The thought of investing in the stock market scares away lots of people. Many get nervous thinking about it like it’s some alien concept. This need not be the case. Chances are that you are already making investments in other areas of your life with a deep sense of commitment. The fundamentals are the same.
Following a football club is one of such areas. Have you ever encountered a circle of friends discussing the performance of their favourite team? They discuss with zeal. They spend a lot of time researching players, deciding which player will fit the team’s philosophy and recommending who the club should buy or sell in the next transfer window.
Some go as far as betting their lives on the outcome of games based on the confidence they have in their analytical skills.
If you find yourself deeply involved in football in this way, with the patience to follow through season after season then you already have what it takes to be a good investor.
Investing in stocks is not much different from investing your time following a football club. In following stocks, however your analysis and recommendations actually count - you’d no longer be frustrated with Arsene Wenger for not listening to you! More importantly you stand a chance of making money investing your time in analysing stocks.
A real football fan understands that football requires diversification and depth. While football is ultimately about scoring more goals than your opponent, a team with only good strikers but no strong midfield or defence has no good chance of winning trophies.
In the same way, a good stock portfolio needs to be diversified. It should have different stocks playing different roles to help achieve the ultimate goal of net gains. It should consist of different types of stocks - growth stocks as well as income stocks - in different industries.
You can think of the growth stocks as the strikers in football. These are stocks have a promise of high capital gains for your portfolio. They would typically be stocks with high price earning (P/E) ratio.
While it is good for a team to have high quality strikers, the team must be prepared to handle a counter-attack successfully so it doesn’t suffer a sudden loss while focused on trying to score lots of goals.
For this the team needs a reliable midfield and defence to fall back on. In the same way, your portfolio needs a fine selection of reliable stocks to fall back on when things get tough. These will usually be blue chip companies. They don’t necessarily promise high capital gains but their stability means your overall portfolio can stay sane when the market goes crazy. Also, stocks like this usually pay dividends regularly to give you a steady stream of income.
From time to time there is a need to strengthen the team by buying one or more new players. Each player is chosen after assessing the needs of the team, the players strengths, past performance etc. Sometimes the new player brings the expected change and fresh energy needed to improve the team, at other times the new player turns out to be a disappointment.
You have probably heard this quote many times: “Past performance is not an indication of future performance”. This is true in football as well as the stock market. One good example is a striker called Fernando Torres. He had an excellent scoring record one season at Liverpool FC, and was bought by Chelsea FC for a record fee the following season. Unfortunately, he failed to live up to the hype at Chelsea and hardly scored goals. He eventually had to be let go by Chelsea to make room for other strikers.
Some stocks may behave the same way when they are added to your portfolio. When this happens, you have to take the decisive step of cutting your losses and getting rid of them. This might be an important step to improve the overall health of your portfolio.
Although you can do a lot of planning, analysis and preparation, when it’s game time, chance becomes an important player. Some games are charged with more emotion than the norm, the referee can be in a mood to dish out cards for almost no reason and these factors can change to outcome of the game in unpredictable ways.
The stock market is not much different in this regard. There are times when unfounded rumours, panic and speculation drive things crazy and the script fails to go according to plan.
Fortunately, each season consists of very many games and there are a few trophies up for grabs. A few bad days are inevitable. The teams that are balanced and smart enough to consistently improve and adapt their game to changing circumstances will have a better chance of winning trophies.
Perhaps you have invested a lot of time and emotion in following your favourite football club simply for bragging rights. Why not channel that energy and enthusiasm to investing in stocks? You have what it takes to be a great investor!
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