Investing can seem incredibly complicated and intimidating, especially for the novice.
There are thousands of stocks and almost as many funds to choose from, not to mention stock markets that always seem volatile and uncertain.
Even tougher is deciding when and how to sell a stock or fund to lock in gains or limit losses.
It helps to follow a simple strategy to help make these decisions pretty much automatically. Here are four principles that will help you get started…
#1: Build a Diversified Core Portfolio
Leonardo Da Vinci was right when he said, “Simplicity is the ultimate sophistication.”
And legendary global investor Sir John Templeton really nailed it with his sage advice, “Diversify. In stocks and bonds, as in much else, there is safety in numbers.”
For your core portfolio, I suggest going with low-cost, tax-efficient exchange-traded funds (ETFs) as building blocks.
As I describe in my book, Think Global, Grow Rich, this core portfolio has capital preservation as its primary goal, and capital appreciation as a secondary goal. It’s a well-diversified portfolio with allocations to fixed income, broad U.S. equity markets, exposure to high-quality international markets, income- and dividend-oriented ETFs, gold, and even some exposure to other strong currencies – in case the dollar falls off its perch.
#2: Set Aside Ample Cash
After setting up a core portfolio, you should set aside a comfortable cash position of at least six months’ worth of living expenses. This is where I differ from many other advisors who want their clients to always be fully invested.
Another reason to keep a lot of cash in your brokerage account is to be able to take advantage of markets and stocks when they’re on sale. You want to have the ability to move quickly and not have to figure out which stocks to sell in a hurry.
#3: Seek Capital Gains With Your Explore Portfolio.
Any capital you have left can go to your “explore” portfolio with the full recognition that seeking capital appreciation means higher risk and volatility. You still need some diversification in this portfolio, but you should also feel free to look at aggressive asset classes like emerging markets, commodities, sector ETFs, and individual stock ideas.
One great way to gain exposure to international markets is through country-specific ETFs.
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Using country ETFs also gives you a hedge on the U.S. dollar weakening since, for example, when you buy the Switzerland ETF, you also gain exposure to the Swiss franc. Pick countries that are out of favor, and with time, you’ll enjoy solid gains.
For individual stocks, stick to investing only in companies you understand.
Invest only in what you know. Don’t just accept someone else’s opinion; do some independent homework on your own.
And try to avoid complicated stories, because managing these companies is difficult and there are just too many things that can go wrong.
#4: Capture Gains and Limit Losses
We’ve all been there. Nothing is more painful than picking a great stock and watching it peak and then fall back to earth. Don’t ride the rollercoaster with your investments.
If you’re fortunate enough to have a stock or fund double in value, immediately sell half of your position to protect profits.
And whenever you buy a stock, it’s smart to put in place a 20% trailing stop loss. This means you have an automatic exit if your stock falls 20% from its high. This is important because it takes emotion out of the equation and protects your hard-earned gains, or limits your losses, so you can fight another day.
It’s not a perfect approach, and sometimes that darn stock will rebound just after your stop loss strategy tells you to sell it. This is irritating, but much less painful than watching all your gains evaporate day after day, right before your eyes.
Follow these four simple rules, and you’ll be way ahead of the crowd.