Often when people think of successful investing, they think of chasing the hottest stocks and getting rich quickly. Sure, you may read the occasional story about someone striking it rich by “playing the market,” but they are the exception to the rule. The truth is that the most successful investors devote time to research and invest according to a plan.
Investing is just Legalized Gambling…Right?
Contrary to what you may hear around the water cooler, investing in the stock market is not akin to gambling. Slot machines, roulette wheels and even poker are games of chance; stock market results are not random. From the moment a stock is offered to the public, its price will rise and fall based on free market forces (the effect of supply and demand on trading within a free market). And market forces, while unpredictable in the short term, are not really as mysterious as they seem. Stock prices are affected by real things like business fundamentals, a company’s current and estimated future earnings, world events (good or bad), and—in the short run—investor psychology.
Research, Research, Research.
The best investors dedicate significant amounts of time to researching their investment ideas. Remember, when you buy a stock you are not just buying a piece of paper, you are buying a piece of a company. It’s always best to focus on products you are familiar with and companies you can understand (what Warren Buffet calls your “circle of competence”). A good place to begin your search for investment ideas is in your own home. Look around for products you and/or your family members really like and maybe even use every day. Learn as much as you can about a company of interest. If you have done your homework, you will be more likely to make sensible investment choices.
If you don’t have time to devote to research, or if you don’t fully understand what you should be doing with your money, remember that there are professionals out there who can help. Consider investing in an actively managed mutual fund, or hiring a knowledgeable financial advisor to help lead you on the right path. In the long run, the cost of investing your hard-earned money in something you don’t really understand may be much higher than the cost of hiring a professional to do it for you.
Don’t “Chase the Market.”
An investor is said to be chasing the market when he or she purchases a stock immediately after a significant price increase (panic buying). On the flip side, an investor who sells soon after the stock has lost substantial value (panic selling) is also said to be chasing the market. Investing this way can—and usually does—lead to substantial losses. As difficult as it may be at times, try not to dwell on short-term performance. Short-term market movements are difficult, if not impossible, to predict. That’s why rushing to buy or sell can be so risky. Make sure there is sound reasoning behind your investment choices, that way you will be less likely to trade on a “hot” tip or chase the latest “hot” trend, and lose. Trading less often will also help you save on transaction costs and capital gains taxes.
“Buy-and-Hold” isn’t Enough. You Need to Buy-and-Monitor.
For most of us, successful investing isn’t about becoming a millionaire overnight, it is about watching our savings grow over time. A common misconception, though, about buying-and-holding is that if you simply buy a single lot of shares and hold them indefinitely, you will make money. Investing for the long term still requires maintenance. If you find a company with strong business fundamentals, short-term price fluctuations probably won’t affect the long-term value of the company. Short-term periods of volatility often present a great time to buy more stock, if you still believe in the company. On the other hand, be sure to have an exit strategy in place if a company’s stock reaches your predetermined target price, or if the fundamentals of the business take a negative turn.
The More you Know…
Following the rules above won’t guard you against the occasional loss, and the list is certainly not meant to be comprehensive. After all, a great deal of work goes in to researching and selecting stocks (topic for a future blog). But stock market investing is much like anything in life: the more you know, the more likely you will be to make smart choices.
All investments are subject to risk, including the possible loss of the money you invest. Past performance does not guarantee future results. There is no guarantee that any particular asset allocation, or mix of funds, or any particular mutual fund, will meet your investment objectives or provide you with a given level of income.