What I've Learned So Far
I've learned a lot about investing since getting started last July, and my style's evolved somewhat as well.
Right now I'm in the position where I have to sell positions in my stock holdings to get money for new ones. I've been doing this over the past month, only if I see a better place for my money elsewhere. This is actually the position Warren Buffett was in during his teen years after getting started investing at 11 years old by investing in Cities Service Preferred. I know this both from what I read, and from a personal response from a letter I wrote to him this summer. Buffett replied to my question: "I can report that in addition to Cities Service Preferred, I also owned quite a few stocks in my young teens. Every time I bought a new one I had to sell the old one, since my funds were limited in the first few years." It actually hasn't been disappointing with me to part with some of my first holdings, because I felt I could do better with different businesses. Flamel Technologies, a French drug company that I never understood, was a no-brainer when I needed extra funds. CDW Computer, primarily an online retailer of computer and computer parts, no longer made much sense to me on a long-term scale, because there are many places to buy computers and I'd never heard of CDW before getting into the stock market. I think this is where it does make sense not to get emotionally attached to your investments, but normally I do see myself as a fellow owner and plan on staying a shareholder of the company for a long time. But, the stocks I've been selling aren't ones I'd researched before buying, and they no longer looked attractive to me, either on a valuation or business level.
Beating the market is something that many Wall Street analysts use as a reason for the individual "small" investor to stick with index funds or mutual funds. They say individual stocks are impossible for the small investor to use as a tool to beat the indices. I'd never bought this argument in the first place, but something recent made me feel this argument was downright bogus and complete fluff. I have nothing against funds, but it's the argument that someone not on Wall Street can't do well with individual stocks that really annoys me. Let's use the Pencils Fund as an example with this. Soon after making Hansen my largest position of the Pencils Fund, it tanked on several pieces of news and analyst takes. So, my largest holding (which made up more than 13% of the portfolio) was down nearly 15%. And you know what? The Pencils Fund was still beating the S&P 500 from its inception. The Pencils Fund has only been active seven months so this probably doesn't prove much, but mutual funds have had absolutely dismal performance over the long-term, with less than 15% of them actually beating the market as of 2002. Don't let the managers who can't beat the market convince you to go put your money with them and get charged for keeping your money with them in the meantime. Heck, a good amount of companies pay their shareholders for investing with them in the form of dividends.
I think the key to beating the market over the long run is to find great businesses that are either in the early stage of growth with large potential or finding stocks that are undervalued for reasons that won't hurt the intrinsic value of the business for long or not at all. I think a market beating technique would be to simply invest in your favorite companies that you believe in and hang onto them for 15 years. I thinks it is very foolish to not have money in stocks if you have a timeframe of at least ten years. Ten years gives a business time to sort out its troubles, gives time to get the stock noticed by Wall Street (often the turning point for a stock's share price), and it gives time for the company to expand and strengthen its brand name. The only ten-year period that the S&P 500 has underperformed bond yields was the 1930-1940 period. All other periods, 1940-1950, 1960-1970, etc., have seen the S&P 500 beat bond yields. The very least you can do is stick money into an index fund tracking the S&P. But, I feel individual stocks can be a much better long-term investment, because rather than betting on 500 different businesses, you can choose a focused portfolio of stocks that you feel have great long-term potential. Their is a company behind every stock, and the small investor can analyze that business as easily as any Wall Street professional. The smartest analyst is yourself.
Diversification is a topic that my views have changed with. My strategy with the Pencils Fund has been to simply invest in the best opportunity I see when I have funds available. What I like to call this strategy is "focused diversification." I try not to get too overloaded in one industry or company, unless the opportunity is just too great to pass up, and you'll get these opportunities plenty of times with stocks. I start with small positions and add at better value points in the future. Sometimes, like with Hansen recently, it's only three weeks time when the value gets better, and sometimes it'll probably be one or two years. You wait for the opportunities, you don't force them. With the Pencils Fund, I invest in companies that I am so comfortable with and like so much that I jump at the opportunity when the value gets significantly better from my previous purchase.
Keeping an investing journal is a huge help to my decisions. With the Pencils Fund purchase write-ups, I write why I invested in the company that I did. This is so that I'll know in five years the exact reasons why I invested in the company when I did. I think the reason so many people are impatient with their stocks is because they don't know how to follow them. I believe keeping an investing journal is the most important aspect to follow stocks, even the ones that you don't own. Make a note of financial changes or recent news that you feel will be important to remember in the future, so that you really understand the business. Many people buy stocks without knowing why, and three months later they're wondering why they are all of a sudden really confused with their holdings. This is what causes impatience, blind investing, it's where it does make sense for the individual investor to stay out of individual stocks. But it isn't hard to keep a journal, write down why you invested in what you did, and jot down important notes. I don't think you need to do this more often, although I think the more often you can the better.
I believe a good strategy is to open small positions in companies you are interested in, are very comfortable with, at a share price you're comfortable with, and keep a journal of their recent movements and happenings as often as you can. This helps you understand the companies behind the stocks even more, helps you establish good value points and target prices, and brings out the fun of stocks: watching great businesses evolve, or crappy businesses deteriorate. You learn as you go.