Lets face it, finding stocks to invest in can sometimes be a complex process. Before deciding to buy we feel the need to spend countless hours analyzing every data point we can find on the company. Then, we’ve got to wash, rinse, and repeat this process multiple times over to make sure we’re properly diversified. At the end of the day we may have found our stock, but not without an exhaustive amount of effort.
“A simple, albeit less than optimal, investment strategy that is easily followed trumps one that will be abandoned at the first sign of under-performance.” – Tadas Viskanta, abnormalreturns.com
Well, it doesn’t necessarily have to be like that. You don’t have to spend all day and night analyzing every metric you can find to be a successful investor. Chances are you’re not a full time investor, and simply don’t have enough time in your day to conduct this much research.
You can become a winning investor by keeping it simple, and here are 4 ways to do it:
Apply the one paragraph test
The one paragraph test is a fantastic rule that many successful investors like Warren Buffett, and Peter Lynch apply. The one paragraph test states that you should be able to succinctly summarize why you’re investing in a stock in one paragraph or less. Peter Lynch used to do something similar when financial analysts and traders called offering their thoughts on a particular stock. He’d set an egg timer to give them 60 seconds to explain the premise of their position in 60 seconds or less.
You can easily apply this to your own investing methods. When evaluating a stock, you should be able to clearly list your position within 1 written paragraph, or within 60 seconds if you were explaining it to someone out loud. Your reasons should be simple, and straightforward. It might look something to the effect of, “I’m buying $7,000 worth of Company ABC at $50 a share because I believe (insert your reasons here such as new innovations will allow the company to dominate it’s market, current valuation is too low, profits have steadily increased over the past 2 years, etc).
You can also use this test when reviewing your portfolio later down the road. Let’s say you bought a stock because of x, y, and z reasons that you stated in your 1 paragraph summary. You hold the stock for 12 months and it’s time to revisit your analysis to determine whether you should buy more, hold, or sell. Well, are the x, y, and z reasons you bought the stock 12 months ago still valid? If so, continue to hold or buy more. If not, then it’s likely you should re-think your position, and possibly sell.
Remove the decision making process – use Dollar Cost Averaging
Dollar cost averaging (also known as DCA) is a simple idea that’s based on the premise of purchasing the same dollar amount of a stock every month. Because you’re buying the same dollar amount of the stock every single month, you’re automating part of your strategy which allows you to focus time & efforts elsewhere.
Dollar cost averaging means that you’ll be buying a lesser number of shares when the price is higher, and a higher number of shares when the stock price is lower. Over time, this has the effect of lowering the average price paid for the stock as compared to if you were to buy all shares in one big lump sum.
As an example, lets say you choose to invest $100 into the fictional stock Widgets2You every month. The first month, when share prices are $25 you’ll buy 4 shares (not including trading costs). The second month when the stock shoots up to $33 you’ll only buy 3 shares. The key idea here is that every single month you’ll buy $100 worth of the stock no matter what the price is. It’s automatic, easy to setup, and will lower your average cost paid for the stock over the life of your investment.
Lots of online stock brokerages even allow you to automatically set this up in your account. All you need to do is list the amount, stock ticker, and frequency, and they’ll take care of the rest. Could it be any easier?
Invest in what you know
Here’s one of the most powerful concepts for new investors and ones with limited time – invest in stocks and industries that you’re already familiar with.
Lets say you’ve got a day job working for a wholesale electronics company. On a daily basis you’ll be exposed to tools, software, and services from publicly held companies that you could easily invest in. Because you work with these companies everyday you’ll already be familiar with the quality of their product, size of the market, pricing model, service standards, and more. If you’re already familiar with the company and use their product or service everyday, then you’ve got a leg up on other investors who have to start their research from ground zero.
The same concept can be applied to your life’s passions. If you’re a motorcycle fanatic that loves to ride your Harley Davidson every weekend, then why not consider investing in the company who makes a product that you know and love? Of course you’ve got to make sure their financials are in order, but if you do some research and find growth, strong earnings, and sizable profit, then take the dive and invest!
Keep it simple – invest in companies you’re already familiar with.
“The most important thing in evaluating a company is to be able to define which ones you can come to an intelligent decision on and which ones are beyond your capacity to evaluate.” – Warren Buffett
Invest in an index fund, ETF, or mutual fund
If you’re not sure which individual stock you should buy, then how about buying several of them all at once? It’ll help diversify your portfolio with only one investment, and will keep research to a minimum. This is where index funds, ETFs, and mutual funds come into play.
Index funds and ETFs are simply groupings of stocks that mimic either a specific index or industry. Mutual funds are a fully diversified portfolio of stocks managed by a group of professional investors. Either of the 3 can be a great addition to your portfolio depending on your specific strategy.
Finally, I leave you with a story published in Pensions & Investment Age magazine in 1981 about an investor named Edgerton Welch. He surfaced as having one of the best track records of investing success over the previous decade, so Forbes magazine paid him a visit to uncover his secret to success. His “secret” turned out to be pretty simple. Welch pulled out a copy of a Value Line newsletter and pointed to all the stocks ranked “1” (the cheapest) that Merrill Lynch or E.F. Hutton also recommended. These are the stocks he invested in.
Investing doesn’t have to be overly complex. Keep it simple!