In this post, I will discuss with you few strategies that will help you to achieve good returns from your equity investment in the long term. All points that I am discussing here is from my personal experience and you may not find these same thought process anywhere else. Go through these process and if you find them convincing, apply them as your own investment strategy.
Make your own thesis
Keep your investment process simple and clean. Identify 20 stocks that you are really confident about. When I say “you are confident about”, I really mean it. Buying stocks based on another person’s idea or suggestion will definitely put you in trouble. When a stock goes up, copying others idea will definitely help you to make a good profit. But when the stock price goes down, negative news about your stocks pour in, and that is the time you should show your confidence in the company you have invested in. For that, you should personally know the reason why you have invested in a particular company. As long as the fundamentals of the company based on which you invested are still good and solid, you don’t need to worry about the market price. Instead, your knowledge about that particular company and industry is so deep that even when the share price goes down, you should be capable enough to buy more stocks. Hence invest in only those companies and industry that you can understand in-depth.
Now just having a deep understanding of a business and industry is not enough. What you know about a company should be reproducible. During the bad time, when negative news comes in, when the stock price goes down, you should be able to recollect the thesis you have built initially that made you invest in a particular stock in the beginning. For that what you should do is, take a diary and pen or open a word or excel file and write down the reasons why you think investing in a particular company is a good bet. Make sure that you don’t explain it too much. Instead, try to consolidate everything into just 500 words maximum. This 500 words document should be written in such a way that at the time of panic when everyone is selling a stock, you should be able to take out this note to reassure yourself that you should hold on to that particular stock because whatever you have written about that stock in those 500 words still remain intact.
Make a simple checklist to identify good stocks
This point is the continuation of the step which I discussed earlier. To have good conviction about a stock, you need to make good buy decisions based on your stock analysis. It is your duty to ensure that your stock selection is done purely based on laid down defined criteria and is not influenced by any market sentiments or any kind of emotion you were in at the time of buying a stock. To do this you need to have a checklist for stock selection with clearly laid down criteria. Again, it is important to mention that the parameters in the checklist should be developed by yourself and not copied or downloaded from somewhere else.
To make your personal equity investment checklist, you must read and learn a lot about equity investment. The more you read and learn, you will continue revising the checklist to make it more perfect and simple.
If you are not ready to do this then a mutual fund is the right place for you. Even if you are ready to read and learn about equity investment, if you are not enjoying the process, then again, a mutual fund is the right place for you. Because reading and learning about equity investment takes a lot of time, effort and thinking and you can’t do it if you are not enjoying the process.
I spend now almost 7 years reading and thinking about equity investment that helped me to make my own investment strategy which I am comfortable in. Please note that I did this when I was continuing with my 9 am to 5 pm / 6 days a week job. During this entire period, I never felt that the equity learning process is boring or irritating. Even though I feel physically tired, I always find it interesting to read and learn more about equity investment.
You can read more about the equity investment checklist here
No matter how much expertise you have in a particular company or industry, even if you know inside out of a company, when you invest in stocks always you should give room for error. Too much concentration by investing only in one or two companies will put you in a do or die situation. For any reason, if your investment thesis goes wrong, you will end up losing 50% or all of your investment corpus.
At the same time, investing in too many companies like for say 50 or 100 stocks will affect your focus to make the right investment decision which will again impact your portfolio performance. All your “buy decisions” will be an end product of thorough stock analysis. Planning to have a lesser number of stocks in your portfolio will help you to take enough time to do a deep and thorough analysis of every stock before taking a “buy decision”. You can read more about portfolio management here
Now assume that you have decided to keep a maximum of 20 stocks in your equity portfolio, let us see how you should expect the stocks in your portfolio should perform. Assuming that you have learned a lot about equity investment and developed your own stock selection checklist, based on a thorough analysis of listed companies in the market you identified 20 great stocks and invested in them. So now you have a great equity portfolio comprised of 20 stocks. Even though you have done all steps right, my suggestion is not to expect all 20 stocks to perform equally well.
Let me put an example below on how I expect my portfolio to perform
Let me explain the table given above. Assume that you have identified 20 stocks and invested an equal amount in all 20 stocks. Now what you have to do is, just don’t touch your investments. Let it compound for 25 years or so. What you can expect from your portfolio. Normally what you will expect is you want all the 20 stocks to perform. But that will rarely happen. Instead what you should expect is something like this.
- Out of 20 stocks, 2 stocks will file for bankruptcy
- For 2 stocks, you will lose 50% of their value
- For 2 stocks, you end up making no return. So if you consider inflation, you can say that these 2 companies have also become value destroyers
- 2 stocks will give you a return equal to your bank fixed deposit rate. This one also you will take it as a poor investment because the entire purpose of investing was to beat inflation and get returns better than bank FDs.
- 4 stocks will give you returns equal to the benchmark index like NASDAQ 100, Nifty 50, Sensex etc. This one also won’t excite you because the patience and effort you have taken are not to get return just equality to a nifty index. For that, you could have simply invested in an index fund.
- 3 stocks were able to generate alpha with 20% CAGR
- 3 stocks gave you multi-baggers out of which 2 gave you 25% CAGR and one gave you 30% CAGR
Even after investing in 8 value-destroying stocks and 2 average performers, you were able to generate a 20% CAGR in 25 years from the entire portfolio just because of 3 stocks with 20% CAGR and 3 multi-baggers with 25 to 30% CAGR.
The point I am trying to make here is, once you made a portfolio, you don’t need all the stocks in your portfolio to perform. All you need is just 5 or 6 stocks out of 20 stocks to do good for your portfolio. That is, from your portfolio, you need only 30% of stocks to do good to earn a good return in long run from your equity investment.
This is in continuation to the previous section. Identifying 20 good stocks is not enough. You need to do one more thing for the next 25 years. That is, you should “DO NOTHING”.
Here, by saying minimalism, I mean minimalism in action.
Once you complete your portfolio, just ignore it. As you have given room for some stocks to bankrupt and some for value destruction, you don’t need to worry about the performance of each stock. Simply ignore your investments and enjoy your life. Don’t touch it, don’t think about it. If you need, you can add more to the already invested stocks, but don’t do things like
- sell a stock in your portfolio and wait for the dip and buy again
- sell a portion from one stock and buy more of another stock in your portfolio
Now even though you have already completed 20 stocks in your portfolio, as you progress in your learning curve, you might find good investment ideas. If you really find it convincing, you can buy new stocks, but please ensure that you won’t touch the previous 20 stocks portfolio. Let your existing portfolio compound.
The more you handle your portfolio, you end up paying more brokerage fee and you will get into the habit of continuously selling old stocks in your portfolio for new investment ideas. If you want the magic of compounding to work for your portfolio, you should not touch it. Let it compound itself. Remember that you have already given space for 2 or 3 stocks for bankruptcy and a few for losers and average performers, from that if you need multi-baggers you need to avoid touching your portfolio.
Believe in your investment thesis and keep patience.