Rules for Investing: How to find the Best Investments

Do you want to be able to make money while doing absolutely nothing? Let’s go out on a limb and assume you do. The idea of earning passive income is what most people fantasise about. In an ideal scenario, passive income gives you the opportunity to take back your life and spend time doing what you love, instead of working in some job you hate.

At the very least, it’ll still allow you to earn some extra bucks towards a happy retirement or that dream family holiday. There are millions of people making passive income through investing, and there’s little reason why you can’t do the same. In a nutshell, all you need is the capital to invest and the ability to choose winning investments.

Read on for a step-by-step guide to successful investing.

Disclaimer: not everyone is ready to invest

When investing in equities, there’s always a possibility of losing your money.

This guide will share ideas to minimize the odds of this happening, but it’s impossible to guarantee a profit. Even the world’s greatest investment experts occasionally recommend a dud.

With this in mind, you should never invest money that you can’t afford to lose. In fact, it’s often said that you shouldn’t invest money you might need to access in the next five years.

It’s difficult to make short-term profits in the stock market. Any short-term investment strategy recommended to you is likely to be extremely risky. The most reliable strategies will only be so in the long-term.

This guide suggests intelligent guidelines for making money in the stock market, but you need to have the emotional maturity to follow them.

If you’re the type of person who is susceptible to the symptoms of gambling addiction, stay away from the stock market.

If you’re likely to let greed prevent you from selling a winning investment, or pride stop you from cutting losses, consider trying to making passive income some other way.

Deciding your goals: the first step to choosing a winning investment

The first question to ask yourself is: what are your investment goals?

Are you looking for some extra income to spend on holiday, a sizeable retirement pot to enjoy in a few decades or are you trying to quit your job within a few years? In most cases, it’s probably somewhere in between these three options…

The final option might sound the most appealing, but the fastest rewards only come to those willing to take the biggest risks. Are you willing to watch your $10,000 investment turn into $4,000 or less within a year? You’ll need the nerves to do that if you want to win the biggest prizes on the stock market.

If you’re not willing to ride this rollercoaster, you can choose to invest in more reliable stocks. The low rewards won’t make you a millionaire overnight, but they’re low-risk and still likely to make more profit than any savings account on the market.

You can determine the risk of an investment by examining the volatility of its value over previous years. Your stockbroker or financial adviser may be able to share information about this too.

Still, here’s a basic scale to follow, with the riskiest investments at the top, based on historical data.

  • Equities from emerging markets.
  • European/Far East equities.
  • U.S equities.
  • Property investments.
  • U.S Treasury securities.

Tracker funds: The most recommended platform to get started with stock market investing

The best way to reduce investment risk is through diversification. This means not putting all your eggs in one basket.

Buying stocks in one company is far riskier than investing in a tracker fund that is based on the share price of multiple companies.

Warren Buffett, arguably the most famous and successful investor in the world, has publicly instructed his heirs to place 90% of his estate into a tracker fund based on the S&P 500.

Other low-risk tracker funds are based on all FTSE 100 share prices or the FTSE 250 share prices. If you want to invest in tracker funds covering higher-risk investments, or investments with a certain industry (e.g tech, property), this is also possible. There are plenty of mix-and-match tracker funds based on various industries and these are your best opportunity to diversify.

You’ll also need to decide whether you want your fund to be passively or actively managed. With an actively managed fund, a seasoned fund manager will continuously attempt to replace underperforming stocks with those they expect to be more profitable. The best actively-managed funds tend to outperform equivalent passively-managed funds, although this is no guarantee and you’ll pay higher commission to your fund manager for this option

How to pick your own stocks

Choosing your own individual stocks may be riskier than investing in funds, but the rewards are potentially greater.

Here’s an example that demonstrates this well:

  • S&P 500 growth between 2006-2010: 75%;
  • Apple Inc. growth between 2006-2010: 348%.

Nevertheless, for every Apple, there are dozens of companies that go bust, so tread carefully. It’s often recommended to invest only a small percentage of your investment pot into individual stocks.

To invest in individual stocks, you’ll need a stockbroker. They will charge commission on each trade you make, but this should still work a lot cheaper than using a fund manager.

You’ll also need a computer with an internet connection, so you can discover real-time price information about the stocks you want to buy. Here are some popular stock screener websites that’ll show you this.

These websites will also display the following information about the stocks:

  • Price-to-earnings (P/E) ratio. This is the stock price divided by the earnings per share. This ratio allows you to compare the value of shares between companies of different sizes. You can also compare it to previous P/E ratios to see if there’s likely to be room for the share price to grow. A low price-to-earnings ratio is a great sign for investors.
  • Spread. This is the difference between the buying and selling price. The buying price will always be higher, meaning you’ll instantly be at a loss upon buying the shares. It’s often recommended to avoid shares with spreads higher than 3% of the share price.
  • Liquidity. This figure represents the number of shares being traded. If a share has poor liquidity, you might have trouble selling it at the exact moment you want to. Liquidity is commonly displayed as a bid/ask ratio, which is the difference between what sellers are willing to accept and buyers are willing to pay. Anything more than a few pennies difference could spell trouble for a seller.
  • Exchange market size. This is the maximum number of shares guaranteed to be sold at the quoted price. If you want to buy more than this, be prepared to pay a higher price.

If you’re looking to trade shares in well-known companies, such as those in the FTSE 100 (and most likely the FTSE 250), you rarely have to worry about poor spreads, liquidity or exchange market size. However, when trading cheaper stocks, you should always check this and seriously consider bailing if the numbers aren’t in your favour.

Find good trading platforms here:

What makes stock prices fluctuate?

On its own, a share’s current price is highly irrelevant. Provided you’re investing the same amount, a 10p share that rises to 20p has the same value as a $4 share that rises to $8.

The important factor is whether the share is likely to increase or decrease in value – and this is based on the demand for these shares.

***WARNING: One of the biggest newbie investor mistakes is believing that it’s easy to get rich from penny stocks. While it may seem like it’s easier for these to gain 10x in value to 10p, it’s also extremely easy for them to lose 10x their value to 0.1p. In reality, most penny stocks are only available for companies showing no hint of being successful, making them the most risky investment choice of all.***

It’s true to say that a company’s success determines the demand for shares. However, in reality, it’s a lot more detailed than that.

Here is a list of situations that may affect a company’s share price.

  • Company news.

Any company news that is likely to affect its future success will have a significant impact on its share price. Takeovers, mergers, major investments or profit warnings are the most extreme examples of this news. When it’s time for a company to announce its annual profits, you can usually expect a share price shift one way or the other.

  • General market moves.

Global events can harm or improve an entire market. For example, the 9/11 terrorist attacks caused a huge dip in the global stock market. When the United Kingdom announced it would be leaving the European Union, the value of the pound and most major British companies plummeted.

  • Sector news.

If a giant in a particular sector makes a major announcement, this could typically affect demand for shares across that whole sector.

  • Recommendations.

Brokers and commentators regularly make recommendations to their clients and these can temporarily affect demand for the share they’re discussing. The most high-profile recommendations are generally reported across all investment media outlets.

  • Dividends.

A lot of publicly-traded companies issue rewards to investors in the form of dividends. These are typically issued either once, twice or four times a year. When the ex-dividend date (the day before dividends are calculated and issued) is approaching, demand for shares tends to grow. After it has passed, there is an inevitable drop in the share price.

  • Tree shaking.

The stock market is filled with “market makers”. These are companies that guarantee they’ll always be willing to buy and sell shares, helping to solve the problem of poor liquidity for small company shares. The more these shares are bought and sold, the more money that “market makers” earn, due to the spread. “Tree shaking” is the process of market makers deliberately manipulating the price of shares in order to spook traders into selling. The process usually lasts a few hours before prices return to normal. If the price of your shares drop dramatically and you can’t explain it through one of the reasons listed above, it’s almost definitely a tree shake. Hold your nerve and your shares. Tree shaking frustrates a lot of investors, but if trading shares was easy, everyone would do it!

It’s common for share prices to drop after positive news about the company is published.

This tends to happen because experienced investors bought shares in the company once rumour of this good news emerged, then banked their profits shortly after the news was confirmed. Indeed, a common rule of investing is: buy on the rumour, sell on the news.

That means you’ve got to be on the ball. Those who successfully buy individual shares will constantly be reading financial news and monitoring the fortunes of companies that catch their interest.

Pay close attention to dividends

Dividends can make up a significant period of your investment income. In fact, the average dividend yield for the FTSE 100 is tipped to rise above 5% in 2019, so it’s worth paying attention to which companies tend to pay the highest dividends.

Dividends are paid directly from the company’s profits, but companies aren’t ever compelled to pay them. They certainly won’t pay out if no profits are made.

You can find the history of a company’s dividend payments and information about the ex-dividend date online or in investor magazines.

You’ll benefit from the dividends paid out within tracker funds too. However, some funds will automatically use the money to invest in more shares, rather than pay you in cash.

How to find the best investments

Many investors will instruct a fund manager or financial adviser to choose the shares they invest in.

However, if you’re keen to make these decisions for themselves, here are some tips to help you pick a winner.

  • Invest in an industry you’re familiar with. Knowledge of how business works in a specific sector will make it far easier to pick a winning investment. After all, your instincts on which businesses are likely to succeed will be based on your knowledge of what it actually takes to be successful. You’ll probably enjoy reading up about the businesses in this sector and should find it easier to “buy on the rumour”.
  • Investigate the tracker funds in specific industries. A quick web search of “tech ETF”, “travel ETF”, etc will help you find the holdings within that industry’s best tracker funds.
  • Use the search function on your stock screener. These websites tend to have quite powerful search filtering options to help you find stocks in specific industries. You can usually also filter based on market cap and dividend yield among other metrics.
  • Start reading investment magazines and websites. This media contains plenty of useful information, but make sure to back it up with your own research.
  • Avoid the hype. Don’t buy stocks unless you have a solid understanding of how the company plans to grow in the future. There’s a lot of hype based on zero fact being published, so always do your own research.
  • Dig into the financial reports. Look for revenue growth, levels of debt, profit margins and dividend history.

Of course, equities are just one type of investment. You could choose to invest in property, cryptocurrency, antiques or precious metals to name just a few assets.

Even so, the basic rules of finding the best investments remain the same. Do your research. Invest in what you understand. Strike when the price is low.

When to sell your investments

There’s no concrete rule for when you should sell your shares. After all, it’s impossible to accurately predict the future.

Your decision should be based on your overall investment goals. Are you playing for quick wins or long-term growth?

Whatever you decide, it’s generally recommended to choose an exit strategy and stick with it. This can spare you a lot of over-analysing and prevent you from making decisions based on greed or pride.

It is possible to set stop orders with your stockbroker. These orders will cause them to automatically sell shares once they reach a certain price. Make the most of this feature. It’ll save you from obsessively checking share prices for fear of your savings disappearing. You can also set stop orders for prices higher than the current price – and you should. It’s impossible to hit the top of a profit wave every time, so you shouldn’t stress about selling too early. Better that than hanging on and missing the peak altogether.

You won’t play the stock markets perfectly. Make peace with this fact now to save yourself from a lot of stress.

After all, by bearing these tips in mind, you’ll make a lot more good decisions than bad.