5 Principles Every Smart Investor Needs to Follow

A lot of investors, particularly beginners, believe that there’s some mysterious secret to making money in the stock market. Of course, they have some help in this area from the would-be stock market gurus who feed into exactly that belief. In truth however, there is no secret at all but principles — principles every smart investor needs to follow.

There’s actually nothing fancy in those principles either:

1. Avoid Distractions

Distractions are one of the biggest problems facing all investors, including seasoned investors. You set up an investment strategy, create a portfolio that fits that strategy, and then leave it alone so that it can do what you intended it to. All of a sudden, along comes the moneymaking strategy du jour, and you find yourself questioning your original strategy.

The problem with new stock market strategies is that there’s a new one just about every day. If you spend too much time chasing too many strategies (even if they seem reasonable) you won’t be able stay with any one of them long enough to ever profit from the effort.

Changing strategies is like trading stocks — you have to baby-sit your portfolio closely, you incur increasing transaction fees, and you lose all sense of long-term direction. This is the very definition of the word distraction when it comes to investing — it’s anything that takes you away from your long-term plan.

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2. Be Disciplined

It’s easy to get sloppy with your investing. Sometimes it happens because life gets busy, sometimes because markets shift unexpectedly, and other times you just kind of get lazy and lose focus.

Smart investing requires that you create your asset allocation, fund your portfolio on a regular basis, and then rebalance as necessary. It’s not much more complicated than that, but those three steps alone require a commitment of time and effort — that’s the discipline part.

3. Think Long-term (Always!)

There are a lot of short-term trading strategies out there, and more coming around all the time. Most of them include carefully crafted marketing programs, with the promise of riches in just months or a couple of years. You’ve probably seen them — double your money in six months, earn 87% on your money annually, earn 17.9% per month — guaranteed.

For the most part, strategies such as these rely on short-term trading. As attractive as the marketing looks (made worse by the fact that there are always people who will swear by it), this is something that you need to avoid entirely. The real money being made in stocks is coming from those who are long-term investors. They buy stocks that represent real value, and hold on to them for years, not months.

There’s a saying, pigs get fat, hogs get slaughtered — and it’s one you should always keep in mind. When you get involved in short-term trading strategies, you increase the transaction fees that you are paying, and you incur short-term capital gains taxes — the kind that don’t get the benefit of lower long-term capital gains tax rates.

Worse, you are subject to the ups and downs of the market. If you’re holding a bunch of positions in which you hope to earn 10 percent on your money within the next 30 days, and the market tanks 20 percent, you’ll be stuck. With long-term investments however, your plan is to ride out any declines, because the stocks you hold have value, and the greatest profits will come in the future.

4. Diversify to Mitigate Risk

Most investors clearly understand the importance of diversifying their investment portfolios. You’re spreading your investments across different industries, different companies within each industry, and non-equity type assets, as a way of minimizing risk.

But diversification can disappear when a certain portion of your portfolio is performing much better than the rest. For example, let’s say that you are holding technology stocks that have been returning 30 percent per year for the past three years — while the rest of your portfolio has mostly languished.

Human nature being what it is, you may gradually allow your technology holdings to grow to where they constitute most of your portfolio. Everything will be fine — as long as the technology sector continues to prosper. But should it get clobbered, your portfolio will take outsized losses compared to the rest of the market.

Moral of the story: diversify no matter what’s happening with any single investment asset sector.

5. Focus on Quality

In #3 — Think Long-term — we talked about buying stocks with real value. The connection between quality stocks and long-term investment strategies is virtually symbiotic. You buy stocks that represent real values — based on market position, financial strength of the company, history of investment returns, and even market sentiment. You hold onto the stocks for years, and the returns will be there.

That’s what it means to focus on quality when it comes to investing. You’re not merely buying a stock because it has been performing well in recent months or years, but rather investing your money into successful companies that have a very long track record of growth, often over a period of decades.

This is the kind of investment that will payoff eventually, even if the market is struggling in the short-run. Quality stacks the long-term in your favor, and that’s why you should always favor it in your investment choices.