10 Tips For The Successful Long-Term Investor

[K.Karthik Raja]

Ten Tips For The Successful Long-Term Investor
While it may be true that in the stock market there is no rule
without
an exception, there are some principles which are tough to dispute.
We'll review 10 general principles to help investors get a better
grasp of how to approach the market from a long-term view. Keep in
mind that these guidelines are quite general, each with different
applications depending on the circumstance. But every point embodies
some fundamental concept every investor should know.
1) Sell the losers and let the winners ride! - Time and time again,
investors take profits by selling their appreciated investments, but
they hold onto stocks that have declined in hopes of a rebound. If an
investor doesn't know when it's time to let go of hopeless stocks, he
or she can, in the worst-case scenario, see the stock sink to the
point where it is almost worthless. Of course, the idea of holding
onto high-quality investments while selling the poor ones is great in
theory, but hard to put into practice. The following information
might
help:
Riding a Winner - Peter Lynch was famous for talking about his
"tenbaggers", his investments that had increased tenfold in value.
The
theory is that much of his overall success was due to a small number
of stocks in his portfolio that returned big. If you have a personal
policy to sell after a stock has increased by a certain multiple -
say
three, for instance - you may never fully ride out a winner. No one
in
the history of investing with a "sell-after-I-have-tripled-my-money"
mentality has ever had a tenbagger. Don't underestimate a stock that
is performing well by sticking to some rigid personal rule - if you
don't have a good understanding of the potential of your investments,
your personal rules may end up being arbitrary and too limiting.
Selling a Loser - There is no guarantee that a stock will bounce back
after a protracted decline. While it's important not to underestimate
good stocks, it's equally important to be realistic about investments
that are performing badly. Recognizing your losers is hard because
it's also an acknowledgment of your mistake. But it's important to be
honest when you realize that a stock is not performing as well as you
expected it to. Don't be afraid to swallow your pride and move on
before your losses become even greater!
In both cases, the point is to judge companies on their merits
according to your research. In each situation, you still have to
decide whether a price justifies future potential. Just remember not
to let your fears limit your returns or inflate your losses.
2) Don't chase the "hot tip" - Whether the tip comes from your
brother, cousin, neighbor, or even broker, no one can ever guarantee
what a stock will do. When you make an investment, it's important you
know the reasons for doing so: do your own research and analysis of
any company before you even consider investing your hard earned
money.
Relying on a tidbit of information from someone else is not only an
attempt at taking the easy way out, it's also a type of gambling.
Sure, with some luck, tips may sometimes pan out. But they will never
make you an informed investor, which is what you need to be to be
successful in the long run.
3) Don't sweat the small stuff - In tip No.1, we explained the
importance of realizing when your investments are not performing as
you expected them to - but remember to expect short-term
fluctuations.
As a long-term investor, you shouldn't panic when your investments
experience short-term movements. When tracking the activities of your
investments, you should look at the big picture. Remember to be
confident in the quality of your investments rather than nervous
about
the inevitable volatility of the short term. Also, don't
overemphasize
the few cents difference you might save from using a limit versus
market order.
Granted, active traders will use these day-to-day and even minute-to-
minute fluctuations as a way to make gains. But the gains of a long-
term investor come from a completely different market movement - the
one that occurs over many years - so keep your focus on developing
your overall investment philosophy by educating yourself.
4) Do not overemphasize the P/E ratio - Investors often place too
much
importance on the P/E ratio. Because it is one key tool among many,
using only this ratio to make buy or sell decisions is dangerous and
ill-advised. The P/E ratio must be interpreted within a context, and
it should be used in conjunction with other analytical processes. So,
a low P/E ratio doesn't necessarily mean a security is undervalued,
nor does a high P/E ratio necessarily mean a company is overvalued.
(For further reading, see our tutorial Understanding the P/E Ratio.)
5) Resist the lure of penny stocks - A common misconception is that
there is less to lose in buying a low-priced stock. But whether you
buy a $5 stock that plunges to $0 or a $75 stock that does the same,
either way you'd still have a 100% loss of your initial investment. A
lousy $5 company has just as much downside risk as a lousy $75
company. In fact, a penny stock is probably riskier than a company
with a higher share price, which would have more regulations placed
on
it. (For further reading, see The Lowdown on Penny Stocks.)
6) Pick a strategy and stick with it - Different people use different
methods to pick stocks and fulfill investing goals. There are many
ways to be successful and no one strategy is inherently better than
any other. However, once you find your style, stick with it. An
investor who flounders between different stock-picking strategies
will
probably experience the worst, rather than the best, of each.
Constantly switching strategies effectively makes you a market timer,
and this is definitely territory most investors should avoid. Take
Warren Buffett's actions during the dotcom boom of the late '90s as
an
example. Buffett's value-oriented strategy had worked for him for
decades, and - despite criticism from the media - it prevented him
from getting sucked into tech startups that had no earnings and
eventually crashed.
7) Focus on the future - The tough part about investing is that we
are
trying to make informed decisions based on things that are yet to
happen. It's important to keep in mind that even though we use past
data as an indication of things to come, it's what happens in the
future that matters most.
8) Investors adopt a long-term perspective - Large short-term profits
can often entice those who are new to the market. But adopting a
long-
term horizon and dismissing the "get in, get out and make a killing"
mentality is a must for any investor. This doesn't mean that it's
impossible to make money by actively trading in the short term. But,
as we already mentioned, investing and trading are very different
ways
of making gains from the market. Trading involves very different
risks
that buy-and-hold investors don't experience. As such, active trading
requires certain specialized skills.
9) Be open-minded when selecting companies - Many great companies are
household names, but many good investments are not household names
(and vice versa). Thousands of smaller companies have the potential
to
turn into the large blue chips of tomorrow. In fact, historically,
small-caps have had greater returns than large-caps: over the decades
from 1926-2001, small-cap stocks in the U.S. returned an average of
12.27% while the S&P 500 returned 10.53%.
This is not to suggest that you should devote your entire portfolio
to
small-cap stocks. Rather, understand that there are many great
companies beyond those in the Dow Jones Industrial Average, and that
by neglecting all these lesser-known companies, you could also be
neglecting some of the biggest gains.
10) Taxes are important, but not that important - Putting taxes above
all else is a dangerous strategy, as it can often cause investors to
make poor, misguided decisions. Yes, tax implications are important,
but they are a secondary concern. The primary goals in investing are
to grow and secure your money. You should always attempt to minimize
the amount of tax you pay and maximize your after-tax return, but the
situations are rare where you'll want to put tax considerations above
all else when making an investment decision (see Basic Investment
Objectives).
Conclusion
we've covered 10 solid tips for long-term investors. We started off
saying that there is an exception to every rule, and we can't
overemphasize this point. Depending on your circumstances, you might
even disagree with some of these pointers. However, we hope that the
common sense principles we've discussed benefit you overall and
provide some insight into how you should think about investing