The adage,
"Buy low and Sell high" and pocket the profit, is well known. I like to also remember it this way:
"Never buy high and Never sell low".
The subsequent discussion applies to investing in high quality good stocks bought at a bargain only.
How can the average investor improves his investment returns in stocks? More specifically how can an average investor improves his return to 10% annually? Even better, to above 15% annually and consistently? Let us examine some factors affecting investment returns.
1. Stock selection
This is important. You wish to have a stock that gives you a good total sustainable return over many years. You will need to invest in those stocks with a high ROE of at least 15% or more. Also, these stocks should have good earnings growth (EPS growth) that is consistent and sustainable. Such companies run businesses with a huge competitive advantage over their competitors with a large moat.
2. Buy when the selected stock is selling at a low price.
This is the better way to get superior return - the potential return is higher with concomitant lower risk. Invest in "value stocks". A good portfolio should always have cash available to benefit from a bear market or a correction or panic sell in a bull market/or a specific stock.
Here is a recent illustration from icap. to emphasize this point:
"This pleasant result is due to the “Intelligently Eclectic” value investing style that Capital Dynamics has adopted for the last 21 years. What does it mean in practical terms ?
A stock that the i Capital Global Fund invested in plunged around 85% during the 2007-2009 bear market. However, instead of selling as it dropped, we bought so much more of this stock that the cost price plunged around 80% too. By now, the i Capital Global Fund is sitting on a gain of 175% on this particular stock. The reason why ICGF bought so much more was because if it was attractive at higher prices, it is even more attractive at depressed prices since the business fundamentals of the company have not changed. "
3. Taking profit
Profit should be realised from sales of stocks in the following situations:
(I) when the stock is obviously overpriced, or
(II) when the sale of the stock frees the capital to be reinvested into another stock with potentially better return.
Not taking profit in the above situations can harm your portfolio and compromise its returns. In other circumstances, let the winners run.
Underperforming stocks should also be sold early. Hanging onto underperforming stocks is costly too. There is the opportunity cost that the capital can be better employed for higher return. Also, hanging onto these lack-lustre stocks reduces the overall return of your portfolio.
4. Reducing serious loss
When the fundamentals of a stock have deteriorated, sell to protect your portfolio. This decision should be make quickly based on the facts and situations, in order to keep your losses small.
5. Diversify, but not overdoing it
According to Buffett, adding the 7th stock to the portfolio reduces the return without reducing the overall non-systemic risk. of the portfolio. Select the best 6 stocks. If you need to add money to your portfolio, buy more of these preexisting stocks when they are offered at a good or bargain price. If you identify a better stock to invest, perhaps, this should replace one of the preexisting stocks in the portfolio.
6. Asset allocate according to your risk taking abilityIt is perplexing to know of investors whose days are affected by the swings in the market. You should not bet your total networth into the stock market. Allocate the amount that you are willing to risk.
Many long-term investors are always riding on a significant amount of gains. This means that they will only lose their capital in very unlikely extreme situations.
Here is an example to illustrate this point.
"After investing more than £2 bln in Barclays Plc, two years ago, Temasek, the well-known investment arm of Singapore, recently sold its stake in the British bank at a big loss."
Sometimes you made a serious mistake, or events turned against you, and there is no way to redeem this without taking a big loss. The only protection here is you have allocated your allocate asset appropriately such that this "black swan" phenomenon won't harm you irreparably. Hopefully this will not 'stopped out' in your investing.
7. So far so good. The hardest part: getting wired like Buffett and Teng Boo!To invest like what Teng Boo did in ICGF, you need to be knowledgeable and able to execute 'coldly' (or cooly) without being affected by emotions. These are among the harder skills to master. Have you wondered what drives this blogger to write on investing? Through writing, rather than lurking, you can focus on the facts and solidify your knowledge, philosophy and strategy.
Admittedly, there is no single philosophy or strategy; but you should have one to guide your investing. It prevents you from over-reacting to emotions and circumstances, that may harm your portfolio and investing returns. As this discussion assumes the portfolio contains only good quality stocks, it prevents you from "Buying high and Selling low" due to falling prices in the market. It may allow you to benefit hugely from the volatilities and follies of the market; making volality your friend.
Understanding and mastering this field of behavioural finance is yet another challenge to higher investment returns for me.
