A central theme in The SmallIvy Book of Investing, Book 1: Investing to Grow Wealthy is a strategy that I call serious investing. I developed this strategy after about twenty years of investing experience, having gone through phases of chasing market trends through momentum investing, trying to scoop up cheap stocks through value investing, buying and selling stocks based on charting, and buying into stocks that just seemed to be in a good position at the time. I found that once in a while I had a stock that looked like a clear winner from a fundamental analysis and I would usually do best by buying and holding that stock. Doing so, I had a few winners that made a hundred percent return or more, compared with gains of 10-20% through trading and charting stocks. Clearly it was better to buy great companies and hold them then try to time the market or use different trading strategies. Note that this is what Warren Buffett does.
I discovered another key that I was missing a few years ago when reading J.D. Spooner’s book, Do you Want to Make Money, or Do You Just Want to Fool Around? I was doing really well in percentage terms on a few of my stock picks, but I was only making perhaps $2000 or $4000 when I did so. I might own 100 shares of a stock that I bought at $20 per share and see it go to $40 or $60, but the gains I was getting weren’t really life-changing. Getting an extra $2000 is nice, and it certainly beats a loss, but compared to my income from working it just wasn’t that significant. In addition, if I got a $2000 gain from one company and had several other stocks that stayed about the same or declined during the year, I might do about as I well as I would have done just buying a mutual fund. At that point buying and selling individual stocks was just entertainment and there was no economic reason for not just investing in mutual funds. I would also often sell a stock when I had gotten a $1000 profit, so I was limiting my profits, thinking that I was “taking gains and limiting losses.” After doing this for a while I ended up with a portfolio full of dogs that hadn’t gone anywhere since I sold all of the ones that had, often before they really took off. My broker loved me, as did the tax man, but I wasn’t really being productive.
One of the points that Spooner makes is that you should buy 500 or 1000 shares instead of just 100 shares. This means that you have a lot fewer stocks in your portfolio but you get to concentrate in your best picks – the stocks that you feel really strongly about. And if you really think about it, that is the advantage you have over the mutual fund manager. While he needs to buy not only his top pick, but five or six others in the same sector of the market because he has to invest several billion dollars and he can’t drop $1 B in a single stock without driving the stock price through the roof as he buys, an individual investor can buy 1000 shares and maybe put 25% of his portfolio into a single stock without making a ripple in the price of the stock.
This is not what you want to do with your retirement funds (usually you aren’t able to do this at all with 401k accounts anyway since most 401k accounts only have mutual funds as investment choices) because you don’t want to risk living in squalor if you find that you are a bad stock picker. You also don’t want to do this with the kid’s college accounts or the money for the next new car unless you have enough of an income to just float those expenses should things go badly or you have mutual funds on the side. For someone who already has these things covered, however, and who is starting out in investing with extra money and the goal of growing financially independent through investing, it makes a lot of sense to invest this way.
Let’s say that you have $3000 in an investment account at the end of the year after taking care of your 401K and your college savings accounts. If you were to put that money in an index fund and you had a really great year, you might have $3900 at the end of the next year. On an average year you might have $3300. If you were to buy an individual stock, however, you might well have $6000 or more at the end of a year. If you put $3000 per year into a $15 single stock over a period of three years, such that you amassed a total of 450 shares and that stock then went to $45, you would now have over $20,000. That would be enough to really make a difference in your life. You could then take $10,000 of that $20,000, buy some shares in a second company, and you’d be off to the races.
The point here isn’t to be risky with your investments. If my Aunt Myrtle had died and left me with $100,000 when I was 21, I wouldn’t go out and invest it in one or two stocks because if I was wrong I could see it all disappear in a matter of a few weeks. I might put $10,000 into a single stock, but the rest would go into mutual funds where I knew it would grow but there would be virtually no chance of losing money over long periods of time. When you are only starting out with a few thousand dollars, however, and this is money you don’t need for several years and you’ve already taken care of your obligations, it makes sense to take the risk of losing it because of the possible gains you could realize.
Now another aspect of serious investing is the style of investing. I wouldn’t take $3000, or even $1000, and buy and sell a stock for a few weeks, sell, and then buy another stock and try to time the markets. I also wouldn’t try to trade based on charting or other some other speculation strategy. This is like flipping a coin, picking heads or tails, and thinking that you’ll guess right more often then you’ll guess wrong over a period of 1000 flips. When I buy a stock, I buy the company. I find a company with a product I really believe in, that has shown that they have a management team that knows how to make money and grow the business, and that has plenty of room to grow and expand. I buy in planning to hold the company for several years, through all sorts of market cycles. If my cousin started a pizza business and I went in with him as an investor, I wouldn’t sell out just because the economy sank for a period and there were fewer people eating out, because I would know that things would improve when the economy turned around so long as my cousin knew how to run a restaurant. Likewise, I wouldn’t sell a great company just because the economy was sinking or the market chose to assign a low price to the company for arbitrary reasons. Just because there is a sale on Coca Cola doesn’t mean you should sell all of the Coke in your pantry because the price is going down.
I go into the serious investing strategy in detail in Chapter 9 of the book where I give my “rules for serious investing.” Is this a gratuitous plug for the book? Yes, but I really wish I had started investing this way thirty years ago instead of just within the last five to ten years. As it turns out, with the way I was investing for the first twenty years I would have saved a lot of time and hassle by just buying mutual funds instead of buying individual stocks. I would have probably also gotten a better return. Since I’ve switched to serious investing, the single stock purchases I make really make sense and I have a good chance of beating the markets with my single stock picks over long period of time. Since that time I’ve had a few big winners and when that has happened it has made a lot more difference than my big winners made in the past because my positions are bigger.
Want to add to the conversation or think I got something wrong? Please leave a comment. Your feedback is appreciated! Otherwise, you can contact me at VTSIOriginal@yahoo.com or on Twitter @SmallIvy_SI.
Disclaimer: This blog is not meant to give financial planning advice, it gives information on a specific investment strategy and picking stocks. 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. All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.