Everyone is seeking a quick, easy path to riches and lifelong happiness.
You have probably stumbled across articles entitled:
- Beat the Stock Market in 3 Easy Steps
- 7 Mind Blowing Secrets to Beating the Stock Market
- The 6 Secrets to Beating the Market
These are REAL articles that people read in search of finding that elusive knowledge to beat the market consistently.
In fact, if you have come across this article, you may be searching for such “elusive” advice.
But what does “beating the market” even mean?
Generally speaking, beating the market occurs when your investment return exceeds the performance of the Standard & Poor’s 500 (S&P 500) index.
The S&P 500 is one of the most popular indicators of the overall U.S. stock market performance.
Everyone sets out to beat this index, but few succeed.
But, let me tell you straight up…
…you have come to the right place!
And I will tell you right now – there really is no beating the market!
Even most professional fund manager can’t reliably beat the market.
You may be able to beat the market every now and again, but it is impossible on a consistent basis.
Consider the investment fees, taxes, and investor emotion working against you, and you are already at a disadvantage.
But do not let this information discourage you…
…in fact, this information should ENCOURAGE you.
There are time-tested investing tips that can put you on the path to financial freedom.
Because let’s face it, entering and being in the stock market is a difficult decision for everyone.
The market highs and lows are difficult to contend with, especially for a first-time investor.
The best part? There is no need to beat the market.
Follow these tips and you will be on your way to financial freedom.
Invest for the future
What are your reasons for investing in the stock market?
Are you saving for retirement, to purchase a home, or to set your loved ones up for life?
You need to define “why” you are investing before you begin investing.
Knowing your purpose and when you need your money is key to setting up a winning strategy.
For example, if you will need your money back in a few years…
…the stock market may not be the correct place for your money.
The market can go up, down, and s i d e w a y s which ultimately provides no certainty that all your money will be there when you need it.
If you know how much money you will need and when you will need it, you can determine:
- How much to invest;
- Where to invest; and
- What kind of return-on-investment you require.
Here is how these calculators work:
Rate of Return: 8%
Number of Years: 35
Your potential investment return: $73,926.72
As you can see, the rate of capital growth you see is determined by:
- The amount of money you invest;
- The amount of earnings on your money; and
- The number of years of your investment.
If you take the example above and change the amount to $10,000, you would earn $147,853.44.
If you take the example above and change the number of years to 10, you would earn $10,794,62.
What is the point of these examples? Invest early, often, and for the long haul.
However, the money you need soon should not be in the stock market.
Money that you are investing for the long-term should not be in a savings account.
Here is how to invest your money for short-, mid-, and long-term financial goals
Short-Term Investments (less than 3 years)
Online savings or Money Market account
Forget your brick-and-mortar bank! The 0.05% savings interest rates are highway robbery.
Online savings and money market accounts are great for regular or emergency savings because they are highly liquid and can provide up to a 2.5% rate of return.
The risk is very low, and this account is geared toward saving for the short-term.
Risk level: Very Low
Mid-Term Investments (3 to 10 years)
Certificate of Deposit (CD)
CDs are an excellent choice for guaranteed returns over a fixed period of time and can provide up to 3.5% rate of return.
You can find CDs with terms ranging from 3-months to 6 years. Typically, the longer the term, the higher the interest rate.
So, if you know you will not need your money for a set period, CDs are a great option.
Risk level: Low
With this investment, you loan money to other people in exchange for interest and can provide up to 8% rate of return.
Risk level: Mid to High
Short-Term Bond Funds
Bonds are loans you make to companies or the government, and you earn money via interest payments on the loan. You can earn 2.5% to 3.5% on short-term bond funds.
You can buy low-cost index funds that hold corporate bonds, municipal bonds, U.S. government bonds, or a mix of these types of bonds.
Risk level: Low to High
Long-Term Investments (10+ years)
Equity Index Funds
For long-term investments, you should be putting your money toward equities (stocks). You can weather the market ups and downs, and earn 7% to 10% doing so.
Pro tip: Look for low-transaction fee funds with low expense ratios.
Risk level: High*
Exchange-Traded Funds (ETFs)
ETFs trade like a stock, but behave like an index fund. Therefore, if you are on a budget, ETFs may be more attractive than index funds. ETFs can earn 7% to 10% returns, on average.
Risk level: High*
*Note: High risk levels are not inherently bad, just be sure to have a longer time horizon.
Understand your risk tolerance
Risk tolerance is an essential concept in investing. So, what is risk tolerance?
“Risk tolerance” is the degree of volatility, or market ups and downs, an investor is willing to withstand.
You should have an idea of your ability and willingness to handle large fluctuations in the value of your investments.
If you take more risk than you can handle, you are likely to sell at the wrong time (and lose your sanity).
On the topic of sanity…
…your investments should not keep you awake at night!
You can think about tolerance like this:
- Would you risk $5 to win $500?
- Would you risk $500 to win $500?
Everyone’s answer will be different, and there is no “correct” answer.
Risk tolerance combines many factors, such as age, education, income, wealth, and personal experience.
Leave your emotions on the sideline
The biggest challenge to stock market profits for many is controlling emotions and making logical decisions.
In the short-term, stock prices reflect the sentiment of all investors combined.
When the majority of investors are worried about a company, the stock price is going to fall.
When the majority of investors are confident about a company, the stock price is going to rise.
Does this feeling make these people correct? Absolutely not!
Investors love buying investments at the top and selling at the bottom.
Many investors get lost in the media hype (or fear) and buy or sell based on this general sentiment.
Warren Buffet said it best:
“Success in investing doesn’t correlate with IQ … what you need is the temperament to control the urges that get other people into trouble in investing.”
When people see their investments tumble, what do they do?
They run to their broker and sell.
Investor emotion can overpower rational thinking during times of stress. That stress can come from opportunities to buy and decisions to sell.
Therefore, taking a rational and realistic approach to investing is essential.
When you purchase a stock, you should be clear on the reasons for your purchase.
Choose companies, not stocks
It is easy to forget that you are becoming “part owner” of the company whose stock you purchase.
You turn on the television, flip to CNBC, and see ticker symbols scrolling everywhere…
…and suddenly stocks seem like a foreign concept.
To further complicate things, you can evaluate stocks based on hundreds of different criteria.
But if you take a step back, you realize investing does not need to be so complicated.
At the end of the day, you are purchasing part ownership of a real BUSINESS.
You need to know things like:
- How the company operates;
- Who the company competes against;
- How the company will succeed long-term; and
- How the company fits into your portfolio.
Forget about earnings per share, price earnings ratio, and other metrics until you can answer these questions.
Start with the basics
Before you make your first investment, you must learn the basics about the stock market.
This advice goes together with choosing companies, not stocks.
Unless all of your investments will be funds, you are likely to focus on individual stocks.
Here are a few key areas to focus on:
- Financial Metrics. Learn the definitions of metrics like:
- Book value per share = Shareholder funds / Total number of shares
- Price earnings ratio (P/E) = Price per share / Earnings per share
- Earnings per share (EPS) = Profit after tax / Total number of shares
- Price-to-Book ratio = Market price per share / Book value per share
- Market Order Types. Learn the market order types like:
- Market order: Order to buy or sell a security at the best available price immediately.
- Limit order: Order to buy or sell a security at a specified price or better.
- Stop order: Order to buy or sell a stock once the price reaches a specified price (i.e., the “stop” price).
- Buy stop order: Order entered at a stop price above the current market price.
- Investment Accounts. There are cash accounts and margin accounts:
- Cash account: Open this account to trade stocks, mutual funds, etc. with cash.
- Margin account: Open this account to borrow cash to purchase securities.
Diversify your investments
One of the best ways to manage risk in your portfolio is through diversification.
You can diversify by looking for investments that are different from the ones you currently own, for example:
- Search for different companies
- Invest in different industries
- Purchase different types of securities (cash, stocks, bonds, ETFs, mutual funds, etc.)
- Different rates of return
- Look in different countries (foreign)
You want a good mix in your portfolio to prevent a single adverse event from decimating your portfolio.
To put diversification into action, check out this example:
You begin investing in 4 different stocks.
At the end of the year…
- Stock A and Stock B are up 20% each
- Stock C and Stock D are down 10% each
Take Stock A and Stock B (20% x 50%) and Stock C and Stock D (-10% x 50%), and you are up 10% on the year.
While this example is simple, it shows the impact diversification has on a small scale.
If you invested solely in Stock A or Stock B, you would have gained 20% on your investment.
If you invested solely in Stock C or Stock D, you would have lost 10% on your investment.
But we are not investing to gamble money, we demand regular returns!
Avoid checking too much
You should check your stocks once per quarter.
We realize that it can be challenging to monitor them on a day-to-day basis.
However, this type of monitoring can lead to overreacting to short-term events.
Investors that do over-monitor their investments focus on share price instead of company value.
Accordingly, these investors sell when there is no need to sell!
When one of your stocks hits choppy waters, figure out what is triggering the event.
You can look at the highs and lows of any stock and determine the news event that triggered the price change.
Be sure to consider questions like:
- Did the stock drop from an unrelated event?
- Did the stock drop due to a change in the company?
- Does the price change reflect the long-term outlook?
Price fluctuations happen, and rarely are they indicative of performance over the long-term.
To put it simply, leverage is investing borrowed funds to increase return on investment.
Investors leverage their investments by using instruments like options, futures, and margin accounts.
Here is an example of how leverage works:
Let’s say that you have $100 to invest, and can borrow $1,000 from the bank at 6%.
You invest the total $1,100 in one investment which you believe will grow by 15% this year.
The value of your investment will be $1,265 at the end of the year.
From there, you pay the bank back $1,000 + $60 = $1,060.
…and what do we have?
Investment value: $1,265
Loan re-paid: ($1,060)
Initial cash: $100
Net gain: $105
You earned a 105% return on this investment!
Imagine how that example would play out on a larger scale. When leverage works, it works very well.
The more leverage you have, the great your return can be. However, the losses can be equally significant.
If you take the same example and assume a -50% return on investment, you would be left with $550 with a $1,060 loan to re-pay!
Leveraging your investments makes your returns more volatile which goes back to risk tolerance.
Can you handle the volatility associated with leverage?
Heck, if you are seeking more risk, why not increase your asset allocation more toward equity?
Very few people should be using leverage, and you are likely not one of them!
Nevertheless, leverage is a tool that is neither good or bad. However, you need plenty of experience before using this tool.
Are you ready to put these stock tips to work?
If you are ready to start investing, you will at least need a brokerage.
However, there are also numerous tools that you can use to improve your investing process.
This section will cover those brokerages and additional tools that you can use to WIN as an investor.
Here are some of the online brokerages that we suggest:
TD Ameritrade is one of the largest discount brokers and a “one-stop shop” for traders and investors.
The company offers a user-friendly platform and tools, top-ranked customer service, and no minimum account balance.
Ally Invest is one of the top low-cost online brokerages with tons of free research, data, and analysis tools.
The firm offers rock-bottom commission fees, superior investing tools, and no minimum account balance.
Here are some of the mobile apps that we suggest:
Robinhood is a free trading app that allows you to trade securities without paying commissions or fees.
The app is an excellent tool to buy and sell stocks because it is 100% FREE.
Stash Invest allows users to purchase fractional shares of stock which makes investing easy and affordable.
You can also access educational resources, “themed” investment categories and a free retirement account for those under the age of 25.
Here are some of the newsletters that we suggest:
Motley Fool Stock Advisor
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You are part of the few, and the proud, people who read the entire article.
The goal of this article has been to cut through the noise coming from self-proclaimed financial gurus, internet advertisements, and your Uncle John.
So, what have we learned today?
- Invest for the future
- Understand risk tolerance
- Leave your emotions on the sideline
- Invest in companies, not stocks
- Start with the basics
- Diversify your investments
- Avoid checking too much
- Avoid leverage
Follow these tips and you will be on your way to becoming a prudent investor.
Investing in the stock market is a tremendous opportunity to grow your wealth over time.
Be sure to save consistently, invest the time to understand your investments, take the appropriate levels of risk, and watch your money grow!
What are you waiting for?
Get out there and start investing!
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