Some investment rules of thumb will help your portfolio, while others will cost you money. Here’s how to tell the difference.
You can find numerous investment rules of thumb that aim to tell you when to buy or sell. Most are based on chart-reading or technical analysis. All these work at times, but none work consistently. When they fail, the profits you miss out on are likely to overwhelm any risk they help you avoid.
Meanwhile, one of the top investment rules of thumb — that does work — is that you can cut way down on times when you really need to sell by consistently buying well-established, high-quality stocks.
These stocks can still drop sharply when the economy falters or bad news strikes, of course. But these are the stocks that snap back quickest and most reliably when the trend reverses and bad news comes less often. That’s why it generally pays to hold on to stocks like these through market setbacks.
Here are successful investment rules of thumb to help bring profits to your portfolio
- Avoid buying and selling too often
- Avoid buying too many low-quality investments
- Avoid portfolio tinkering, especially when it comes to selling stocks that have gone up too far and too fast
- Diversify across industry sectors
- Avoid buying too many stocks in the broker/media limelight
- Build a balanced portfolio
- Utilize proven strategies for compound interest
- Keep fees low with traditional ETF picks
- Look for hidden assets
- Look for dividend-paying stocks
One of the best investment rules of thumb is to stay out of new stock issues
Companies sell new issues (also called Initial Public Offerings, or IPOs) to the public when they feel it’s a good time to sell. That may not be, and often isn’t, a good time for you to buy.
In addition, the underwriting brokerage firms try to spark publicity about the new issue, and they pay extra commission (as much as double the regular rates) to spur their salespeople to sell the new issue to their clients. This tends to create a high-water mark in the price of the new issue. Unless the new company can follow up with business success, the price of the new issue may languish for months or years.
Some new stock issues — so-called “hot new issues” — depart from this pattern. They begin moving up as soon as they hit the market. Some even “gap upward” on their first day of trading: that is, their first public trading takes place well above the new issue price.
This possibility attracts buyers who fail to appreciate how rare it is. In addition, the underwriting brokers can generally tell when this is going to happen, by judging the reaction of their biggest clients (who of course get first pick on their new issues), and the media. They reserve most of their allotments of hot new issues to their biggest and best clients.
New clients and occasional new issue clients may get to buy only token amounts of a hot new issue, if any.
Speaking very generally, your best course of action as an investor is to stay out of most new issues. You’re better off to wait until they have been trading for a few years and have shown some of the potential that the initial hype promised.
The sell-half rule is one of our investment rules of thumb for aggressive investors
Selling half of hot stocks that surge helps you guard your profits. But in general, apply this rule only to more aggressive stocks, and not to the well-established stocks that may surprise you by going a lot higher in the long run.
Selling half after a stock’s price doubles makes sense in a high-risk investment such as a penny mine. That way, you get back your initial stake. This can give you a clearer perspective on what to do with the other half of your investment. If you are too slow to sell speculative stuff, after all, your profits and even your principal can evaporate all too quickly.
However, as mentioned, it’s a mistake to apply this rule to your best holdings that are not high-risk investments. To succeed as an investor, you need to hold on to your best picks for lengthy periods. If you’re too quick to sell, you’ll never hold a stock that vastly outperforms the market, and you need a few of those to offset the inevitable disappointments.
Use our three-part Successful Investor approach to build a top portfolio
- Hold mostly high-quality, dividend-paying stocks.
- Spread your money out across most if not all of the five main economic sectors: Manufacturing & Industry, Resources & Commodities, Consumer, Finance and Utilities.
- Downplay or stay out of stocks in the broker/media limelight.
What are investment rules of thumb that you consistently follow in your investing career?
Have you followed any investment rules that led you in a bad direction?
Pat McKeough has been one of Canada’s most respected investment advisors for over three decades. He is the founder and senior editor of TSI Network and the founder of Successful Investor Wealth Management. He is also the author of several acclaimed investment books. This article was published on Nov. 18, 2022 and is republished on the Hub with permission.