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Wednesday, August 15, 2012

Individual Investors & Stock Market

If you are an individual investor in the stock market, you should know that the system stacks the deck in its favour. By this we mean large investment banks, hedge funds and other large investors have many advantages including information you do not have and that you are the victim of this one-sided system.

If that is true, why should anyone invest in the stock market knowing the odds were against them at the start?

Some investors throw up their hands and say I can't win so why try? They opt to let a professional money manager, such as a mutual fund make investment decisions for them. Other investors attempt to assemble a portfolio by patching mutual funds or exchange traded funds to cover all their bases.

Neither of these strategies is wrong and each will meet with mixed results. If you decide to go with a mutual fund be sure to select those that have the lowest expenses, since they have a better chance of long-term success than funds that charge much higher fees.

If you want to buy individual stocks and assemble them in a portfolio or in connection with mutual funds, what are your chances for success?

First let's be very clear. If your strategy is to frequently trade stocks and execute sophisticated trading strategies such as short-selling, options, futures and other derivatives our estimate for your success is very low.

Some of you may in fact employ these strategies and others and do quite well. However, most research shows you would be in the minority of stock traders.

If your goal is to be a long-term investor in the stock market, then we would suggest your odds of success are much higher.

The key to success of long-term investing is to pick great companies that have solid economic motes and are in markets that allow for growth and buy them at a great price. Many, if not all of these great companies pay dividends and since dividends are one sure way stocks can earn money for you today as well as tomorrow they are keys to investment success.

It is okay to have a small portion of your portfolio in more speculative investments, however the majority of your holdings should be great companies that mostly pay consistent dividends.

The other key to long-term investing success is to patiently wait, if necessary, until a great company's stock is at a great price. What is a great price?

If you have done your homework, you know what the intrinsic value of the company. Your goal is to buy below this price (preferably 20% or more). This cushion called a margin of safety acknowledges that your price estimate may have been off and this cushion will help protect you.

No one knows what the stock market what it will look like a week from today much less 10 years from now, but if you buy great companies at great prices you can find a winning strategy that should survive many years.

This formula (buy great companies that pay consistent dividends at great prices) will help you find long-term investing success, however it is not foolproof nor is it on automatic pilot.

You need to constantly review (at least once per year) the stocks you own to make sure that the great company you bought two years ago is still a great company today and looks like it'll be a great company tomorrow.

Given this formula and what we know about the stock market you will be in a great position to let your companies build wealth for you over time, which is the ultimate long-term investing goal.