My Top Tip for Building Stock Market Wealth
Finding great stocks is important, but not as important as this key trading practice.
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The best way to build wealth in the stock market is to buy and hold great stocks. Unfortunately, that is a very difficult thing to do. No matter how good you might be, you will make mistakes and suffer bad luck. The vast majority of professional money managers are unable to outperform the indexes.
While finding great stocks is extremely important, the most effective way to build stock market wealth is to keep your investment accounts as close to their highs as possible. If you do that, then the inevitable investing mistakes that you will make are not nearly as costly.
There are two great benefits to keeping investment accounts close to highs. The first is that it avoids the very unproductive work of making up losses and lets you focus on producing more gains. If you allow your investment account to lose half of its value, you have to generate a 100% return just to return to even. That is a massive amount of work for zero net progress.
The second benefit of keeping accounts close to highs is that it sets the stage for the power of compounding. Substantial wealth is created when you are able to produce gains on your gains. Over the course of years, the compounding of profits can produce staggering returns.
Most people think of compounding in terms of an individual stock that they hold, but it applies on the portfolio level as well. You have to keep hitting new highs to produce a compounding effect. If your accounts are never too far from new highs, then the power of compounding will come into play.
Keeping investment accounts near highs is a simple concept to understand, but actually doing it is very challenging. No matter what stocks you buy or your investment style, there is going to be a certain level of volatility. If you dump a stock every time it pulls back a couple of percentage points, you are very likely to never hold on to a big winner.
There will be a substantial amount of time when your accounts are pulling back and are not at their highs. The issue is how deep you let losses go before you take action and cut the offending stock. Having a very rigid loss-cutting methodology is key. The biggest investing mistake that most investors make is building too large a position in stocks that keep declining. The thinking is that the market is wrong and it will soon come to its senses, but if that doesn’t happen, those losses are the ones that can set you back for a long time.
The best solution for dealing with high levels of volatility. It is always best to be ready to sell and rebuy. That takes a lot of time and effort and requires constant vigilance, but when you sell a stock that is breaking below important technical support, that doesn’t mean that you can’t rebuy it when the price action improves. Don’t let conviction about fundamentals blind you to poor price action.
I’ll have much more in future columns on tactics and strategies to keep your investment accounts close to highs, but the main thing you can do is to embrace the idea mentally. Don’t find ways to justify allowing a sharp drop in your accounts. When the losses start to build, take action and don’t just sit there and hope everything will work out.
Keeping your investment accounts as close to highs as possible is the best way to grow great wealth.
At the time of publication, DePorre had no position in any security mentioned.
