Stock Market Investing Part 1 - Philosophy Of Investing

Disclaimer: I am not a professional stock broker, with any kind of licensing. I'm a mechanic with a B.A. in English. These are the strategies I use when I pick stocks. I am currently averaging 25% annual growth.

This guide is meant to focus only on stocks, as that is my primary vehicle for investment at this time. I have tried this strategy out at Investopedia.com 's stock market simulation game. In the game, you begin with $100,000 hypothetically. You can then research the stock like normal, and make trades. The game then tracks the performance of each stock and adjusts accordingly; the only limitation is that your "purchase" does not affect the real world price, so the game may or may not reflect an accurate performance of your strategy. I highly recommend people who are interested in stocks to start there; it will show you whether or not your strategy needs some fine tuning, or perhaps that you need a strategy to begin with.

To that end, here are the four components of my philosophy when it comes to investing in stocks. I've also included Practice What You Preach (PWYP) tips for each point:

1) Pick what you know, and only pick as much as you can follow. Investing is pointless if you don't know what you're buying. If you "play" at the market, you might as well go spend that money at an arcade; at least you're guaranteed a prize for your tickets. You must spend time looking at companies before you buy them, which is why you should limit yourself to a handful of companies, especially in the beginning. While I agree that you should invest in several stocks, if you aren't comfortable putting all of your money into one company, you shouldn't put any money into it.

Your most powerful research tool is yourself. Do you work in healthcare? Perhaps you know about a new drug that has been successful. Research the company that makes it, and then invest if the balance sheet looks good. How about a car salesman? Have sales been lagging at your dealership? Is there another company that keeps you up at night? Those are prime examples of how information you already know can help you pick a winning portfolio. Also, when looking at retail stocks, ask yourself a very simple question: Do I like the product/service/store? If so, it's likely you'll love the stock.

PWYP: The next time you go to a mall or plaza, notice what businesses are crowded, which ones are empty, which ones are new, which ones are old and neglected. Chances are some of the best investment opportunities will be right in front of you.

2) A downturn in the market is simply an opportunity to buy your favorite stock at sale price. Most people invest with their stomachs, not their brains, and bail out of the market during or immediately after a big drop in prices. This is a good way to lose a lot of money, as you haven't "lost" money until you sell below your purchase price.

By looking at a sudden drop in stock prices as equivalent to a clearance sale at your favorite bookstore, you can mitigate some of the fear that naturally occurs when you see your investment shrink by a third. I have noticed that when there is a market correction, stock prices tend to resume almost exactly where they left off and then continue an upward trend from there. Yes, a four-day sell-off can destroy a year's worth of growth, but the two-day rebound is almost as likely to recover 3/4 of your losses.

PWYP: Only invest in a company if you plan to hold the stock for five or more years. When you hear that stocks have dropped by 100 points or more in a day, look at your best performing stocks and see if any of them are at sale prices. If you have difficulty holding stocks after a sudden drop, consider investing a particular dollar amount on a regular basis (like once a month) and only research companies once year. This will insulate you from the vagaries of the market and help you stay disciplined in looking long term.

3) Ignore the professionals. Stocks that are followed closely brokerage firms tend to have larger swings in prices. For example, if Edward Jones begins recommending Home Depot to buy, the herd mentality can artificially inflate prices that can come crashing down once profits fail to materialize. Likewise, an overtly negative outlook can create an artificially low price, handicapping a company's ability to purchase equipment and personnel necessary for growth.

Likewise, some of the best companies are boring. My best performer, Cummins (CMI), has tripled from 2008 to 2011. It makes diesel engines, and damn good ones at that. In July 2011, only 16 brokers made any recommendation. In contrast, Wal-Mart and Home Depot each had 29 brokers publish opinions.

PWYP: Go through index listings instead of looking at companies that are mentioned on the news or brokerage sites. This will open you up to companies that may be quietly growing into a two-, four-, or even ten-bagger (a tenbagger is a stock whose price has multiplied by 10). The more boring the name (and the industry), the better.

4) Ignore your ego. Similarly, don't fall in love with a stock. Look at each stock as you would an employee. Is it working for you? Has the performance been lacking? Are there good fundamentals, but something just isn't clicking? Do you need more out of your stock portfolio, like higher dividend returns? Develop a set schedule for taking another look at the companies you've invested in, to make sure that your investments match your financial situation. While I may have espoused ignoring professionals when it comes to picking stocks, it makes no sense to disregard good financial planning advice. Just be wary of the sales pitch.

Be prepared when you have to sell off your first stock at a loss because something went wrong. Even companies with the best balance sheets can't plan for every contingency. A natural disaster, an accident, political or economic environments can destroy even the best planning with little or no notice. Your best defense against the unknown is knowledge, so arm yourself with good information so you can feel confident in your stocks, even during a market correction, and be just as confident when you have to let a stock go.

PWYP: When it comes to checking stock prices, limit this according to your stomach. Feeling nervous? Only check once a month (or less). Also, decide how often you will re-research your stocks. Once a year, twice a year, quarterly, every two years? Ideally, your schedule balances being able to react quickly to favorable market conditions with not driving yourself bonkers trying to guess the market. Look at the numbers, and don't take a failing stock personally (unless you're the CEO!).

Hopefully these guidelines will help you weather the rocky seas that characterize stock market investing. By having a philosophy set before you ever pick your first stock keeps you focused on your goal: a portfolio that will ensure your financial security for the rest of your life. These points are loosely based on Peter Lynch's One Up On Wall Street and Beating The Street books. I highly recommend them.

Part 2 - How I Pick Stocks - Coming Soon!

UJC6JJB6TGG9