Long term investment in stocks plays an important role in any investment. Although the investment in stocks is full of uncertainty, certain proper principles can assist investors to increase their chances for success in the long term investment in stocks.
The ideal way to make money in stocks is to invest in quality stocks in the long run. The quality stocks may be referred to as good and clean companies. These stocks are sufficiently fundamentally strong companies.
It is a common practice that many investors lock their profits by selling their valued investments, and at the same time, they hold their under-performing stocks with the hope that these stocks will rebound shortly. However, good stocks go up further and bad stocks go down further. Therefore, it is required to take correct decisions during the buying and selling of stocks during the long term investment in stocks.
The general investment advice in stocks is riding the winners and selling the losers.
Peter Lynch once told about Tenbaggers which means that the long term investment in stocks that yield ten times their value. However, he ascribed his achievement by keeping a few stocks in his portfolio, by following proper disciplines. This means that if you follow proper disciplines in investments, you can achieve multiple returns in a few years.
Before going ahead, you should know the definition of long term investment in stocks.
Definition of Long Term Investment in Stocks
Any investment in stocks in which a person holds for more than a year is known as a long term investment in stocks. The long term investments are largely different from the short term investments (holds for some days or weeks).
The long term investment in stocks will not be sold for years, and in some cases, it will not be sold forever. The long term investors can obtain maximum returns (or multiple returns) in a long run, and they only focus on this point. At the same time, long term investors generally take more risks in their investments for higher rewards.
Goals of Long Term Investment in Stocks
Long term investment in stocks proposes numerous advantages. In general, the long term investment in stocks is held for 3 years or more, however, this kind of investment option requires commitment even if you face financial difficulties in between.
Long term investment in stocks provides higher returns. It is known as the long term due to the reason that you invest in stocks and forget until it gives a higher return. This kind of investment is well-matched for your child’s future such as education, marriage, and lifestyle.
Other goals of long term investment in stocks may be as per the following.
To buy a house
To start a business
To save money for the future
To pay off the debt
To retire with rich
To achieve financial freedom and retire early, etc.
9 Tips for a Successful Long Term Investment in Stocks
Getting success in long-term investments in stocks, you should follow some rules. These are explained below.
1. Focus on the Stock Quality
Stock quality plays an important role in investing. Be sure that the stock quality is good. It is my experience that if the stock quality is good, it will give good returns in the coming years.
2. Focus on the Long Term Perspective
Investments in stocks require informed decisions yet to occur. It is essential to invest in stocks based on future potential rather than past performance. The past performance cannot be guaranteed as future performance. Therefore, be careful in this matter and focus on the long term perspective of the stock.
3. Follow the Value Investing Principle
Value investing is nothing but to choose stocks whose present value is less than their intrinsic value or true value. The value investors buy a good quality stock when the stock price is undervalued (means the current market price of the stock is less than the intrinsic value of the stock). The famous investor Warren Buffett used the value investing principle to pick stocks.
You can use my online stock intrinsic value calculator (given in the below link) to check whether a stock is suitable for value investing or not. Moreover, the quality of the stock must be good. If the stock quality is bad, it may not yield higher returns in the long run.
It is also necessary to correctly find the stock intrinsic value by putting correct fundamental parameters.
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4. Follow a Workable Strategy
It is important to follow a single strategy to pick stocks for long term investment. Although there are several strategies to pick stocks, following a single and working strategy can give you success in long term investment in stocks.
5. Don’t Put High Emphasis on the Price-to-Earnings Ratio (P/E Ratio)
The P/E ratio of a stock is the ratio of the current market price of the stock to its earnings per share (EPS). Many investors give high attention to the P/E ratio like a P/E ratio of less than 15 means the stock is undervalued. However, it is not correct. It is not advisable to consider a single metric like the P/E ratio to evaluate a stock. The P/E ratio should be used in conjunction with other fundamental parameters. It is better to calculate the stock’s intrinsic value to correctly justify whether a stock is undervalued or not.
Hence, a low P/E ratio of a stock does not essentially mean the stock is undervalued. Similarly, a high P/E ratio of a stock does not essentially mean the stock is overvalued.
You can see in the above figure that:
The P/E ratio is very low but the debt-to-equity (D/E) ratio is very high. Be careful!
6. Don’t Put High Emphasis on the Price-to-Book Ratio (P/B Ratio)
The P/B ratio of a stock is used to compare the market value of the stock with its book value. It is calculated by dividing the stock price by its book value per share.
Many investors give high attention to the P/B ratio, like a P/B ratio of fewer than 1 means a solid investment. However, it is not correct. The only P/B ratio should not be used, and it should be used in conjunction with other fundamental parameters that define the stock quality. It is better to calculate the stock’s intrinsic value to correctly justify whether a stock is undervalued or not.
Again, a low P/B ratio of a stock does not mean the stock is undervalued. Likewise, a high P/B ratio of a stock does not mean the stock is overvalued.
7. Diversify Your Portfolio
Putting all eggs in a single basket can create problems when the basket falls. Similarly, putting all the money in a single stock or a single sector creates problems when the stock or the sector goes down. Hence, it is a must required to point to diversify your portfolio to get better returns.
It is very difficult to correctly predict the market. In other words, you can say that the market is unpredictable. Likewise, it is not possible to perfectly predict which single stock or single sector will go up and which single stock or single sector will go down. Therefore, the term diversification of stocks comes into play.
This is the problem with the new investors who put a maximum of their money in a single stock or a single sector. If the stock or the sector falls, you know very well that what the condition will be.
All right, all people know that the condition will be very painful. So do not put all your eggs in a single basket. It is better to put a fraction of eggs in different baskets.
Did you understand?
I think now you understood the benefits of diversification of your portfolio.
In a simple term, diversification is a risk management strategy that mixes a large variety of stocks from different sectors within your portfolio. Therefore, the diversification of your portfolio maximizes your potential return.
8. Sell the Loser
Finally, I would like to say:
Sell the major loser if the stock quality is not good.
Sometimes, people buy stocks in a hurry without doing proper research. After some days or months, the stock undergoes a major decline. It is better to sell the major loser and reinvest the money in good quality and undervalued stock. There is no guarantee that the loser stock will rebound early after a major decline.
However, if you are sure that the loser is a good quality stock and also undervalued, you can hold it.
9. Focus on the Long Term Capital Gains Tax
The long term capital gains built up from selling long term stocks. Hence, you should consider this point while selling your stocks.
You should always remember:
It is all about following the disciplines in investments. Don’t break or avoid the disciplines.
For a successful long term investment in stocks, follow the two golden principles:
Rule number #1: The stock quality should be good.
Rule number #2: The stock should be undervalued at the time of buying.
If the stock is technically sound for buying, it will give immediate returns after some days or weeks. And this point can be added as an optional Rule Number #3.
I hope you enjoy the post regarding the long term investment in stocks. If you have any queries or suggestions, you are always welcome.
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