Indexes like the S&P 500 or the FTSE 100 are effectively averages of how large stock markets have been performing. For some investors, buying an index fund or ETF that simple tracks on of these indexes will be enough for them. These funds buy all of the shares included in the index, and so over time will perform very similarly to the index itself. If the index rises 5%, so will the fund, and if the index sinks 5%, the index fund will fall by a similar amount.
However, some investors want to earn more than the average rate of return in the market! Some investors want to try their hand at picking the stocks that will outperform the market. Of course, every year that the market rises by 5% on average, many stocks within this market will rise by 10%, 15% or even more.
Likewise, some stocks will only rise by 1% or 2%, and some will even fall in value. The real art of being a successful investor consistent in being able to pick which companies will outperform the market. Although nobody gets this right every time, if you can be right more times than you’re wrong then your portfolio will soar in value.
In this article we take you through a few key ideas to have in mind if you have decided you want to try to beat the market.
Can You Control Your Emotions?
Legendary investor Benjamin Graham once said that the intelligent investor is someone who buys from pessimists and sells to optimists, and there is a lot of truth in this statement! First and foremost, individual shares are much more volatile than indexes or other mutual funds.
Individual shares experience much wider and more regular swings in their value, and this means as an investor you need to be emotionally resilient! You might check your portfolio one morning to see some piece of news released last night has already moved the value of your holdings overnight, and not necessarily in the right direction!
If you are going to stock-pick, by which we mean try to pick the winning stocks, you must be ready to experience everything from euphoria when everything is rising, to blind panic when things are falling. It sounds like a cliché, but as much as possible you need to stay balanced and objective and try not to get caught up in these trends.
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Are You Willing to Work Hard?
Secondly, you should be aware that beating the market is very, very difficult! Few manage to do it consistently over time, although having a ‘good year’ or a ‘good quarter’ is much more achievable. This is because markets in developed nations are by now very efficient.
This means that share prices adjust very quickly to new information, and the price of a stock is rarely too high or too low for very long. The simple fact of the matter is that very few hedge funds or individual investors who try to beat the market will actually be able to do so.
This is not to say it’s impossible, but you should be aware it is going to be hard work if this is what you want to do. What sort of work? Well, you’ll need to thoroughly research the companies you want to invest in. You’ll also need to find good news sources and keep up to date with market developments. You’ll also need to monitor your positions and adjust them quickly when needed. All this is to say that beating the market can be a full-time job – don’t expect an easy ride!
How Much Time do You Have?
This follows on from the above point. You need to seriously think about how much time you can spare because this will determine how actively you can trade. If you already have a full-time job, then you should only consider running a relatively small portfolio.
This is simple because the time needed to do the work won’t be available to you. Many part-time traders have a rule about how many mins or hours a day they spend on their portfolio. It also might be useful to limit the number of positions you’ll hold at any one time. If you have more time, then you can choose to run a larger portfolio in a more active manner.
You should be under no illusion – you more time and effort you can put it into researching your stocks, the better your portfolio will perform over time. But it is also true that this lifestyle isn’t for everyone, and you need to realistically think about how much time you can spare for investing.
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What Technical Knowledge do I Need?
There are varying schools of thought on how much theory is needed to be a successful investor. Then there is a secondary debate about which theories are correct! Whilst the old debate between ‘chartists’ and ‘fundamentalists’ is more or less finished now, because most people accept both are useful in different situations, it’s up to you who you chose to listen to a learn from.
Whilst investment sages like Warren Buffet are always worth reading up on, social media is these days full of financial commentary from good quality sources involved in the markets. The only thing you must get your head around are the basics of balance sheets and profit and loss accounts.
These are the most important pieces of info public companies publish, and you will need to have some sense of what these numbers mean if you are to make informed decisions in the markets.
Are You Ready for the Roller-coaster Ride?
Finally, prepare yourself mentally for all the good and bad things that may be about to happen. It is fully possible that your portfolio will significantly over- or under- perform the whole market. This may be the case in the short run, but it could persist for months or even years! Be ready for the volatility that simple cannot be avoided with stock picking.
Be ready for the fact that if this is your case, your investments may lose money. However, with stocks, you will always have the dividends to factor in over the long run.
Even if they have fallen in valuation, they should be yielding dividends which can partly make up for this. Plus, the final consolation of the investor who has seen their shares fall in value, is that over the long run, almost everything should rise.
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