Ask any investor how they’ve been doing in recent years and the answer is probably, “I’ve been crushing it.” But have they really?
In a go-go market, everyone thinks they’re blessed with the Midas touch. But the true measure of killer investment returns is how it compares with what you would have earned investing in a benchmark index.
Lately, outearning the market hasn’t been easy. Over the past three years, the Standard & Poor’s 500 Index has increased a brag-worthy 26% as of mid-June. All you had to do to get those returns was invest in a low-expense S&P 500 index fund and sit tight.
We’ve all been dealt a hot hand. But for many investors, that’s not good enough. They take on unnecessary risk, sometimes without realizing it, to the point where excitement, excessive investing expenses and failed attempts at market timing leave them with market-trailing returns.
Everyone’s a winner!
It’s hard to resist the Vegas-like atmosphere of stock trading. Shows and sites cover the market’s every move with the breathless intensity of sports announcers. Short on money? Penny stock trading seemingly sets a low enough bar for anyone to get in on the action. Until you learn more about their inherent risks.
The immediacy and ease of online trading can distract the most stoic investors from their game of seeking solid companies to buy and hold for the long haul. Just a little overtrading, which racks up extra investment fees, can stymie even a master stock picker’s overall returns.
When the market’s on an upswing, investing turns into a game that’s ours to lose.
And when the frothy market eventually flattens and falls? That’s when novice investors who have been crushing it sometimes seal their fate by cashing out. Too often they also try to time re-entry — if they haven’t been scared away from stocks for life.
How to play a winning hand
Despite the above red flags, this isn’t an article shooing you away from buying individual stocks. For investors able to avoid the three-headed monster of excitement, excessive investing expenses and market timing, buying individual stocks for an added kick to your index returns can be a sound long-term strategy. Just take a few precautions:
- Don’t dive in until your financial bases are covered. We’re talking about having adequate emergency savings, keeping any money you need in the next five years out of the market and maxing out your retirement savings with low-expense index funds (saving 10% to 20% of your income each year is ideal).
- Practice with Monopoly money. Many online brokers offer virtual trading platforms fueled by live market data. Test-drive their platforms to practice the art of buying and selling stocks in a safe environment.
- When you’re ready to put real money behind your stock picks, make sure it’s money you can afford to lose. Keep your investments in individual stocks to less than 10% of your overall holdings — and much lower if you’re just in it for a bit of fun. (Even in practice commit to following a few basic rules for successful investing.)
- Be honest about your performance. Benchmarks don’t lie. Choose the appropriate ones to use for comparison. There are index funds and exchange-traded funds that include technology companies, pharmaceutical firms and businesses in all sorts of industries. Also keep an eye on how your picks are doing compared with their peers. Don’t forget to account for investment fees in your returns.
Remember, if your returns aren’t crushing it, there’s always the old standby: boring but beautifully simple index funds. If you can’t beat ’em, there’s no shame in buying in.