Updated – 12/14/23
To get to the secret of success in the stock market takes just a few easy to remember, short phrases which are mostly well-known by seasoned investors.
Some of them can be easy to forget—that’s why it’s good to go back to the basics.
If you’re struggling with your performance in the market, why not revisit these key fundamentals to success in the stock market; just because they are simple doesn’t make them any less powerful.
Table of Contents
- Time in the market beats timing the market
- Slow and steady wins the race
- Don’t put your eggs in one basket
- Remember that the stock market is manic-depressive
- Invest like the market will close for the next 10 years
- Know what you own, and know why you own it
- When the information changes, change your mind
- Invest with a margin of safety, emphasis on the safety
Change your habits for the better. Let’s dive into the first crucial lesson for investors.
1— Time in the market beats timing the market
Unfortunately, a new crop of investors learn this lesson over and over again. Nobody has a crystal ball. And stock market gains are often quite lumpy. This means that if you miss out on big stock moves, you WILL underperform the market.
The best thing the average investor can count on is the fact that the stock market tends to rise over the long term.
It has since its inception in the 1790’s.
By investing in the stock market over the long term, you can absorb these gains… without needing a crystal ball, and without knowing when to jump in or out of the market.
Simple and effective compounding.
That’s an advantage that even many fund managers don’t have, as those guys’ salaries are chained to their performance looking great every year so they try mastering market timing (doesn’t end well). You, the average investor, don’t have to be chained like that.
2— Slow and steady wins the race
Wouldn’t you love to automatically buy more when stocks are low and buy less when stocks are high? Well that’s exactly what you do with a simple strategy called dollar cost averaging.
Dollar cost averaging is simply an investing habit that you commit to.
For example, I advocate a $150 per month dollar cost averaging strategy.
This means every single month, without fail, you put $150 into the stock market. This automatically helps you “back up the truck” when the market turns sour.
To illustrate this…
Let’s say, for simplicity, that the stock market was at $100 today. If it rose to $150, you’d be buying 1 share per month with your $150 habit.
Now let’s say the stock market crashes to $75. With your same investing habit, you’d be buying 2 shares per month with your $150 monthly dollar cost averaging strategy.
Do you see how that automatically buys you more when the market is down? And less when the market is up?
What a great perk—giving you some benefits of “buying low” without having to time the market.
And I hope I don’t have to extort the benefits of good habits.
If you want results, in anything, put the right habits in place. Then watch your portfolio’s compounding take off to the races.
3— Don’t put your eggs in one basket
This one is simple. Diversify your investments.
Don’t put your life savings all into one stock.
Every once in a while a business will go bankrupt or be fraudulent. It’s rare but it happens.
You don’t want the price of one wrong decision completely derailing your entire financial future. So mitigate this by having a diversified portfolio, ideally with at least 15 stocks or more.
4— Remember that the stock market is manic-depressive
There are two words that encapsulate the essence of the stock market.
Fear and greed.
And as we’ve seen over the various cycles of the stock market, stocks move on heavy optimism and heavy pessimism.
The great billionaire investor Warren Buffett used to credit his investing teacher Benjamin Graham as coming up with the idea that the stock market is like a manic-depressive man. Graham dubbed it Mr. Market.
Graham liked to teach about Mr. Market by having investors think about their shares not as stocks but as a business. And he would say—imagine this man called Mr. Market approaches you every single day with an offer to buy your business.
If the man was in a cheery mood, he’d offer you a high price to buy your business. On bad days, he might offer you a very low price for that same business. He was very emotional, and so you’d see a wide range of his emotions and offers over time.
Now first off, if you really liked your business, you probably wouldn’t sell it, period.
But if you might be inclined to sell your business, wouldn’t you sell it on the days that Mr. Market is in a very good mood rather than bad?
Graham teaches that the stock market works the exact same way.
As owners of stock shares, we are part owners of the businesses whose shares that we own.
Why would we sell our part ownership stake in a business if we’re happy with the way it is growing, compounding, and providing a return on our capital? Yet investors get tempted to sell out of their best stocks all of the time, because they want to “lock-in their gains”.
It’s usually a mistake.
And if we still like the business, why should we sell it just because it’s getting crushed in the stock market, the Mr. Market in a bad mood equivalent?
Yet investors do this all of the time as well, because they feel bad about seeing losses in their brokerage accounts even if they say more about the fearfulness of the market rather than the actual long term prospects of the underlying businesses.
If you can separate the Mr. Market aspect of the stock market and instead take an ownership mindset, you will find much greater success in compounding your wealth in the market over the very long term.
In fact, it’s the only way to get those long term stock market gains you seek…
After all, the market is made of people, and people are emotional. And the stock market has bounced from fear to greed and back since the dawn of its inception.
5— Invest like the market will close for the next 10 years
Going back to our favorite investor, Warren Buffett likes to say that if he won’t hold a stock for 10 years, he doesn’t see a point in holding that stock for 10 minutes.
This goes hand-in-hand with the Mr. Market concept of secret #4.
If you’re buying stocks for the ownership stakes of a business, you shouldn’t care at all about how its stock price bounces around. You are only concerned with how the business itself does.
Buffett understands a few key truths about the stock market.
First, the market goes up over the long term, but has many periods where it goes down even for years (these are called bear markets).
So while we can hang our hat on the long term growth of the stock market, we can’t necessarily rely on good performance next year, or even the next 5.
In the short term, the market is very noisy. It’s often driven by sentiment, and large groups of investors jumping in-and-out of factors (growth to value and back, for example).
Over a long enough period of time, a stock will get past the short term noise, and trade on its fundamentals—i.e. how the business has done rather than what Mr. Market is doing.
This phenomenon is captured by another great Benjamin Graham quote:
“In the short run, the market is a voting machine, but in the long run, it is a weighing machine”.
You shouldn’t evaluate your investment based on what it’s done because of short term stock market noise rather than long term fundamental performance. And so that’s why Buffett says he’d rather pretend the market is closed over that time, since it has no bearing on the business’s performance.
Secondly, Buffett knows that timing the market is a fool’s errand. He knows that he can’t possibly be great at market timing so he doesn’t try it.
And he knows that investing based on the market’s performance is a form of market timing; that’s why it’s better to act as if the market is closed.
You can’t time the market if you can’t buy or sell in the short term, so you automatically remove a detrimental behavior by buying as if the stock market were to close.
Finally, Buffett wants those stocks that will grow and are strong. Businesses that grow will be worth more in the future, and so the stock price will take care of itself at that point.
A stock or business that is “strong” is one with a good, solid foundation. In other words, it shouldn’t have excess debt or liabilities in regards to its business model, and should have a strong competitive positioning (also called a “competitive moat”).
These characteristics of strength will help ensure that a business has long lasting staying power, which increases the likelihood their stock has a higher price in a decade from now.
Buffett automatically looks for those characteristics in the businesses he invests in, and is secretly suggesting you follow a similar approach by implying the importance of the long term holding period.
6— Know what you own, and know why you own it
This is a quote by the great investor Peter Lynch, who had a stellar track record in his time managing Fidelity’s Magellan fund.
By knowing exactly what you own, you can more easily convince yourself to continue to hold a great stock even if the market is not confirming that you are right.
You can’t control how the market will react to a stock and its performance, but you can control the exact businesses you own.
Researching a company and how it makes money, and what factors will allow it to continue to grow, is what will give you the conviction to act like Buffett and Lynch and buy and hold for years.
This way—as long as the factors for growth are still in place, you can feel great about holding the stock regardless of how it performs in the market because you know why it should succeed anyway.
If we remember that the emotions of Mr. Market are fickle, we can remind ourselves that extremes in fear or greed are usually temporary, and when these “moods” change, we should see our stock perform in a great way again.
If it’s truly a great business, bought at a great price, you can take that to the bank.
7— When the information changes, change your mind
Here’s a quote famously attributed to the economist John Maynard Keynes, and should be one to heed for investors deliberately looking for that great success with the stock market.
Not only do investors need to implement the right strategies, but they also need humility.
A good case of humble pie can be your big secret to massive success.
And it’s a great thing to keep in mind because the simple fact is that you are going to make mistakes. Even the best investors in the world make mistakes, and usually many of them.
The fact that business and the stock market is so unpredictable makes it so exciting, and also creates that great potential for high rewards.
Going back to secret #3, diversification helps limit catastrophic mistakes. And having humility helps you avoid taking deep losses by getting you out of losing stocks and back into winning ones.
It’s a big reason why I’m vehemently against the idea of heavy concentration for most investors.
Even great investors can analyze a stock and be wrong—with a heavy concentration on a stock that you end up being wrong on, your total performance will be absolutely crushed. That can be really hard to come back from, especially if you’re trying to benchmark your performance to a high performer like the S&P 500.
Going back to Keynes and Lynch, knowing what you know and having the ability to change your mind will reduce the consequences of your mistakes in the market.
That’s a huge asset.
Remembering that the market is emotional, we can remember that our stocks going down doesn’t mean we are wrong—instead, remembering the factors which will drive the growth of the business you invest in and checking if those factors are still prevalent is how you can limit mistakes.
Be careful of putting too much weight in analyst projections or the opinions of journalists. Those are more like the short term stock market noise.
Instead, look at a company’s financials, such as those disclosed and audited in a company’s annual report, to get the best information on your side.
(Here’s a great guide to help you learn to read annual reports).
8— Invest with a margin of safety, emphasis on the safety
This last secret has somewhat of a double meaning, but both can help you find massive success.
A margin of safety is an engineering concept which says that you essentially leave room for error. For example, a bridge might be designed to hold 10,000 tons of weight even if only 5,000 tons will ever be carried on it.
Likewise, you want room for error with the prices you pay for a stock…
Because it’s been proven over and over again that buying stocks at prices which are too expensive is a disastrous way to invest.
But not only do you want to pay what a business is worth…
You also want to buy stocks that will last. To get that beautiful compounding from the stock market, you need that business to continue its growth path, and to do that it helps to have a strong (or “safe”) balance sheet.
By keeping a cushion of cash or assets, companies can better weather the storm of economic busts and other tough competitive situations. By keeping debt low, they can do that same thing—as well as unlock more cash for the business to use to increase returns for its shareholders.
Emphasizing the safety in margin of safety has these benefits which help you buy stocks as if the market were to close for 10 years, and actually succeed in doing it.
That’s the theme of our podcast, and I highly encourage you to check it out for more great “secrets” of the stock market which we uncover every week.
Andrew has always believed that average investors have so much potential to build wealth, through the power of patience, a long-term mindset, and compound interest.