How can the average investor improves his investment returns in stocks?
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.
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 ability
It 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.
7. So far so good. The hardest part: getting wired like Buffett!
To invest like what Buffett, 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 volatility your friend.
Understanding and mastering this field of behavioural finance is yet another challenge to higher investment returns for the investors.
Here is a summary of how an average investor can improve their stock market returns:
The core principle is to buy high-quality stocks at a bargain price and avoid the mistake of "buying high and selling low."
Here are the key strategies to achieve consistent annual returns of 10% or more:
Stock Selection: Focus on companies with a sustainable competitive advantage ("large moat"), a high Return on Equity (ROE) of at least 15%, and consistent earnings growth (EPS growth).
Buy at a Low Price: Purchase these quality stocks when they are undervalued. Always keep some cash available to take advantage of market downturns, corrections, or panic selling.
Take Profits Strategically: Sell stocks in two key situations:
When they are obviously overpriced.
To free up capital for a better investment opportunity.
Additionally, sell underperforming stocks early to avoid opportunity costs.
Cut Losses Quickly: If a company's fundamentals deteriorate, sell immediately to keep losses small and protect your portfolio.
Focused Diversification: Don't over-diversify. A portfolio of around six high-quality stocks is sufficient to manage risk without diluting returns. Add new money to existing winners or replace a current stock with a clearly better one.
Appropriate Asset Allocation: Only invest money you are willing to risk. Your investment amount should not cause you stress from normal market swings. Long-term investors who have built up gains are better insulated from losing their initial capital.
Master the Psychology: The hardest part is to emulate Warren Buffett's disciplined, unemotional approach. Having a clear investment philosophy and strategy (which can be solidified through activities like writing) helps you avoid emotional decisions and instead use market volatility to your advantage.
