When I first began investing, I often learned investment lesson through by trial and error. Learning about the in’s and out’s of investing by trial and error can be painful and expensive experience. This article focuses on five valuable investment tips that can save you some of the painful and expensive lesson that I went through. These tips are not highly technical or unique, just common sense investing tips that investors need to constantly keep in mind.
Diversification
Many investment professionals agree that, although diversification does not guarantee against losses, it is an important component towards reaching long term investment goals. Diversification is way of investing that minimizes risk by spreading investments among different asset classes and business sectors. Diversification strategies vary from investor to investor. For instance, some investors consider themselves to be diversified if they invest in stocks, bonds, mutual funds and commodities. A stock investor might consider themselves to be diversified if they own stocks in different sectors such as utilities, technology and transportation. A bond investor might diversify by investing in government bonds, investment grade corporate bonds and low grade high yield bonds. It should be noted that a portfolio that a portfolio that only holds stocks or bonds is not truly diversified. A truly diversified portfolio will provide income such as one will receive from bonds, dividend paying stocks and annuities, and appreciation such as one would hope to receive from growth stocks. The key to diversification is to spread ones investments so that the losers are likely to offset the winners. For instance investing in bonds is a popular way to diversify against the risk of volatile growth stocks. Jeremy Vohwinkle who is a personal finance writer and Chartered Retirement Planning Counselor says, “Diversification is the single greatest factor in determining long-term investment returns.”
Sell Your Losers
It is common for investors to take profits by selling their appreciated investments, but to hold onto losing investments. The reasons that investors hold onto losing stocks vary. Some investors suffer from an affliction called loss aversion. Loss aversion is a tendency that causes investors to ride out a paper loss in the hopes that the stock will rebound. All investors pick losers, but good investors learn to swallow their pride, accept their losses and then sell their losers before the losses become unacceptable. I would never advise an investor to sell a high quality stock that is in a temporary pullback, but investors must be realistic about a stock’s chances of making a comeback. In addition to managing portfolio losses, selling losing stocks can be used offset the taxable income derived from winning investments. William J. O’Neil who is the author of How to Make Money in Stocks and founder of Investor’s Business Daily gives this advice “Carefully average up, not down, and cut every single loss when it is 7% or 8% below your purchase price, with absolutely no exceptions. Forget your pride and your ego; the market doesn’t care what you think or want. No matter how smart you think you are the market is always smarter.” It is important to remember that holding on to losing stocks is the surest way to destroy the value of your portfolio. My worst investments decisions resulted from holding onto losers.
Be an informed investor
When you make an investment be sure that you know the reason for during so. Make sure that you do enough research so that you understand what you are getting into before you invest your hard earned money. Making investments based solely on a stock analyst tip is usually not a good idea. While some hot tips may work out if you do not do the proper research you are doing nothing more than gambling. Stock investors should always check a company’s earning history, valuations such as price to earnings ratio and price to book ratio and the stocks historical price movements. Bond investors should check the issuer’s credit rating, financial history (10-K or prospectus) as well as the bonds coupon rate, call provisions and maturity date. Michael Schmidt who has spent 20 years working as an analyst, a portfolio manager and an institutional investment consultant, says, “pundits sometimes provide valuable information and, on occasion, some entertainment. To get the best information available, it’s wise to take in outlooks from surveys or multiple sources and draw your own conclusions based on the outlooks with the soundest principles.”
Focus on the Future
The hardest part of investing is figuring out how to use past data to make good decisions about future events. There is no pat answer about how to make decisions about future events, but understanding a company’s fundamentals is the best starting point. There are many different investment strategies, but it is generally a good idea to invest in companies with strong balance sheets, and growing earnings. Legendary investment manager Peter Lynch said this about focusing on a future investment: “If I’d bothered to ask myself, ‘How can this stock go any higher?’ I would have never bought Subaru after it already went up twentyfold. But I checked the fundamentals, realized that Subaru was still cheap, and bought the stock, and made sevenfold after that.” The point is that Mr. Lynch made a highly successful investment by focusing on the stock’s future, and not its past. When focusing on a company’s future, a person should think about whether there is a future market for the product or service that a company is marketing. An investor will also want to know if the company is innovative and does it have a competitive advantage over other companies in its market sector. It is also important to analyze a company’s rate of growth as that will help to predict future growth.
Decide on an Investment Strategy
Every investor should look in the mirror and make sure that they know what type of investment strategy is best for them. Investors that switch investment strategies in order to keep up with investment trends are really just market timers or gamblers. When deciding on a strategy you should consider your tolerance for risk, your market knowledge and whether you want to be a passive investor or an active investor. One of the world’s most successful investors is Warren Buffet. Mr. Buffett is the chairman of the board of Berkshire Hathaway, which manages over $200 billion in assets. Mr. Buffett has stayed with a value-oriented investment strategy for decades and is now considered to be one of the greatest investors of our time. His value-oriented style of investing is not for everyone, but he is a good example of how picking an investment strategy and sticking with it can be beneficial. Mr. Buffet’s investing strategy is simple he looks for fairly priced best of breed businesses, and has said, “If a business does well, the stock eventually follows.”
Conclusion
The investment tips that were covered in this article are not hard to understand, but unfortunately, many investors forget about them when making investment decisions. Sometimes keeping things simple can be a good idea.
Darnell Brown is an accountant with over 20 years of auditing experience. He has worked in both the private sector and for the United States Government. He currently works as a freelance writer and has written numerous financial articles for the investmentunderground.com website.