Many people try to “beat the market,” which is to say that they try to get a better return than some index such as the Dow Jones Industrial Average, the S&P 500 Index, or the Russell 2000 index. There are many strategies that are tried, including looking for patterns in the prices of the stocks, buying stocks considered to be undervalued, finding stocks that are going up and buying in, hoping that they will continue to go up, and trying to find stocks that are likely buy-out candidates. While some people may beat the market for a period of time, these strategies rarely work for longer than a year or two. If someone actually does find some strategy that works because of some inefficiency in the market or something, other people pile in and the strategy no longer works.
There are a few people who do beat the markets, however. One of the most famous people to do so is Warren Buffett, but there are hundreds, perhaps thousands of others who have done so as well, although perhaps not to the same extent. The strategy they use is available to all and isn’t subject to the same issues that dooms others to failure. Perhaps the strategy also goes against human nature, which wants a quick return, and that keeps too many people from using the same strategy to the point where it no longer works.
This strategy is what I refer to as serious investing. It is not for those who want to invest for entertainment. It is for those who want to beat the markets and become financially independent. It takes some degree of stock picking, but more so it takes discipline and patience. Lots and lots of patience.
So what is this strategy? Here are the steps:
Step 1: Give in to the fact that you have no control over the markets and what they will do to your portfolio in short periods of time. Anything you know about a given stock or the economy is already known by millions of others. Any idea that you have about the effect of this or that on this company or that industry, others have as well and they are making trades at the same time you do. The reason that great parking space is open is because the guy is parked over the line and no one else could park there either. If he weren’t parked poorly, it wouldn’t be there when you pulled up. Accept the fact that the markets will do what the markets will do and you will not outperform the markets by jumping in and out.
Step 2: Start thinking like a venture capitalist. Venture capitalist put their money into companies that they think have lots of room to grow. They also find companies that have a very high probability of success and only buy in if they can get a good price that will allow them for a big return if things work out. They then put their money in and plan to sit and wait for things to happen. They don’t make a small gain and jump out. They wait for the huge returns that make up for the companies that don’t work out.
Step 3: Invest regularly. Remember step 1. You’ll never hit the timing just right. The more often you invest, the more you average out the prices you pay and improve your cost basis. Plan on making an initial investment, then plan on buying more on dips and falls. This means putting aside money regularly so that you can acquire more shares.
Step 4: Make significant investments. If you make only small investments in several different companies, you might as well be investing through mutual funds because that is what you are creating. Find your best companies and focus your resources on them. Spread out into different sectors of the markets, but only buy your top pick in each sector. Larger positions mean much larger profits when your positions pay off.
Step 5: Only invest when you’re really excited. Don’t buy a stock just because you have some money to invest or it has a decent dividend. Find stocks that have great prospects and make you very excited about where they may be in five to ten years. Develop a watch list of these stocks and then buy the one that have the best price when you have cash available.
Step 6: Sell when things change or a position gets too large. If you buy a company because they have a great line of sportswear and then they start selling dress clothes, get out. Likewise, if a position grows to the point where it constitutes a significant portion of your portfolio, cut the position back to manageable levels and put some of the money elsewhere.
Step 7: Be in it for the long haul. Truly great, life changing profits are made over decades, not months. Why sell out just when things are getting good? Find a great company that has a great products and room to grow, then don’t worry about the small ups and downs. Wait for the huge payoff that comes from years of compounding.
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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.