The 12 Principles of Equity Investing
If you follow these 12 principles, you can have confidence that you are doing all you can to property manage your equity investment portfolio.
Principle 1: Always Hold A Balanced Portfolio
Based on the knowledge that equities, and small cap (small company) equities in particular, have shown the best performance over the long term, you might be tempted to put all your investments in small cap equities. But every Investment Advisor will agree that you need to trade a bit of potential return for less risk and more confidence in a solid return year over year. Therefore, a good investor will always hold a portfolio with a mix of cash, fixed income and equities, with potential some other investments as well (e.g. real estate).
Principle 2: Buy And Retain Quality
While there are always a number of examples of companies or assets that ultimately fail achieving great returns for investors over the short term, it is always impossible to know when the market will turn against you and the underlying weakness of the poor quality asset drives the value down. Further, during a market downturn, it is always the weaker companies or assets that fail first. Smart investors will always try to hold quality assets that have solid foundations and are more likely to survive a downturn in the market.
Principle 3: Focus On Simplicity, Understandability And Comfort Level
Never buy anything you don’t really understand or at least feel comfortable with. You need to be able to make informed decisions on whether you should be holding, selling or buying more of a particular security and you must have some basis on how to make these decisions. For example, while you might read in the paper that "everyone is buying bitcoin", without a basic understanding of the new cryptocurrency, you are simply making a blind (and very risky) bet.
Principle 4: Let Time Work For You
Investors are fickle. They tend to hold a stock while things are fine but when the going gets tough, they sell. They are also generally too focused on and influenced by the short term price fluctuations of a particular security since real time prices are available online and investors often set up alerts to warn of price movements. But, checking the stock price everyday (or every hour) can be counter-productive. Imagine if you could check the price of your house every day (and in some places you can with online tools such as Zillow). This might be beneficial for the moving companies as people move from house to house looking to maximize their returns and avoid losses but it wouldn't make sense over the long term. When you have a good, quality stock, hold it and enjoy the returns.
Principle 5: Cut Your Losses And Let Your Profits Run
The corollary to the previous principle (try to hold good stocks for a long time) is to try to identify when a good stock has gone bad, and eliminate it from your portfolio. The price you paid should not be particularly relevant except perhaps from a tax standpoint. The only issue of importance is what you expect the shares to do from on. As such, investors have a tendency to want to take a profit and are not very willing to take a loss. The result of these preferences is that investors will tend to sell a good stock which has appreciated.
Principle 6: Invest Consistently
There can be great benefits for investors who invest on a consistent and structured basis, One method of achieving this goal is a concept called ‘Dollar Cost Averaging (DCA).” The principle behind DCA is that the investor invests a fixed dollar amount in a particular investment on a regular basis (weekly, monthly, quarterly etc.), and in so doing is able to buy more shares when the price is down and fewer shares at higher prices. The end result is that the investor owns the stocks at an average cost that is lower than the average price of the investment over time.
Principle 7: Don’t Own ‘Timing” Stocks If You Can’t Time Them
Some companies tend to grow regardless of the economy – food, utilities etc... – whereas others tend to be more sensitive to economic swings---resources stocks, manufacturing concerns, economy-sensitive industries, etc... Both groups can have attractive investment characteristics, but they must be treated differently.
Principle 8: Buy Stocks That Pay A Growing Dividend
Dividend growth is the tangible evidence of earnings growth which is what ultimately drives stock prices over the long term. But equally important is the fact that rising dividends are the best way to ensure future income. And in this regard, the rate at which dividends grow is often more important long term than the current dividend rate.
Principle 9: Reinvest Your Dividends
The only thing better than receiving growing income from dividends, is re-investing them!
Principle 10: Hold A Diversified Portfolio Of Equities
Many investors mistakenly assume that they can purchase one or two stocks and they will do well. In the absence of good luck, this can be a dangerous strategy since there is always a risk of a stock declining in value or actually going out of business. The more stocks one holds, the less the impact on the overall portfolio of one poor performing security.
It is also important to diversity among types of stocks, industry groups, regions, etc.
Principle 11: Diversify Internationally
Most Canadians own their home in Canada, work in Canada, and have all their assets in Canada. For that reason, many investors should also consider putting some of their assets outside of Canada. Why? The same basic diversification issue. The Canadian markets do relatively well versus other international markets some years, and relatively poorly other years. Some exposure to other markets will usually raise the long term returns and even out the fluctuations of these returns.
Principle 12: Check Your Expectations
It is important that an investor’s expectations be consistent with what it is possible for financial assets to return. History can be a reasonable guide. It shows that stocks have provided an average annual return of approximately 10% per annum over the past 40 years.