Are you enjoying the volatility in the markets now? I am assuming that the answer is probably no.
It can be quite nerve-wracking watching the values of our portfolios go up and down faster than US President Donald Trump can change his mind about anything and everything. If not for him, the investing world could be a much calmer place.
But we don’t get to choose the conditions that we invest in, especially if we are long-term investors. Whether we like it or not, if we invest for long enough, we will eventually encounter a maverick leader who will try to upend the natural order of things.
Most of us are likely aware that investing in shares is the best way to grow our wealth in the long run. We are probably also aware that investing in the stock market is one of the best ways to beat inflation over the long term.
But market volatility can make it very difficult at times. Here are my five tips on how to enjoy investing and avoid sleepless nights.
1. Avoid Hot Sectors
Chasing the latest fads has burnt holes in lots of investors’ pockets. Yet, many private investors keep falling for the hype that we need to buy shares in hot sectors to make the best returns. Nothing could be further from the truth.
Boring as it may seem, some of the best long-term investments are those that pay regular dividends and could grow steadily over time.
There can, however, be a place for speculative stocks within a portfolio. But they should not be the focus. The overall performance of a portfolio should not hinge on just a handful of counters.
2. Don’t Overtrade
Don’t be conned into thinking that we need to buy and sell often to make money. Overtrading can be very easy to do, if we listen to sell-side analysts. But it can badly damage our overall performance. Each time we buy and sell shares, we incur costs.
Don’t be taken in by brokers that promote commission-free trading. The difference between the buy and sell price of a counter is still a cost. Those costs can mount over time, and those deals will inevitably eat into our returns.
Constantly buying and selling shares also implies that we can accurately time the market each and every time, which is almost impossible to do.
3. Don’t Borrow to Invest
Perhaps one of the most important rules of investing is to invest only with money that we don’t need. This should ideally be for five years or longer, if possible. In my case, it is forever.
We should never put ourselves in a position where we are forced to sell shares at short notice. Chances are, it can happen when stock markets are down and share prices are depressed.
If we do want to sell shares, then it should be at a time when it is favourable to us rather than when we have to. It therefore goes without saying that we should never borrow to invest.
4. Diversify
One of the secrets of successful investing is to minimise risk while maintaining an attractive return on our investments. One of the best ways to do that is to diversify by holding a wide portfolio of shares.
It is estimated that a portfolio of around 20 counters in different sectors should reduce risk sufficiently for most investors. Around three-fifths of the portfolio could be in shares that generate a reliable stream of strong income.
About a third may be in counters that could grow quickly. The rest of the portfolio could be in more speculative shares, such as some counters in those hot sectors highlighted earlier.
5. Stay Focused
Finally, try to stay focused. If growth is our lodestar, then pay attention to the earnings per share that our chosen investments are generating. If we are an income investor, then we should be watching the income being generated by our portfolios.
Provided the earnings are rising or the dividends are growing, it could mean that our portfolios are performing well. If we are easily upset by share-price volatility, then we probably don’t know enough about the companies we have invested in.
Just bear in mind: We don’t like volatility when it causes our shares to drop in price, but we don’t mind it if it causes share prices to rise. We can’t have it both ways.
When we invest, we have to accept that share prices can fall as well as rise. But over the long term, the returns we could achieve should be better than the returns from investments such as bonds.
The equity risk premium, or the excess return that we earn over risk-free assets, is our reward for staying invested over the long term, even in times of conflict.
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