Learning how to manage your stock portfolio to get the best returns includes looking beyond simple financial indicators, focusing on dividends and their ability to compound, and knowing when not to sell
Here are three key tips for learning how to manage your Successful Investor stock portfolio effectively. First, invest mainly in well-established companies. When the market goes into a lengthy downturn, these stocks generally keep paying their dividends, and they are among the first to recover when conditions improve.
Second, spread your money out across most if not all of the five main economic sectors: Manufacturing & Industry, Resources & Commodities, Consumer, Finance and Utilities. This keeps you from investing too heavily in any industry or sector that is headed into a period of big losses. This cuts your risk of losses. But, by spreading your investments out more widely, you also improve 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.
Third, avoid or downplay stocks in the broker/media limelight. That limelight tends to raise investor expectations to excessive levels. When companies fail to live up to expectations, these stocks can plunge. Remember, when expectations are excessive, occasional failure to live up to them is virtually guaranteed—in the long term if not in the short.
Here are some more important pointers:
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How to manage your stock portfolio risk: Look beyond simple financial indicators
When they first set out to formulate an investment strategy, many investors decide to focus their stock market research on a handful of measures. For instance, they may want to see a p/e ratio (the ratio of a stock’s price to its per-share earnings) below 15.0, along with an earnings growth rate of 20% or more a year, and perhaps a 2% dividend yield.
If you find a stock with this combination of favourable ratios, it probably comes with some more-or-less hidden drawback not covered by your system. Instead of steering you away from investments that you don’t understand, or that harbour hidden risk, this system will steer you toward them.
A measurement of volatility that has limited use—if any
A stock’s “beta coefficient,” or “beta” for short, is a measure of a stock’s volatility relative to the market and based on how it has performed relative to the market. That’s generally over the previous five years.
When a stock has a beta of 1.0, that means it is just as volatile as the market. If the beta is below 1.0, the stock is less volatile than the market. Beta enthusiasts say this is the kind of stock to load up on when you have qualms about the market outlook.
Betas give you a general idea of what to expect from a stock, but you should already have that from looking at the stock’s business history and fundamentals. The notion is absurd that you can buy low-beta stocks when the market is going to be weak, and high-beta stocks when it is going to be strong. After all, if you knew when the market was going to be strong or weak, you wouldn’t waste time with betas. You’d simply trade stock index futures and get rich overnight.
How to manage your stock portfolio for long-term gains by understanding the magic of compounding and by seeking out quality dividends
Compound interest is earning interest on interest. Over time, your long-term investments will earn more and more money from the effects of compound interest. Compound interest is what makes investing a worthwhile pursuit.
But it’s important to note that compound interest can apply equally to dividend-paying equity investments like stocks, and not just fixed-return, interest-paying investments like bonds. When you earn a return on past investment returns (including dividends), the value of your investment can multiply. Instead of rising at a steady rate, the number of dollars in your portfolio will grow at an accelerating rate. It’s also very important to keep an eye on investments or expense fees that affect the amount of interest you earn. Even 1% a year can be a huge drain on your portfolio.
If you’re new to our Successful Investing approach, one tip we share often is to invest in companies that have been paying a dividend for 5 or more years. Dividends are typically cash payouts that serve as a way for companies to share the wealth they’ve accumulated. These payouts are drawn from earnings and cash flow and paid to the shareholders of the company. Typically these dividends are paid quarterly, although they may be paid annually or even monthly as well. Canadian citizens who own shares in Canadian stocks that pay dividends will also benefit from a special dividend tax credit.
How to manage your stock portfolio: Three considerations to take into account before selling
Be quicker to sell low-quality stocks, and slower to sell shares of high-quality stocks.
Before you sell, ask yourself this: does the stock have a poor outlook? Or, do you want to sell because it just doesn’t fit your portfolio? If neither condition applies, and you just think it has gone up too far or too fast, then you should ask yourself if selling will improve your portfolio, or if you just want to tinker with it.
Avoid portfolio tinkering, especially when it comes to selling stocks that you feel have gone up too far and too fast. To succeed as a Successful Investor, you need a big winner in your portfolio from time to time. One key fact about big winners is that they tend to go up further and faster than most investors expect, and they keep doing it for years if not decades. If you sell them when they’re just getting started, you may never experience the joy or profit of having a big winner in your portfolio.
The impulse to sell can hurt a portfolio. How do you double-check a decision to sell one of your stock holdings?
What are some steps you take to limit the risk in your stock portfolio?
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