With a long-term portfolio, the goal is to earn a constant rate of return over a long period. Sadly, even with this in mind, investors end up making decisions that jeopardize their long-term objectives.
They make mistakes, but luckily, the effects of these mistakes can be easily controlled, saving their portfolio from disaster—it all comes down to these three principles of smart long-term investing that every investor needs to know when building their long-term portfolio.
When There's Rising Optimism, Go into Protective Mode
Too often investors try to predict when the exact bottom or the top will occur. It is dangerous for their portfolio, and long-term investors should certainly avoid doing this. Investors have to know that they can be very wrong and face massive losses if their predictions don't come true.
With this said, there are certain things an investor can look out for when predicting if a top or bottom is near, allowing them to then act accordingly. For example, there's a saying: "Buy when there's blood on the streets." Investors should follow this saying as a guideline of when the bottom is nearing. This essentially means to buy when no one wants to buy. Those who remember will recall that in March of 2009, we had a very similar situation to this.
If there's increasing optimism, such as we see these days, investors should be worried and go into protective mode; rising optimism is an indicator of a top. Raise cash in your portfolio, and wait to see where the markets go. Aggressively buying new stock to add to your portfolio as the optimism is increasing can be very dangerous.
Don't Attempt to Know Everything About a Stock
Too often, investors try to learn everything about their investments and spend a significant amount of time researching. It's a good practice to research, but digging into very minute details can cause investors to make faulty decisions—a sort of information overload. Knowing the core business of the company certainly helps; investors also look at the bigger picture for the business, which includes their earnings potential and so on.
Investors dedicated to finding out everything about an investment have to know that while there may not be an explicit cost to their portfolio, there is an implicit cost and that cost is their time. Investing for the long term isn't easy, and this pursuit to know everything can make it even more difficult.
Dump Stocks When They're Not Working Hard Enough for You
An investment, at the very basic level, is an asset that is used to make money. It can be a stock, bond, or a house, among many other securities. Investors have to keep one important factor in mind: if their investment isn't making money, it can't be called an investment. The best idea would be to reduce your exposure and sell.
The idea behind this is simple, but sometimes, long-term investors forget it: you want your money to work hard for you. Investments that are providing a negative return aren't working hard for you, so it may be time to dump them. At the same time, if investors continue to hold these negative investments in their long-term portfolio, hoping they will recover, they will not only lose money, but they'll also miss out on a future buying opportunity elsewhere.
This article The Three Basic Principles of Profitable Long-Term Investing by Mohammad Zulfiqar, BA was originally published at Daily Gains Letter.