Advice on building an all-star stock portfolio
Fewer individual investors these days seem to buy individual stocks, preferring instead to put their investment dollars into mutual funds and exchange traded index funds, a fast-growing product category. These funds offer professional management, diversification and, in the case of ETFs, very low cost. For most investors these products do a terrific job, particularly for those uninterested in doing their own individual stock research and selection.
But, for some investors, buying individual stocks remains a viable option, one which provides customization, direct ownership, low cost and the potential to outperform the overall market. In fact, individual investors enjoy some advantages over their professional counterparts. Thanks to technology, almost all information needed to evaluate stocks is available online at a reasonable cost, with much of it free. Individual investors can also have much longer investment time horizons than many professionals and can operate without the short-term performance pressure that plagues pros.
For those who are interested in creating their own personalized mutual fund, here are some steps to consider.
1. Make a time commitment. Being a stock investor needn't be a full-time job, but you should be able to commit several hours each month to follow news and earnings reports of the companies you own and to research new potential purchases. Setting aside time at regular, scheduled intervals for research will be necessary.
2. Gather your resources. You will need to know where to find the data and analysis needed to evaluate your stocks. Publicly listed companies often have an Investor Relations tab on their website where you can download annual reports and investor presentations. Many business news sites will allow you to create an alert which notifies you via email of relevant news regarding the companies you are following. Also, there are many reputable subscription research services available. Take a look online.
3. Be diversified - but not overly so. Much research has been done to determine how many stocks are required to create a diversified portfolio, and the consensus is that you should have at least 20 to 30 stocks from a variety of sectors in your portfolio. Fewer than that and you run the risk of a single stock sinking your portfolio. On the other hand, too many stocks in your portfolio will simply make it look like an index fund. In that case, it is certainly cheaper to buy an index fund than to create your own.
4. Think long term. Let's face it; short-term stock prices are inherently volatile and fairly random. Only over the course of five to 10 years does an average return begin to emerge. If you have less than five years to commit to an investment strategy, in my opinion, you shouldn't buy individual stocks.
5. Be patient - don't overpay! OK, you've found a great company to invest in, and you're excited to add shares to your portfolio. But wait. Just how expensive is that stock? Take a look at historical valuations (a common measure is the price/earnings multiple). If a stock is trading at a significant premium to its historical valuation, you may want to wait for a better price before buying. Here's where short-term stock price fluctuations work in your favor. If you're patient and alert, you may well pick up those shares at a discount.
6. Identify your selling strategy before you buy. In my experience, making a decision to buy a stock is much easier than deciding when and how to sell. It's best to make that decision before you buy the stock. For example, if a stock is down by 15 percent from my purchase price and the overall market is flat or up, I may elect to sell the stock even if there is no news indicating a potential problem. This keeps me from holding on to a losing position too long, even at the expense of a potential recovery. On the other hand, if a stock is a winner and gaining faster than the overall market, I will often let it run until I find a better idea to replace it with. This is a "cut your losers early, but let your winners run" philosophy, but each investor must have their own strategy as it relates to selling.
7. Tend to your garden. In investing, the exciting part often occurs when you are researching and buying a new position (planting) and when you are selling a position at a gain (harvesting). To achieve a consistently bountiful harvest, however, there's a lot of work that happens in between (weeding). Investors need to pay attention to not only their individual stock investments, but also what is happening in the broader economic environment. If a storm's a-brewin', you may want to harvest a little early!
Jonathan Lokken, CIMA, is managing principal of Lokken Investment Group LLC in Lewes. He has been professionally managing client investments since 1997. Go to www.lokkeninvest.com for details or call Lokken Investment Group LLC at 302-645-6650 for more information.
Disclaimer: The foregoing content reflects the opinions of Lokken Investment Group LLC and is subject to change at any time without notice. Content provided herein is for informational purposes only and should not be used or construed as investment advice or a recommendation regarding the purchase or sale of any security. Past performance is not a guarantee of future results. Asset allocation and diversification does not ensure a profit or protect against a loss.
