How to Make Money through Individual Stock Picking


Don’t forget – send your investing questions to vtsioriginal@yahoo.com or leave a comment.

Having discussed the factors that affect risk and the potential return in previous posts, I now lay out a
strategy for investing tied to life stage.  Note that this differs
somewhat from the standard advice that favors large amounts of
diversification from the very start regardless of age.   Some
advisers will even recommend against investing in common stocks
directly at all because they believe sufficient diversification
cannot be achieved without mutual funds.    For them one must be
invested in thousands of different stocks in every sector of the
market.

And yet thousands of people start their own business and succeed each year.  In that case
they are betting on one company – theirs.  This would be extremely
risky for an individual who is nearing retirement and needs to
succeed to eat.  When one is young and has a long time frame,
however, that time frame gives enough time to wait for businesses to
grow and succeed.  Likewise, that long time frame allows for one to
recover when things do not work out.  It therefore makes sense to use
less diversification and only buy the best companies while one has a
longer time frame.

The strategy therefore is to buy large interests in companies with good prospects for
substantial growth in the years ahead while one is young and has a
long time horizon.  One is acting like a silent partner in these
companies.  This is as opposed to trading stocks, where one is trying
to pick the stock whose price will go up soon, or simply buying the
market through a diversified set of mutual funds.

Because one will not have a large amount to invest at this stage of life, shares will be bought
over time, 100-200 at a time, until good-sized positions are held
(500-1000 shares) in a few companies.  Maybe you’ll have a growing
internet company, a retailer, a restaurant chain, a healthcare
company, and a software company in your portfolio after a few years
of saving and investing.  You’ll be buying only the best prospects –
there is no reason to select anything but your top pick in a sector
since, unlike the mutual fund manager, you don’t have enough money to
affect the prices of these companies.

The lack of diversification and the selection of younger growth companies will
cause large gyrations in your account balance from month to month.
While this would be foolish if you were only investing for a year,
the long time horizon allows for patience.  While short-term market
forces may cause the price of some stocks to languish, eventually the
growth of the business will lead to a growth in the price of the
stock.

Hopefully one will pick a few winners (there will certainly also be some losers).  As some of
these positions become large (say, $50,000 or more), one would sell
off some of the shares and use the proceeds to invest in other
companies.  The cardinal rule is again to never have more in one
position that you would be willing to lose.  This will lead to
natural diversification as your portfolio grows.

As one grows older and has more capital to protect, some of the money would be put into more
stable companies and placed into mutual funds.  More diversification
is also favored to help protect against events at any one company
resulting in a large loss.  A percentage of the portfolio would
remain in your best-of-the-best picks, but this percentage would
decline with time as you shift from asset growth to asset protection.
This allows one to hold onto gains that have been made while still
allowing for some growth.

Note that a small gain in a large portfolio will provide the same dollar return as a large gain
in a small account.  Ironically the dollar amount held in the young
growth companies may remain about the same with time.  It will just
become a smaller percentage of the account since the account will get
bigger.

Having outlined the strategy, I’ll now describe the life stages with more detail.  Before
one ever starts investing, however, one need to put his financial
house in order.  To start investing while deep in debt will only
result in disaster.  One will never be able to overcome the 18% rates
charged by credit cards.  Likewise, not having cash on hand to handle
life’s little calamities will result in needing to sell stocks and
pay capital gain and commissions each time a car breaks down or the
furnace goes.  Investing in individual stocks without putting away
other funds for retirement is also not wise.  Here are the things
that must be done before you ever buy your first shares of stock:

  1. Save up an emergency fund of 3-6 months worth of expenses.  This will allow you to fix
    the car without needing to sell stocks or pull out the credit card.

  2. Pay off all credit cards and cut them up.  Really.  Start paying extra on the smallest
    balance and then as each is paid, roll the extra money saved from
    not having payments into the next largest debt.

  3. Pay off student loans and pay off or sell cars with large balances and buy less
    expensive ones for cash.

  4. Fund your retirement accounts with 15% of your take-home pay in growth stock mutual funds
    in tax protected accounts.  This will ensure you have funds for
    retirements even if you have terrible luck in stock picking.

  5. If you have a home loan, refinance into a 15 year fixed rate loan.  This will mean that
    your house will actually be paid off in 15 years.

Once you have accomplished the above, you are ready to start investing and growing
wealth.

Have a burning investing question you’d like answered?  Please send to vtsioriginal@yahoo.com or leave in a comment.

Follow on Twitter to get news about new articles.  @SmallIvy_SI

Disclaimer: This blog is not meant to give financial planning or tax advice.  It gives general information on investment strategy, picking stocks, and generally managing money to build wealth. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. Tax advice should be sought from a CPA.  All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.

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