I woke up the other day and found that my portfolio was full of penny stocks.
OK, not literal penny stocks -- not the kinds of stocks that probably flood your inbox every day. But given that the SEC definition of a penny stock is anything below $5, I'm dangerously close: Credit specialist CompuCredit
It wasn't supposed to be like this
How did this happen? I'd chosen each of the stocks in my portfolio with care and due diligence. They were respected names in their industries. All possessed tremendous growth prospects. Whether through market dominance or a proprietary business model, I believed they had the makings of market-beating investments.
And still ... my well-crafted portfolio has been just as damaged as any other portfolio by the market malaise of the past six months.
Does all this doom and gloom of my portfolio mean poverty and penury for me? Of course not. While the CompuCredits in my portfolio have hurt, my portfolio at large is OK. (More on that later.)
As a student of investing, I've learned to follow the investing masters, who help me to position my portfolio for long-term outperformance.
Follow the greats
I'm not following the trades of the investing greats. Though that's proven to work out for some Buffett followers, I'm reminded of the investors who bought shares of Safescript Pharmacies because Fidelity Magellan legend Peter Lynch did -- and then got burned when the company filed for Chapter 11. Ouch.
No, I'm following the principles of the greats, and I recommend you do, too. Soaking in the teachings of investing masters has revealed four simple keys to investing success that will ultimately benefit my portfolio -- and yours -- even if I have to endure some dramatic price declines in the process. They are:
- Buy good companies
- Ignore daily price dips and swings
- Diversify
- Invest for the long term
Even if your stocks hit a rough patch, as some of mine have lately, owning only good companies should minimize any detrimental impact to your overall performance. Because even if you own the best of the best, you'll still suffer down times. Lynch said that investors only had to be right about 60% of the time to have a winning portfolio! Another impressive investor, Shelby Davis, owned about 1,000 different stocks -- many of them losers -- during an investing career in which he turned $50,000 into $900 million. (While owning a thousand stocks is hardly replicable for us average investors, Davis teaches a key lesson about diversification.)
Buffett's mentor Benjamin Graham likened the market to a nervous and jerky investor that offered to sell you his shares -- or buy yours -- on a daily basis. One day "Mr. Market" was dour, considering stocks too expensive and offering lowball bids. The next day he was in good spirits, willing to pay a premium for your stock.
Look at daily price gyrations, and you'll realize that this moody metaphorical figure isn't much of a stretch. Every day, I try to ignore those manic short-term moods and concentrate only on the long-term business.
Boiling it down
Thinking of all those elements together, consider these words from Fool co-founder and Motley Fool Stock Advisor co-advisor David Gardner:
Stocks have been the best investment over this century, and we expect the same to be the case for the next century. ... If the market dropped another 20% tomorrow, does that put you out? If you've been listening to The Motley Fool, it should not. You're putting money away that you won't need anytime soon, you are NOT on margin in any significant way, and you probably like your companies just as much as you did yesterday, even if the broad market has now devalued them. You're looking forward to that next paycheck, because you'll still be socking away 5%-10% of that into your 401(k) or IRA or brokerage account, at a substantially cheaper price. That's Foolish.
Here's the kicker: David wrote that a decade ago, when the market was in a bad mood. Even with the Nasdaq debacle seven years ago and the subprime mess still ongoing, stock market investors have done just fine since then.
The disclaimer
Adopting this mind-set doesn't mean your stock picks will always work out. In Stock Advisor, David held Krispy Kreme
Still, following the principles of the greats gives you the chance to separate stock from business and price from value. In 2002, David picked Activision
A key decision
Buy good companies, ignore the price the market is giving you, diversify, and hold on for the long term. Those are the keys great investors use to unlock enormous profits.
They're also how we invest every day at Stock Advisor, where our average pick is up 64% over the past five years, versus 21% for the market.
I'm not worried that my so-called penny stocks will ruin me. I think I've got some good companies for which Mr. Market will ultimately offer a pretty penny. If you're looking for some additional recommendations to turn your own penny stocks into dollar bills, click here to sign up for Stock Advisor free for 30 days.
Fool contributor Rich Duprey owns shares in CompuCredit, Candela, Wabash National, and Ford. You can see his holdings here. CompuCredit and Activision are Stock Advisor recommendations. The Motley Fool has a disclosure policy.
