantly worse than chance in predicting economic growth and turning points in inflation between 1980 through 1995.

Nonetheless, the data consistently demonstrates that – historically – stocks trump bonds, cash and every other investment vehicles. This is why most independent financial advisors say only through a well-diversified and properly-allocated fund or model can individual investors gain assurance of strong, steady returns with the least relative risk.

The only way to fully benefit from market returns is to be fully invested … 100% of the time.

This is the oldest adage in investing – and it's the crux of the debate between active vs. passive management.

Among active managers it's standard procedure, whenever they perceive potential market or stock sector weakness, to "dial back" the stock-to-bonds ratio in their portfolios … or flee a particular sector altogether.

Often you'll see a sell-off on Wall Street, or an afternoon of "profit-taking." This will be followed, the next morning or a day later, with a renewed buying frenzy. What you're witnessing is active managers and individual investors "timing" the market - dumping stocks, jumping into other sectors, out of real or perceived fear.

Sometimes a major sell-off can be prompted by one marquee firm's quarterly report missing analysts' expectations by only a few pennies.

(cont.)