While the stock market is rife with uncertainty, some tried-and-true principles can help investors increase their chances of long-term success.
Some investors lock in profits by selling their valuable investments while holding on to underperforming stocks that they hope will recover. But good stocks can rise even higher, and bad stocks risk falling completely.
Assemble a winner
Peter Lynch famously spoke of “tenbaggers” — investments that increased in value tenfold. He attributed his success to the small number of these stocks in his portfolio.
But that required the discipline to hold onto the stock even after it had risen many multiples, when he felt it still had significant upside potential.
Conclusion: Avoid clinging to arbitrary rules and consider an action for yourself.
Sell a loser
There is no guarantee that a stock will recover after a prolonged decline, and it is important to be realistic about the prospect of underperformance. And while admitting a stock loss can psychologically signal failure, there’s no shame in acknowledging mistakes and selling investments to stem further losses.
In both scenarios, evaluating companies on their merits is crucial in determining whether a price justifies future potential.
Don’t let little things frustrate you.
Rather than panicking about an investment’s short-term movements , it’s better to track its overall performance. Trust the bigger story of an investment and don’t let short-term volatility get to you.
Don’t overestimate the pennies you can save using a limit versus a market order. Of course, active traders use minute-to-minute fluctuations to make profits. However, long-term investors find success based on timeframes that span years or longer.
Always be wary of hints, regardless of the source.
Never accept a stock tip as valid, regardless of the source. Always do your own analysis on a company before investing your hard-earned money.
Tips sometimes work depending on the reliability of the source, but long-term success requires thorough research.
Stick with the strategy you choose
There are many ways to pick stocks and it’s important to stick to a single philosophy. Oscillating between different approaches effectively makes you a market timer, which is dangerous territory.
Consider how well-known investor Warren Buffett stuck to his value strategy and avoided the dot-com boom of the late 1990s—thus avoiding big losses when tech startups collapsed.
Don’t overestimate the P/E ratio
Investors often place a lot of emphasis on price/earnings ratios, but it is advisable not to place too much emphasis on any one metric. P/E ratios are best used in conjunction with other analytical techniques.
Therefore, a low P/E ratio does not necessarily mean a security is undervalued, and a high P/E ratio does not necessarily mean a company is overvalued.
Focus on the future and keep a long-term perspective
Investing requires making informed decisions based on things that haven’t happened yet. Past data can indicate a high probability of what is to come, but it is never guaranteed to actually happen.
In his 1989 book “One Up on Wall Street,” Peter Lynch said, “If I were asking myself, ‘How can this stock go any higher?’ I would never have bought the Subaru after having gone up twenty times. But I checked the fundamentals, found that Subaru was still cheap, bought the stock and made seven returns after that.” It is important to invest based on future potential versus past performance.
While big short-term gains can often attract newcomers to the market, long-term investments are essential for greater success. And while short-term active trading can make money, it comes with a higher risk than buy-and-hold strategies.
Have and be open minded
Many great companies are household names, but many good investments lack brand recognition. In addition, thousands of smaller companies have the potential to become the big names of the future. In fact, small-cap stocks have historically produced higher returns than their large-cap counterparts.
From 1926 to 2017, small cap stocks in the US returned an average of 12.1%, while the Standard & Poor’s 500 Index (S&P 500) returned 10.2%.
Avoid the Lure of Penny Stocks
Some mistakenly believe that you have less to lose with cheap stocks. But if a $5 stock drops to $0 or a $75 stock does the same, you’ve lost 100% of your original investment, so both stocks carry similar downside risks.
In fact, penny stocks are likely riskier than higher priced stocks as they tend to be less regulated and generally have much higher volatility.
Worry about taxes, but be careful not to get lost in emotions
Putting taxes above all else can lead investors to make the wrong decisions. While the tax implications are important, they are secondary to investing safely and growing your money.
While you should strive to minimize your tax burden, the main goal is to generate high returns.