Topic: Value Stocks

How to invest in the stock market: Our three-part formula for success

Here’s our three-part formula for how to invest in the stock market for above-average gains—and a bonus tip on how not to invest in the market

It pays to keep the mechanics of successful investing in mind when learning how to invest in the stock market.

Below we share a process for portfolio building that leverages our three-part Successful Investor philosophy.

The Profits from Hidden Value

Learn everything you need to know in 7 Pro Secrets to Value Investing for a FREE special report for you.

Canadian Value Stocks:
How to Spot Undervalued Stocks
PLUS! Our Top 4 Value Stocks

How to invest in the stock market: The three parts of our Successful Investor approach

  1. Hold mostly high-quality, dividend-paying stocks.
  2. Spread your money out across most if not all of the five main economic sectors: Manufacturing & Industry, Resources & Commodities, Consumer, Finance and Utilities.
  3. Downplay or stay out of stocks in the broker/media limelight.

Our first rule tells you to buy high-quality stocks. These stocks have generally been succeeding in business for a decade or more, perhaps much longer. But in any case, they have shown that they have a durable business concept. They can wilt in economic and stock-market downturns, like any stock. But most thrive anew when the good times return, as they inevitably do.

The second rule tells you how to diversify effectively. This has two benefits. It keeps you from investing too heavily in any industry or sector that is headed into a period of big losses. At the same time, by spreading your investments out more widely, it also improves your chances of latching on to a market superstar—a stock that will wind up producing two or five or 10 times more profit than average. Over the course of any investing career, you need a few super stocks in your portfolio, to offset the losses you’ll have from the inevitable duds.

The third Successful Investor rule keeps you out of investor fads, particularly when they are nearing a popularity peak. Getting in at the peak of an investor fad can be an extremely costly misstep.

Follow our rules over long periods and you’ll probably achieve better-than-average investing results. But remember that your results will inevitably be uneven, in a variety of ways. They’ll vary widely from year to year. In many years, most of your profits will occur in only a few of the sectors; you may lose money in the others. Some years your U.S. stocks will provide most of the profits. Some years, your biggest profits may come from groups you hardly thought of as groups, such as stocks you own that trade on Nasdaq, or your biggest multinational companies.

How to invest in the stock market and stop worrying at the same time

If you constantly worry about the “big picture,” including trying to pick market tops, you may at times manage to sell at just the right moment to sidestep a serious downturn. But you may only do that after sitting through a series of downturns. The downturn you avoid may turn out to be the last in a series—the “final leg downward,” as short-term traders like to refer to it.

The next big move in the market may be upward. You need to get back in the market or you’ll miss out. Wait too long and you could wind up paying more than prices you got when you sold.

Note, however, that the stocks that make up the market don’t go up and down like a bunch of people in an elevator. They are more like commuters in a city. Most go the same way every morning and evening, with the traffic. But lots of others go against the traffic, if only sporadically.

Bonus Tip: Practice accounts are not a good way for Successful Investors to learn how to invest in the stock market

The online brokerage industry is winning a lot of attention and goodwill for itself by offering “practice accounts.” These accounts are supposed to be identical to real accounts in all but one respect: you trade in them with imaginary or “play” money, rather than the real thing. The industry says this gives would-be traders a free opportunity to learn how to trade online, without risking any money.

Using an online broker’s practice account, you can learn online trading essentials, such as how to enter a buy order or a sell order; how to double-check your order before submitting it, so you avoid obvious but common mistakes like buying 10,000 shares when you only meant to buy 1,000; and so on. In doing so, you can choose what stocks to buy, but the only feedback you’ll get on your choices is the price changes they go through after you buy. However, there is a large random element in short-term stock market results. It will take months or years before you know if your choices are likely to provide attractive long-term returns. In fact, the real test will come only when you see how you do in the next bear market.

The big risk with practice accounts is that you’ll try out a risky and ultimately unwinnable investment approach, like day trading or options trading, and hit a lucky streak. This could embolden you to put serious money at risk just when your results are about to regress to the mean and deliver losses instead of profits.

How did you learn to invest in the stock market? What guides are your best resources?

If you could give advice to someone new to the stock market, what would you tell them is the best way to start investing?


Tell Us What YOU Think

You must be logged in to post a comment.

Please be respectful with your comments and help us keep this an area that everyone can enjoy. If you believe a comment is abusive or otherwise violates our Terms of Use, please click here to report it to the administrator.