Hot stock tips come from a lot of sources, including friends, family, co-workers, the mainstream media, and investment professionals. However, that doesn’t mean they have any investing value.

Most of those following the Successful Investor approach know better than to invest any money in the stereotypical “hot stock tips” —the gotta-act-quick buy recommendations that come from a friend (or a friend of a friend).

Stocks like these are supposed to make you a lot of money, but they virtually never succeed. Some of these recommendations start out as the honest opinions of investors who know just enough to jump to conclusions about a stock’s outlook. However, some naïve investors may have come under the influence of dishonest stock promoters and professional swindlers.

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Hot stock tips could turn out to be accurate but they may also fail miserably

You may at times pick a stock that you think will rise tenfold or more, and it does precisely what you expect and then some. But you need to brace yourself for the fact that you could be wrong.

So if you feel you have stumbled across a sure thing in the market, you should look at it very closely.

The Successful Investor approach is to keep your portfolio well-diversified across most if not all of the five main economic sectors.

That way, you avoid loading up on stocks that are about to slump simply because of industry conditions or changes in investor fashion. By diversifying across the sectors, you also increase your chances of stumbling upon a market superstar—a stock that does two to three times better than the market average, or even more.

These stocks come along every year. By nature, their appearance is unpredictable; if you could routinely spot them ahead of time, you’d quickly acquire a large proportion of all the money in the world, and nobody ever does that.

Hot stock tips often fail because they focus almost exclusively on highly speculative investments

The odds are against you when you act on hot stock tips and invest in speculative stocks and companies that are not yet making money. Some, if not many, of these companies will never make any money.

Every individual has different investment objectives, acceptable risk levels and so on. But you should generally hold on to high-quality stocks that fit into our Successful Investor approach, even if they have doubled in price. However, you may want to consider selling some shares in successful conservative stocks you own if they go way up and start to make up too much of your portfolio—say, more than 8% to 10%. In that case, it may make sense to take at least partial profits.

Hot stock tips are not more credible just because they come from industry insiders

You may feel your work gives you special expertise for investing in your own industry. Lots of tech company workers, for instance, feel that way. They have strong feelings about which tech firms are most likely to thrive and which are apt to fail. But the strength of that feeling can mislead you, for a couple of reasons.

First, no single individual can possibly know all you’d need to know to foresee which tech stocks are likely to beat out their competitors. That’s true of stocks in any industry.

Second, the success or failure of any single tech stock is due to a variety of events that will happen in the future. The company may start out with a promising business plan. But it needs all sorts of things to prosper in the long run: the right employees, a favourable economic and regulatory climate, a favourable competitive situation, successful research outcomes, adequate financing, perhaps the right merger partner or acquisition—the list is nearly endless. This is also the case with stocks in other industries.

A deeper look at portfolio diversification

Portfolio diversification gives you the greatest opportunity for safety and profit, which makes it a key part of our Successful Investor philosophy.

The proportions largely depend on your objectives and the risk you can accept. The Canadian Finance and Utilities sectors generally involve below-average risk. Manufacturing and Resources tend to be riskier, and the Consumer sector is in the middle. Diversifying your portfolio can also mean balancing your investments geographically. Avoid focusing your portfolio exclusively on any one country or region. As well, you can add international exposure to your portfolio with less risk by holding multinational U.S. stocks such as IBM, McDonald’s and Wal-Mart, which are active in markets around the world.

7 tips for making better stock picks with our Successful Investor approach

• Look for strong management
• Look for well-financed companies
• Look for a strong balance sheet
• Look for a focused company
• Look for stocks trading on a well-regulated exchange
• Look past the hype
• Look for reasonable share prices

Have you invested in hot stock tips that have gone on to be successful? What qualities did these stocks have?

Hot stock tips don’t always lead to good investments, but some of them surprise us. What hot tips have you passed over that went on to be successful?