So you’ve done your research, spoken to friends and acquaintances and are finally sold on the idea of investing in the share market.
But don’t press the ‘buy’ button on any stock until you finish reading this article.
Understanding the numerous advantages to share market investing is the easy part. These can range from securing your retirement savings to generating a good return which enables you to put a deposit down on a property. Or perhaps it is the interest rate outlook that is prompting you to seek a better alternative to the dwindling returns on your savings or term deposit accounts? These are all great reasons, but before you move to the next step, there are three key things to portfolio success that you need to know.
1. Understanding the psychology of investing
Share market volatility is a reality for all investors, which should be embraced rather than feared. It is the share market ups and downs, as a result of changing demand alongside the constant buying and selling of stocks, that generates long-term returns for investors. So keep your eye on the end game and ignore short-term dips.
As long as you’re invested in quality companies (see the next section) then have the confidence you’ve made a solid decision to invest in a particular stock. This will help you ride out the mercurial nature of the stock market and reap the rewards that come with share market investing.
[Related article: Why share market volatility creates opportunity.]
Don’t listen to noisy naysayers who like to get their opinions published. They’re always around, creating newspaper headlines, promoting their opinions and generating panic. It keeps them in a job.
Instead, master the art of ‘blocking out the noise’. It will stop you from making knee-jerk decisions and straying from solid decision making. If you can’t achieve this, then perhaps direct investing in the share market is not for you. Investing in a managed fund, which holds a portfolio of shares, may be more suitable for you.
2. Stock selection and rejection
The recipe for constructing a successful share portfolio boils down to how you select stocks. The ability to choose strong companies with good fundamentals and avoid the weak should ensure you stay ahead of market benchmarks over the long-term. Here are three important steps to consider.
The first step is to understand the financial health of any company you are considering. It means you need to look closely at the company’s financials. The accounting ratios will tell an important story and is the basis of stock selection and rejection. The outcome of this review will determine the business risk of a particular company (and no one wants to invest in a risky business!).
You may be surprised to know that, as of 1 July 2016, we’ve determined over 70% of ASX stocks are exposed to unacceptable levels of financial risk, with many in danger of failure. So, understanding financial health is vital.
The second step is to understand more about the company’s management team. Have they proven themselves as able to deliver the financial and strategic objectives? Look at their track record – much like they’re applying for a job working for you. And, simply put, that is what they will be doing!
Thirdly, what is the outlook and forecast for the company? Do you consider it to be sustainable? Are the opportunities going to continue for the company’s products or services? It’s important to ask yourself these questions and then make an informed assessment, so research will be your best friend for this task.
All this may sound complicated, but it is a formula we’ve mastered. Our Stock Doctor clients are quickly able to access all this information along with our assessment and ratings, on all ASX stocks, with a few mouse clicks. How do we do it? It’s explained simply in our Golden Rules white paper.
Lincoln’s Golden Rules will provide you with a robust framework for share selection strategy. This will allow you to make sound decisions on which stocks to buy and sell and help you avoid investment disasters.
If a stock fails to meet, or continue to meet, these fundamental guidelines such as an unhealthy balance sheet or poor cash flow, then this stock should be replaced by another one that does meet this criterion.
A short cut to assessing the financial health rating of your portfolio is available by using our Portfolio Health Check tool.
3. Portfolio management and optimisation
Maintaining a rock solid share portfolio, is the area where most investors fall short.
Many investors have plenty of enthusiasm when they begin investing, spending a lot of time researching and selecting strong stocks for their portfolio.
It is once this enthusiasm begins to wane that investors run into problems, leading to their portfolios becoming mismanaged, forgotten or even abandoned.
Portfolio neglect is one of the key reasons why many investors fail.
The other area where investors fail is by holding onto stocks that are no longer healthy as they become emotionally attached to the company, in the hope they will come back into favour with the market.
It is important to remember that a company performing strongly today, may not be a good investment tomorrow. When the fundamentals of a business change, it is important to always be ready to make the necessary changes before a stock negatively affects your portfolio. It’s the disciplined investor, who takes this step seriously, and avoids emotional investing that will enjoy long-term success.
Being proactive and continuously monitoring your portfolio will make all the difference to the performance of your overall portfolio.
Don’t allow your heart to rule your head when it comes to the stock market. Sell stocks that no longer meet your selection criteria and avoid an ‘emotional hold’ approach. Once you get rid of the weak stocks, replace with new and exciting companies that are financially strong and have great stories to tell the market.
We recommend investors spend an hour or so, at least once a week, to review and optimise their portfolios to ensure it’s always in the best shape possible. Do this and you’ll always hold a portfolio that is optimised and well placed to achieve share market success.
Important: Lincoln Indicators Pty Limited ABN 23 006 715 573, as Corporate Authorised Representative of Lincoln Financial Group Pty Ltd ABN 70 609 751 966, AFSL 483167. This blog may contain general financial product advice. It has been prepared without taking account of your personal circumstances (including your objectives, financial situation or needs) and you should therefore consider its appropriateness in light of your objectives, financial situation and needs, before acting on it. You should read and consider our Disclaimer for more Important Information and our Financial Services Guide (FSG) which sets out key information about the services we provide. The Disclaimer and FSG are available at www.lincolnindicators.com.au.