In spite of my admonitions and those of most other finance experts, many people still insist on actively trading stocks in an attempt to beat the market. If you are one of these people, then I recommend you at least consider using the following principles in your active trading strategy so you have a higher probability of success.
The “Core and Explore” Investment Strategy
Trading stocks without specialized knowledge is “speculation,” which is essentially a form of gambling. Considering this, you would probably be wise not to gamble with your entire investment portfolio. If you only have a small amount of money, you can’t afford to lose it. If you have a large amount of savings, you would be devastated to lose most or all of it. Either way, you will likely want to protect, at least to some extent, your hard-earned savings.
A great way to protect most of your savings and still satisfy your appetite for active trading is to employ what is known as a “core and explore” strategy. This involves splitting your portfolio into two segments, each managed separately. The “core” portion is the part you want to protect. These funds should be invested in low-cost, broad-based index funds and ETF’s (a so-called “passive” investment strategy), with a heavy emphasis on safer investments, such as bonds and cash instruments. These would be held for the long term and not actively traded. The “explore” segment of your investments would be stocks and bonds that you trade in an attempt to earn returns superior to the overall market.
Most financial planners, me included, recommend you place 70 – 90% of your investable funds in a safer, “core” segment, and no more than 10 – 30% in an “explore” segment. However, how you allocate between core and explore is a personal decision based on your level of risk tolerance and your confidence in your ability to earn above-market returns.
Warren Buffett’s Words of Wisdom Regarding Active Trading
Buffett admonishes people to invest in low cost, well-diversified and tax-efficient index funds and ETF’s, but says that if you insist on trying to try to compete with professional investors like him, then at least consider the following advice:
- Rule number one: never lose money. Rule number two: don’t forget rule number one.
- Never invest in a company that you don’t understand or couldn’t explain in one simple sentence.
- The stock market is a “no ‘called strike’ game.” You don’t have to swing at everything—you can wait for your pitch.
- It is far better to buy a wonderful company at a fair price than a fair company at a wonderful price.
- A pin “lies in wait” for every stock market bubble.
- Never count on making a good sale. Have the purchase price be so attractive that even a mediocre sale gives good results.
- When you own stock in outstanding companies with outstanding managements, your holding period should be forever.
I will add one thing to “The Master’s” great advice: if you actively trade, very carefully track how your active investments are doing against market benchmarks so you have objective data as to how your stock picking is faring. If you mostly underperform the market, then be honest with yourself and consider moving to a passive investment strategy with all of your savings.