Following these principles will help you become successful at long-term investing in stocks.
Whatever your financial goals are — such as funding retirement, saving for your children’s college education, or buying a home — investing in stocks should play a critical role.
Over the long term, stocks have provided the best return compared with bonds, Treasury bills, and gold and other commodities. Wall Street argues otherwise, but BetterInvesting believes Main Street investors can meet these major goals by investing in the stock market without relying on a financial adviser or a brokerage firm to recommend specific stocks.
Though you can benefit from mutual funds and index funds composed of stocks, BetterInvesting believes that ownership of individual stocks can lead to more profitable investing. Any investor willing to dedicate a few hours a month and a set amount monthly can buy stocks by applying commonsense principles and a consistent approach to identifying quality companies whose common stocks are selling at reasonable prices. The following are the main principles for successful long-term investing.
1. Buy Stocks Regularly, Regardless of the Market Outlook
Trying to guess the stock market’s direction so that you’re investing in stocks when share prices are low and selling stocks when prices are high has never worked. Despite the stock market’s gyrations, stock prices over the long term have continued to increase — about 10% a year, historically. So investors are better off taking the long view and investing a set amount regularly, not matter what the market is doing and Wall Street analysts are saying.
This method, called dollar-cost averaging, means you automatically buy more shares of a stock when the price is lower and fewer when the price is higher. The result is a lower average purchase price and a higher overall return.
Here’s an example of how you can benefit from regular investing. Say you buy $100 of a stock on the first day of the month over five months. The share prices on the day you buy the stocks are, in order, $10, $12.50, $8, $12, and $15. So when you invest $100 to buy a stock when shares are at $10, you purchase 10 shares; when you invest $100 when shares are at $12.50, you purchase 8.33 shares; and so on.
At the end of five months, you have 45.82 shares of the stock, and the stock is currently selling at $15. The average price you paid for a share was $10.91, while shares now sell for $15. Not a bad profit — you didn’t buy all the shares at their lowest point, sure, but how could you possibly know what the low price would be?
2. Reinvest All Earnings to Meet Long-Term Financial Goals
Plowing the earnings you receive from investing in individual stocks (from selling stocks at a profit or receiving dividends from current holdings) is a great way to charge up your portfolio. Over the years reinvesting those seemingly insignificant dividend payments as well as your gains from selling appreciated stock (the capital gains) can lead to tremendous growth in portfolio value via the magic of compounding.
Here’s an example of the compounding’s power. If you invested $1,000 in the S&P 500 index on Jan. 1, 1978, and spent all the dividends you received, you would have amassed $26,360 by Dec. 31, 2018. But if you had reinvested those dividends, you would have had $61,639. And if you would have invested $50 a month over that time, your total would have been $349,553.
3. Invest in Stocks of Quality Growth Companies
BetterInvesting’s principles work best when applied to quality growth companies. Growth companies generally increase their revenues and earnings faster than the combined rates of growth for the overall economy and inflation. The ones to focus on also grow faster than other companies in their industry.
With quality growth companies, sales growth leads to earnings growth. And earnings growth leads to growth in share prices. BetterInvesting can help you identify quality growth stocks, and we discuss the hallmarks of these stocks in the article Common Traits of the Best Stocks
4. Diversify Your Investments in the Stock Market to Reduce Risk
Investing is a humbling activity: We all make mistakes. Even if you buy stocks only after a thorough study, be prepared for one out of every five stocks you buy to perform worse than expected. (Also expect three to do about as you expected, and one to do much better than you forecast.)
So diversify your investments to limit the damage an underperforming stock can do. You’ll want to own stocks not only in different industries but also of different company sizes. Don’t buy so many stocks, however, that your portfolio looks like an S&P 500 index fund. BetterInvesting suggests that you need only around 10 to maybe 20 companies of different sizes from at least 10 to 12 unrelated industries to reduce the risk in your portfolio. A good rule of thumb is not to own more stocks than you can follow.
5. Follow a Consistent Approach to Analysis of Common Stocks
Warren Buffett has always studied potential investments the same way. So has legendary mutual fund manager Peter Lynch. The great investors all might have different ways to find stocks, but they all maintain a consistent philosophy, no matter what the market is doing.
BetterInvesting’s approach to stock analysis hasn’t changed since the organization’s founding in 1951. We ask ourselves two questions when studying a stock: Is this a quality company? and Is the stock selling at a reasonable price? Our Stock Selection Guide helps you answer these two questions. You can learn more about how we identify stocks to buy in How to Pick Great Stocks
— or try out our free resources, tools, and education
6. Shut Out the Noise From Wall Street
With financial news channels and websites, you can follow the stock market’s and your individual stocks’ daily movements. But we don’t recommend doing so. When the market’s down, the financial news networks tend to specialize in negative stories that create a mood of fear. When the market’s up, the ebullience can convince you that any stock is worth buying at any price.
Very little of this conversation helps you invest for retirement or meet other long-term financial goals. Stay focused on company fundamentals — sales, earnings, and profitability.