culled from:investopedia.com
1. Sell the losers and let the winners ride!
Time
and time again, investors take profits by selling their appreciated
investments, but they hold onto stocks that have declined in the hope of
a rebound. If an investor doesn’t know when it’s time to let go of
hopeless stocks, he or she can, in the worst-case scenario, see the
stock sink to the point where it is almost worthless. Of course, the
idea of holding onto high-quality investments while selling the poor
ones is great in theory, but hard to put into practice. The following
information might help:
- Riding a Winner – Peter Lynch was famous for talking about “tenbaggers“,
or investments that increased tenfold in value. The theory is that much
of his overall success was due to a small number of stocks in his portfolio
that returned big. If you have a personal policy to sell after a stock
has increased by a certain multiple – say three, for instance – you may
never fully ride out a winner. No one in the history of investing with a
“sell-after-I-have-tripled-my-money” mentality has ever had a
tenbagger. Don’t underestimate a stock that is performing well by
sticking to some rigid personal rule – if you don’t have a good
understanding of the potential of your investments, your personal rules
may end up being arbitrary and too limiting. (For more insight, see Pick Stocks Like Peter Lynch.)
- Selling a Loser – There is no guarantee
that a stock will bounce back after a protracted decline. While it’s
important not to underestimate good stocks, it’s equally important to be
realistic about investments that are performing badly. Recognizing your
losers is hard because it’s also an acknowledgment of your mistake. But
it’s important to be honest when you realize that a stock is not
performing as well as you expected it to. Don’t be afraid to swallow
your pride and move on before your losses become even greater.
In both cases, the point is to judge companies on their merits
according to your research. In each situation, you still have to decide
whether a price justifies future potential. Just remember not to let
your fears limit your returns or inflate your losses. (For related
reading, check out To Sell Or Not To Sell.)
2. Don’t chase a “hot tip”.
Whether the tip comes from your brother, your cousin, your neighbor or even your broker,
you shouldn’t accept it as law. When you make an investment, it’s
important you know the reasons for doing so; do your own research and
analysis of any company before you even consider investing your
hard-earned money. Relying on a tidbit of information from someone else
is not only an attempt at taking the easy way out, it’s also a type of
gambling. Sure, with some luck, tips sometimes pan out. But they will
never make you an informed investor, which is what you need to be to be
successful in the long run. (Find what you should pay attention to – and
what you should ignore in Listen To The Markets, Not Its Pundits.)
3. Don’t sweat the small stuff.
As a long-term
investor, you shouldn’t panic when your investments experience
short-term movements. When tracking the activities of your investments,
you should look at the big picture. Remember to be confident in the
quality of your investments rather than nervous about the inevitable volatility of the short term. Also, don’t overemphasize the few cents difference you might save from using a limit versus market order.
Granted, active traders
will use these day-to-day and even minute-to-minute fluctuations as a
way to make gains. But the gains of a long-term investor come from a
completely different market movement – the one that occurs over many
years – so keep your focus on developing your overall investment
philosophy by educating yourself. (Learn the difference between passive
investing and apathy in Ostrich Approach To Investing A Bird-Brained Idea.)
4. Don’t overemphasize the P/E ratio.
Investors often place too much importance on the price-earnings ratio (P/E
ratio). Because it is one key tool among many, using only this ratio to
make buy or sell decisions is dangerous and ill-advised. The P/E ratio
must be interpreted within a context, and it should be used in
conjunction with other analytical processes. So, a low P/E ratio doesn’t
necessarily mean a security is undervalued, nor does a high P/E ratio necessarily mean a company is overvalued. (For further reading, see our tutorial Understanding the P/E Ratio.)
5. Resist the lure of penny stocks.
A common
misconception is that there is less to lose in buying a low-priced
stock. But whether you buy a $5 stock that plunges to $0 or a $75 stock
that does the same, either way you’ve lost 100% of your initial
investment. A lousy $5 company has just as much downside risk as a lousy $75 company. In fact, a penny stock
is probably riskier than a company with a higher share price, which
would have more regulations placed on it. (For further reading, see The Lowdown on Penny Stocks.)
6. Pick a strategy and stick with it.
Different
people use different methods to pick stocks and fulfill investing goals.
There are many ways to be successful and no one strategy is inherently
better than any other. However, once you find your style, stick with it.
An investor who flounders between different stock-picking strategies
will probably experience the worst, rather than the best, of each.
Constantly switching strategies effectively makes you a market timer, and this is definitely territory most investors should avoid. Take Warren Buffett’s actions during the dotcom boom of the late ’90s as an example. Buffett’s value-oriented
strategy had worked for him for decades, and – despite criticism from
the media – it prevented him from getting sucked into tech startups that
had no earnings and eventually crashed. (Want to adopt the Oracle of
Omaha’s investing style? See Think Like Warren Buffett.)
7. Focus on the future.
The tough part about
investing is that we are trying to make informed decisions based on
things that have yet to happen. It’s important to keep in mind that even
though we use past data as an indication of things to come, it’s what
happens in the future that matters most.
A quote from Peter Lynch’s book “One Up on Wall Street” (1990) about
his experience with Subaru demonstrates this: “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, bought the stock, and made
sevenfold after that.” The point is to base a decision on future
potential rather than on what has already happened in the past. (For
more insight, see The Value Investor’s Handbook.)
8. Adopt a long-term perspective.
Large
short-term profits can often entice those who are new to the market. But
adopting a long-term horizon and dismissing the “get in, get out and
make a killing” mentality is a must for any investor. This doesn’t mean
that it’s impossible to make money by actively trading in the short
term. But, as we already mentioned, investing and trading are very
different ways of making gains from the market. Trading involves very
different risks that buy-and-hold investors don’t experience. As such, active trading requires certain specialized skills.
Neither investing style is necessarily better than the other – both
have their pros and cons. But active trading can be wrong for someone
without the appropriate time, financial resources, education and desire.
(For further reading, see Defining Active Trading.)
9. Be open-minded.
Many great companies are
household names, but many good investments are not household names.
Thousands of smaller companies have the potential to turn into the large
blue chips of tomorrow. In fact, historically, small-caps have had greater returns than large-caps; over the decades from 1926-2001, small-cap stocks in the U.S. returned an average of 12.27% while the Standard & Poor’s 500 Index (S&P 500) returned 10.53%.
This is not to suggest that you should devote your entire portfolio
to small-cap stocks. Rather, understand that there are many great
companies beyond those in the Dow Jones Industrial Average
(DJIA), and that by neglecting all these lesser-known companies, you
could also be neglecting some of the biggest gains. (For more on
investing in small caps, see Small Caps Boast Big Advantages.)
10. Be concerned about taxes, but don’t worry.
Putting
taxes above all else is a dangerous strategy, as it can often cause
investors to make poor, misguided decisions. Yes, tax implications are
important, but they are a secondary concern. The primary goals in
investing are to grow and secure your money. You should always attempt
to minimize the amount of tax you pay and maximize your after-tax
return, but the situations are rare where you’ll want to put tax
considerations above all else when making an investment decision (see Basic Investment Objectives).
Conclusion
There are exceptions to
every rule, but we hope that these solid tips for long-term investors
and the common-sense principles we’ve discussed benefit you overall and
provide some insight into how you should think about investing.
