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There’s a never-ending tug of war between two opposing stock investing camps. The first, day trading, is quite popular these days, and its members own numerous investments in different industries. The second camp flies the banner of Warren Buffett, and its members invest in a few stocks that they hold for a long time. Both camps can boast success stories, but only one might be right for you.
The Day-Trading Camp: Diversified Portfolios, Short-Term Holdings
Conventional wisdom dictates that spreading your investments across different industries, companies, and geographic regions gives investors the best chance of profiting from their investments. For ultra-conservative investors, this strategy is their hedge against losing any money in the market. Investors who diversify their portfolio as a form of insurance are often referred to as day traders, actively buying and selling a variety of stocks and looking for the next big return on investment.
But day traders may not know enough about the companies, markets, and industries in which they invest. Moreover, it can be challenging for an investor or small group of investors to understand how more than 30 companies operate, make money, and are affected by events all over the world. Lastly, if the sheer number of companies in a portfolio can protect it from poor performance, then why do most day traders lose money on the stock market?
Reacting to News and Events
Day traders are famous for following the 99-1 rule: 99% of them make investment decisions based on 1% of the news they get about a company, industry, or market. While this has undoubtedly saved some investors from catastrophic losses, it has caused even more to sell at a loss, buy too high, and trade too often.
Investors who fall under the 99-1 rule often fail to realize significant returns on their investments, because they don’t hold onto their investments long enough to realize a decent return, and often sell too soon for fear of losing their entire investment.
Spreading the Risk
New, novice, inexperienced, and conservative investors often lean heavily towards strategies that avoid risk. This makes sense, given the market’s crises, upheavals, and losses over the past 30 years. Spreading out your risk makes even more sense when investors carefully choose their holdings so that they’re not all likely to respond in the same way to different market-rocking events.
However, for investors who park their money in mediocre or poor investments, this strategy fails big time. In such a portfolio, few if any investments will perform well enough to protect the whole thing from significant losses. Moreover, if your only goal is to not lose money, why invest in the market at all? There are safer, if less lucrative, places for your money that come with a far smaller chance of loss.
Investors who “play it safe” by investing without researching their holdings, and simply hoping that a diverse portfolio will save them, are not likely to outperform the market – or, for that matter, breakeven.
The Warren Buffett Camp: Limited Investments, Long-Term Holdings
Limit Your Investments
There is no magic number of securities that people should invest in. In fact, the only rule here is that investors should research all the stocks they own (i.e., understand them, how they’re managed, and what affects their market performance) and be willing to hold onto those securities for life, or until some major event changes their original assessment.
This strategy is time-consuming. It also requires that investors have confidence in their judgments, tolerate a higher level of risk than day traders do, and be willing to accept the consequences of being wrong and learn from each market mistake.
Hold Your Investments
This strategy is not as exciting as day trading. Once you have made your market bets, your job is to sit back and watch them, while looking for new ones to add. The least sexy part of this strategy is that you keep the same stocks for years, and watch the value of your investments rise and fall over time, with the confidence that your investment will attain the valuation that you have predicted for it.
As for risks: The biggest one is that you’re wrong about your investments. You don’t cut your losses when stock prices keep sliding. And you lose out on great investment opportunities because you’ve kept your money tied up in lackluster performers.
Don’t Be Emotional
Jaded, experienced, and market-savvy investors don’t get emotional about their investments. They’re simply a bet that you can make money on something, against other people betting that you won’t. In the end, the market doesn’t have feelings for you, and you’re wasting your time and energy by becoming emotional over something that instead requires analysis, logical thinking, and self-control.
That’s all easy to say, but it’s hard notto become emotional about what’s happening to your money, portfolio, and investments – especially if you have long- or short-term plans for that wealth. It’s also hard to look at an investment doing worse than expected, and not second-guess yourself. Lastly, when you are watching the market reward people with more dynamic and active portfolios, you may find it incredibly challenging not to imitate their strategy.
Think for Yourself
The hardest part of this strategy provides the greatest rewards – but it’s also the loneliest. You, the investor, have to look at all the information available on your investment, analyze it, and make the decision that looks right to you. This may require you to act against the market, discount the opinions of others, hold unpopular investment positions, and endure other investors’ ridicule.
You face three risks with this strategy:
- The people who disagree with you are correct, and you didn’t make the best call.
- You don’t learn to master the market and its vagaries and profit from it.
- You lose out on great investment opportunities because you don’t understand them and can’t see their potential.
The Best Camp . . .
If you’re not a savvy and/or experienced investor, the best camp is the Warren Buffett camp. It gives you the time and room to grow as an investor, learning to understand the market and work it to your benefit.
If you are a savvy and/or experienced investor, make the best decision for you. Day trading has been quite lucrative for a small number of investors. But how many billionaire investors do you know who are day traders? There are solid reasons why market-savvy, experienced, wealthy investors like Warren Buffet don’t invest in companies and industries they don’t understand. Most retail investors who use the day trading investment strategy don’t profit from the market or breakeven in the long run.
So how many stocks should you own? The answer’s both simple and complicated: As many as you can thoroughly research, understand, follow, and feel confident holding onto for the long term.
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