If you're one of the millions of investors who love picking their own stocks, it can be tough to decide which companies are best for your portfolio.
However, if you follow a few simple guidelines, it can be pretty easy to build a portfolio of great companies that will produce amazing growth over time and won't give you a heart attack along the way. Here are three principles to incorporate into your own investment strategy to make this a reality for you.
When buying stocks, think long term
Don't chase the next big thing by investing in the latest "it" stocks. Sure, they might make you a lot of money very fast, but they're much more likely to take a bite out of your portfolio.
Instead, look at investing as a marathon instead of a sprint. Consistently outperforming the market is the most certain way to create wealth over time. Just look at Warren Buffett's portfolio. He has delivered consistent, market-beating performance not by investing in stocks that double overnight, but by buying long-term winners at good prices, such as Coca Cola, American Express, and Procter & Gamble.
Look for companies that have an excellent track record of consistent growth. Dividends are nice (but not necessarily a requirement), as is a history of raising the dividend over time. A list of stocks known as the "dividend aristocrats" have raised their payouts for over 25 consecutive years, and are a good place to start.
Look for companies that have a distinct competitive advantage that will help them survive the tough times. For example, Coca Cola has one of the strongest brand recognitions in the world. Procter & Gamble produces a variety of products that are household names.
Obviously you don't want 100% of your money in any one investment, but proper diversification means much more than that.
First, and most obvious, it means not putting too much of your money in any one stock or fund. You can own 20 different companies, but if your Coca Cola stock represents 30% of your portfolio's value, you're a little too dependent on one company.
Second, diversification means not putting too much of your money in any one sector. At a minimum, I suggest that you have exposure to at least five distinct sectors (financials, technology, healthcare, etc.) with no more than 25% of your money in any one of them. After all, if you own 20 stocks but 12 of them are banks, you could find yourself in a tough spot if a financial crisis similar to the one in 2008-2009 happens again. It's not likely, but why leave yourself vulnerable?
Leave it alone
If you invest in the right kind of companies, you should believe in your stocks for the long run. Don't sell every time you make a nice gain, or even worse, when the market is going down. Trying to time the market almost never works out over the long run.
Let's say that you can cut down by just 10 trades per year, which should save you about $100 in commissions. Well, over a 30-year time period, savings of $100 per year could mean an extra $16,000 or so in your account, assuming the S&P 500's average annual return over the past few decades.
Not only that, but if you hold your stocks for less than a year, any gains will be taxed at the higher "short term" capital gains rate, which is equal to your marginal tax rate. Investments held for more than a year are taxed at lower "long-term" capital gains rates, and the savings can really add up over time.
Simply put, if your portfolio is properly diversified and you own high-quality dividend growth companies, one of the best things you can do with your stocks is to leave them alone and let them do the work for you.
Matthew Frankel has no position in any stocks mentioned. The Motley Fool recommends American Express, Coca-Cola, and Procter & Gamble. The Motley Fool has the following options: long January 2016 $37 calls on Coca-Cola and short January 2016 $37 puts on Coca-Cola. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.