My Most Helpful Investment Advice Is This Simple Point
Each year around this time I ask readers what tip is most effective. Here's the answer.
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Every year, when I write my Thanksgiving column, I talk with investors who have followed my writing for many years. I am curious about what advice I have provided that they feel has been most useful. The answer I receive most often is to work to keep your account balances as close to highs as possible.
That sounds vague and general, but it is a way of thinking that can profoundly impact your results if you employ it effectively. Nothing else—not stock selection, style, or methodology—has a greater impact than this seemingly trite piece of advice.
There are two reasons why this is so effective:
1. Making up losses is a hugely unproductive activity. If you lose half your money, you need a 100% return just to return to where you were before the loss. A 25% loss requires a 33.3% gain to move your account back to even. That is a lot of work and can take months and years. The smaller the pullback from highs, the quicker you can start making money again.
2. Keeping accounts close to highs allows you to benefit from the tremendous power of compounding. No less a genius than Albert Einstein called compound interest the eighth wonder of the world. The richest people in the world have all mastered the art of making profits on their profits.
The only way to benefit from compounding is to make sure your accounts are hitting new highs. Most people think of this in terms of a single stock. Warren Buffett and his long-term buy and hold of names like Coca-Cola KO and Apple AAPL are classic examples, but you can still compound your capital through active trading. You just have to make sure accounts stay at highs, and you are producing gains on the profits you already have.
Like most things in trading, this advice is quite simple in theory, but very challenging to actually employ. How do you keep accounts at highs, but still take enough risk to produce high returns? If you sell on every minor pullback, then you won’t ever hold anything long enough to make big gains.
Even the best stocks will have substantial pullbacks. For example, in 2008, Apple pulled back 57% before it went up 80-fold. Subsequently, it has had several pullbacks of 30% or more.
The only way to avoid those sorts of pullbacks is to actively trade. What makes that very difficult for most market players is that they do not have a methodology or the discipline to rebuy a stock that they have sold. They never jump back in, and then they miss out on big gains.
To keep accounts at highs while maintaining exposure to the best stocks you can find requires a lot of work. It means having a clear point where you cut and then active vigilance and trading as you try to time a re-entry. You may buy and be stopped out dozens of times while trying to build a position in a stock that you favor.
There are many tactics and strategies that I employ to try to keep accounts close to highs, but the one thing they all require is incremental action and very active trading. You can’t just sit there and do nothing when losses start to build.
I’ll be writing about this much more in future columns, but simply reminding yourself that the ultimate goal is to keep accounts near all-time highs is a good way to start.
At the time of publication, DePorre had no position in any security mentioned.
