By Dale Gillham
Over the past twenty years, I have been fortunate enough to be involved in helping thousands of people achieve their financial goals. However, a common theme,which became apparent in the early days of my career, is that most people don’t know where to begin their journey towards achieving financial independence.Interestingly, in my experience, little has changed despite the enormity of information available on this subject.
The cold reality is that investing in the stock market is one of the few things you can do where you know from the outset you will lose money. The issue I find is that while many people agree with this statement on an intellectual level, the majority never believe it will happen to them.
The irony is that most people seek out quick fixes to achieving their financial goals with the mindset that short-term gratification will fulfill their long-term needs.This is often spurred on by the proliferation of seminars available on trading the stock market. Whether the strategies presented actually work for you or not is usually of no concern once a sale is made. Indeed, from experience, I can say that all you really gain is a little bit of knowledge and very little understanding.
Think about it: If I spent a few days with you learning how to do your job, do you really believe I would gain the required knowledge or experience to be proficient?It is highly unlikely. Yet, many people are blinded by the instant gratification that the stock market offers, plunging head-first into the market using complex strategies in the hope of profiting from their efforts. Sadly, many have lost their capital, or a substantial portion of it, trying to implement these supposed wealth strategies. As a result of these poor experiences, many do nothing or seek out-advice from a financial planner or broker, believing this is their only hope of achieving long-term wealth. But is it?
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What I’ve learnt from over twenty years of investing in the stock market is this: gaining knowledge is one thing; it’s gaining the right knowledge and understanding that is critical to your long-term success in the stock market.While self-education requires both commitment and work, what I have discovered, and what I share with you in my book, Accelerate Your Wealth, is that you don’t need to be a genius or a rocket scientist to achieve consistently profitable returns in the stock market. In fact, I think it help snot to be a rocket scientist.
What people need to be truly successful in creating financial independence in the stock market is a practical framework they can follow that is tried and tested, and provides a higher probability of ensuring that they are consistently profitable while reducing their risk of losing. Therefore, what follows, are my four golden rules to success in the stock market. While some may see these rules as too simplistic, please do not underestimate the power of them, as they do really work and will make you a lot of money while reducing your risk. I then follow this up with how you can apply these rules regardless of the amount of capital you have to invest.
Golden rule #1
Irrespective of the amount of money you have to invest or the instrument you are trading, you should always spend the same amount of time researching your options to ensure you are protecting your capital on each and every occasion.
Golden rule #2
When constructing a medium to long-term portfolio, you should always aim to have between five and twelve stocks in your portfolio. The idea is not to have lots of stocks with small amounts invested in each; instead, you only require a small number of the right stocks, with larger amounts invested in each because:
- Smaller portfolios are easier to manage and represent lower risk
- It is far easier to select a smaller number of stocks that are rising in price. The result is increased returns.
- You will have fewer transaction costs when buying and selling stocks simply because a smaller portfolio will have fewer transactions.
Golden rule #3
Never invest more than twenty percent of your total capital in any one stock. If you invest in the stock market, you need to accept that some stocks will fall in value. However, this rule will help reduce your exposure to risk, while allowing you to achieve good returns simply because you are minimising the amount of capital you could lose at any one time.
Golden rule #4
You should only ever invest ten percent of your available capital in trading short-term highly leveraged markets and allocate the remaining ninety per cent to trading a medium to long-term portfolio. This is a very solid money management rule that allows you to take a low risk approach with your money while still achieving good returns on your capital.
Now that you know the four golden rules to success in the stock market that will help you Accelerate Your Wealth, let’s take a look at how you would initially construct your portfolio based on the amount of capital you have to invest.
One of the most common questions I get asked is: “How much do I need to start investing in the stock market?” You can begin investing with as little as a $1,000, although you will want to develop a savings strategy so that you can build up your portfolio until you hold at least five stocks. Because of transaction costs, I always recommend that the minimum amount you should allocate to a particular stock is $1,000.
Obviously, if you have less than $5,000 to invest, you will be breaking Golden Rule #3 which is to never invest more than twenty percent of your total capital in any one stock. Until your portfolio grows large enough to ensure you only ever invest twenty percent of your total portfolio in any one stock it’s okay to break this rule in the short term; for many, it is the only way they can get started in the stock market.
Once you hold a minimum of five stocks, you can begin to increase the amount of shares you hold in each company. If you sell a stock, reinvest the capital from the sale into another stock, as well as any savings you may have accumulated, to increase the amount you are purchasing. Gradually your position size will increase, rather than the amount of stocks you own, which will ensure you are able to manage your risk.
If you have less than $5,000 to invest, it is not recommended that you consider leveraging as part of your overall portfolio strategy until you build up your capital to around $20,000.
Small to medium investors
If you have between $5,000 and $20,000 to invest, you may still need to break Golden Rule #3, particularly if you have less than $10,000, as you want larger parcels of your capital invested in stocks, so that you minimise your risk. Therefore, if you have less than $10,000, I recommend you split your capital into parcels of twenty-five per cent so you hold four different stocks.
If you have $10,000 to $20,000 to invest, you would comfortably invest no more than twenty percent of your total capital in each stock. In other words, you would simply buy five different stocks to hold in your portfolio.
If you want to incorporate leveraging into your portfolio, I would only recommend this if you have $20,000 or more to invest. In this instance, you would allocate $18,000 to your medium to long-term portfolio and $2,000 to your short-term trading account, which would provide you with capital of $20,000 at 10:1 trading on margin. To minimise your risk when using margin lending, it is advisable that you avoid using all of the available funds that the lender provides. Allow yourself a safety margin in case something does go wrong.
If you are a large investor with capital holdings over $20,000, you may want to purchase more than five stocks. This way, the percentage of your total capital that you invest in each stock will drop below twenty per cent. For example, if you have $100,000 to invest, you may want to purchase ten stocks, with each stock representing ten per cent of your total portfolio. On the other hand, if you have a million to invest, you may want to invest $100,000 in each stock, which would still represent only ten per cent of your total portfolio in any one stock.
Although I recommend you should never invest more than twenty percent of your total portfolio in any one stock, obviously your portfolio will grow as the stocks rise in value. Over time, this growth will change the percentage each stock represents in your portfolio, as one or more rise in price. This is perfectly okay, as Golden Rule #3 only relates to the amount of capital you should invest when initially purchasing a stock. Remember—the purpose of this money management rule is to protect your total capital should a newly entered position turn bad.
Those with larger portfolios are better placed to incorporate leveraging as part of their overall investment strategy, however, as I have stressed many times before, you need to ensure you are consistently profitable in the stock market over the medium to long term before you consider this approach.
To sum up
Let me say, from experience, if you follow the golden rules and strategies outlined, you will reduce your risk and achieve greater returns than most in the stock market. Remember,
- Always take the same amount of time researching your options to ensure you are protecting your capital on each and every occasion.
- Always aim to have between five and twelve stocks in your portfolio.
- Never invest more than twenty percent of your total capital in any one stock.
- Only ever invest ten percent of your available capital in trading short- term highly leveraged markets and allocate the remaining ninety per cent to trading a medium to long-term portfolio.
You also need to consider the amount of capital you have to invest, as this will determine how you initially construct your portfolio.
Last, but not least, it is important, if you want to achieve better than average returns, to focus your attention on assets that are rising in value and increasing your wealth.
Good luck and good trading!
Dale Gillham is Chief Analyst at Wealth Within and international best-selling author of How to Beat the Managed Funds by 20%. He is also author of Accelerate Your Wealth: It’s Your Money, Your Choice, which is available in book stores and online at www.wealthwithin.us.