Buying stock is easy. The challenging part is choosing companies that consistently beat the market.
That’s something most people can’t do, which is why investing in a diversified mix of low-cost index funds and exchange-traded funds is a smart long-term strategy for the average investor. So smart that even diehard stock jocks swear by indexing for the money they’re not using to buy individual equities.
But you’re reading this to get better at investing in stocks. We’ll assume you’ve got a yen for research, time to let your investments ride through many market cycles and have set parameters for the amount of money you’ll put on the line. (We recommend no more than 10% of your overall holdings be invested in individual stocks.) And let’s not forget this vitally important investing PSA: “Money you need in the next five years should not be invested in stocks.”
Here are five investing habits essential for success in the stock market:
- Check your emotions at the door.
- Pick companies, not ticker symbols.
- Plan ahead for panicky times.
- Build up your positions with a minimum of risk.
- Avoid trading overactivity.
1. Check your emotions at the door
“Success in investing doesn’t correlate with IQ … what you need is the temperament to control the urges that get other people into trouble in investing.” That’s wisdom from Warren Buffett, chairman of Berkshire Hathaway, oft-quoted investing sage and role model for investors seeking long-term, market-beating, wealth-building returns.
Buffett is referring to investors who let their heads, not their guts, drive their investing decisions. In fact, trading overactivity triggered by emotions is one of the most common ways investors hurt their own portfolio returns.
All the investing tips that follow can help investors cultivate the temperament required for long-term success.
2. Pick companies, not ticker symbols
It’s easy to forget that behind the alphabet soup of stock quotes crawling along the bottom of every CNBC broadcast is an actual business. But don’t let stock picking become an abstract concept. Remember: Buying a share of a company’s stock makes you a part owner of that business.
You’ll come across an overwhelming amount of information as you screen potential business partners. But it’s easier to home in on the right stuff when wearing a “business buyer” hat. You want to know how this company operates, its place in the overall industry, its competitors, its long-term prospects and whether it brings something new to the portfolio of businesses you already own.
3. Plan ahead for panicky times
All investors are sometimes tempted to change their relationship statuses with their stocks. But making heat-of-the-moment decisions can lead to the classic investing gaffe: buying high and selling low.
Here’s where journaling helps. (That’s right, investor: journaling. Chamomile tea is a nice touch, but it’s completely optional.)
Write down what makes every stock in your portfolio worthy of a commitment and, while your head is clear, the circumstances that would justify a breakup. For example:
Why I’m buying: Spell out what you find attractive about the company and the opportunity you see for the future. What are your expectations? What metrics matter most and what milestones will you use to judge the company’s progress? Catalog the potential pitfalls and mark which ones would be game-changers and which would be signs of a temporary setback.
What would make me sell: Sometimes there are good reasons to split up. For this part of your journal, compose an investing prenup that spells out what would drive you to sell the stock. We’re not talking about stock price movement, especially not short term, but fundamental changes to the business that affect its ability to grow over the long term. Some examples: The company loses a major customer, the CEO’s successor starts taking the business in a different direction, a major viable competitor emerges, or your investing thesis doesn’t pan out after a reasonable period of time.
4. Build up positions gradually
Time, not timing, is an investor’s superpower. The most successful investors buy businesses because they expect to be rewarded — via share price appreciation, dividends, etc. — over years or even decades. That means you can take your time in buying, too. Here are three buying strategies that reduce your exposure to price volatility:
Dollar-cost average: This sounds complicated, but it’s not. Dollar-cost averaging means investing a set amount of money at regular intervals, such as once per week or month. That set amount buys more shares when the stock price goes down and fewer shares when it rises, but overall, it evens out the average price you pay. Some online brokerage firms let investors set up an automated investing schedule.
Buy in thirds: Like dollar-cost averaging, “buying in thirds” helps you avoid the morale-crushing experience of bumpy results right out of the gate. Divide the amount you want to invest by three and then, as the name implies, pick three separate points to buy shares. These can be at regular intervals (e.g., monthly or quarterly) or based on performance or company events. For example, you might buy shares before a product is released and put the next third of your money into play if it’s a hit — or divert the remaining money elsewhere if it’s not.
Buy “the basket”: Can’t decide which of the companies in a particular industry will be the long-term winner? Buy ’em all! Buying a basket of stocks takes the pressure off picking “the one.” Having a stake in all the players that pass muster in your analysis means you won’t miss out if one takes off, and you can use gains from that winner to offset any losses. This strategy will also help you identify which company is “the one” so you can double down on your position if desired.
5. Avoid trading overactivity
Checking in on your stocks once per quarter — such as when you receive quarterly reports — is plenty. But it’s hard not to keep a constant eye on the scoreboard. This can lead to overreacting to short-term events, focusing on share price instead of company value, and feeling like you need to do something when no action is warranted.
When one of your stocks experiences a sharp price movement find out what triggered the event. Is your stock the victim of collateral damage from the market responding to an unrelated event? Has something changed in the underlying business of the company? Is it something that meaningfully affects your long-term outlook?
Rarely is short-term noise (blaring headlines, temporary price fluctuations) relevant to how a well-chosen company performs over the long term. It’s how investors react to the noise that really matters. Here’s where that rational voice from calmer times — your investing journal — can serve as a guide to sticking it out during the inevitable ups and downs that come with investing in stocks.