So you're finally ready to take the plunge and put some of your hard-earned money to work in the stock market, and you want to handle things yourself? That's great. Most everyone knows or can learn enough to build and maintain their own portfolio, if they want to do so.
Before plowing ahead though -- and assuming you understand the procedural intricacies of placing trades -- here are four nuggets of wisdom you'll want to absorb. This is advice that may help you sidestep some of the most common stumbling blocks that newcomers to the market trip over.
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1. Above all else, think about sustainable profit growth
It seems simple enough. The purpose of any for-profit corporation is to make money, year in and year out. The longer it can do that, the better. It's easy to become captivated by companies that have great backstories, however, and forget that just because a company has a slick, marketable product doesn't necessarily mean that it will ever be profitable.
Groupon comes to mind. It was a Wall Street darling back in 2011 with sales growing like crazy shortly before its initial public offering that year. Fans were sure that the losses being booked then would turn into profits later, so they snapped up its newly minted shares at nearly any price.
What those buyers should have been looking at was the business model itself. Companies using Groupon's marketing services quickly grew tired of reaping poor returns from their steep investments. Some of its clients were driven out of business as a result of the losses they took on their Groupon promotions. The funny thing is, these horror stories were being told well before the company went public. A bunch of people just chose to ignore them.
Groupon shares are now trading at less than a tenth of their 2011 peak price. The company never turned a sustained profit, even after making adjustments to its business model. Those adjustments proved ineffective largely because Groupon has no competitive moat -- another nuance that went unnoticed by early investors.
2. Use relatively small positions
It can be tempting to put most or all of your fresh investment dollars into one "surefire" stock. It's also a mistake.
Spreading your money around into a number of different stocks (and even a few non-stock investments like bonds or commodities) just makes good sense, and not solely for the reasons you might suspect. Sure, diversification limits the scope of any total loss you may suffer due to a soured stock pick. More than that, however, it reduces the chances that you'll be driven into making panic-induced bad decisions. It's relatively easy to relax when troubles afflict a stock that only makes up a small fraction of your holdings. It's much harder to remain calm when that one struggling stock comprises your entire portfolio.
As a rule of thumb, no single company should account for more than a tenth of your investment holdings. If you want more exposure to the market, it's better to just find more buy-worthy stocks.
3. Establish reasonable, achievable expectations
Every new investor should make sure they know exactly what the market is capable of doing -- and what it's not. Yes, you will hear the stories about companies posting triple-digit percentage share price gains in a single year. Tesla, for example, rallied an incredible 743% in 2020. What you don't hear is that nobody entered last year thinking the electric vehicle company's stock was going to dish out that kind of gain. It isn't the norm.
Furthermore, for every winner like Tesla, there's an unexpected loser like Delta. It was wrecked by the global pandemic, and the stock's value ended the year down by more than 50%. But both of those companies started last year with similar degrees of investor enthusiasm.
This might help: The average annualized gain for the S&P 500 varies between 8% and 12%, depending on how long a time frame you're using (10% per year is a nice round figure to use in any assumptions). Some years, the market as a whole does much better than that, but bear in mind, the S&P 500 also declines in value around one out of every three years, on average.
It's possible you'll consistently beat the market by picking out better stocks, but there's a reason not even most professional fund managers do so -- it's hard to do year after year.
4. Keep the financial media (and TV in particular) in perspective
Finally, exposure to investment-related news sources may have played a key role in getting you involved in the stock market. That doesn't mean you should hang on every word expounded by the financial pundits they feature, nor make trades whenever they suggest it.
Admittedly, it can be easy to get caught up in those pundits' hype, especially when it comes to business television. It sounds as if their commentaries are all actionable, and maybe in some ways, they are. That doesn't mean they're necessarily the right actionable ideas for you. They're merely part of a television program meant to entertain first and inform second, with the ultimate goal of generating ad revenue. These people don't know you or understand your particular financial situation, as well-intended as their advice may be.
In other words, enjoy the show and absorb the information, but remember it's only a small part of your investing homework.
This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis -- even one of our own -- helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.
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