We’ve all heard that markets are driven by fear and greed. Those two emotions are what cause the wild intraday swings in stock prices, and they’re what makes learning to invest so difficult. We all want large and immediate gains. If we could all get them, though, none of us would have jobs. We’d trade stocks for a few years and retire to a cozy island in the Caribbean.
To invest successfully, you’ve got to banish the idea that you can predict where the markets are going from day to day. One of my favorite quotes from Warren Buffett – the CEO of Berkshire Hathaway Inc. (NYSE:BRK.A) and the so-called Oracle of Omaha – came when he was asked how long he likes to hold onto specific stocks. His one-word answer? “Forever.”
If you’re looking to get rich quickly, you’d be better served by going to the horse track or riverboat; not the NASDAQ or NYSE. But, if you’re emotionally able and willing to let your investment plans play out over months or years, you can and probably will make money in the stock market – even if you’re starting out with a relatively small chunk of change.
Here’s a simple secret beginning investors can use to make money on stocks: you’ve got a profound advantage over giant hedge funds, professional money managers and corporations. The relatively small size of your portfolio gives you access to stocks that the big fish just aren’t able to invest in.
“It’s a huge structural advantage not to have a lot of money,” Buffett said in 1999. “I think I could make you 50% a year on $1 million. No, I know I could. I guarantee that. But you can’t compound $100 million or $1 billion at anything remotely like that rate.”
See, investors with lots of capital at their disposal just can’t meaningfully invest in small-cap, high-growth companies. They have too much capital to put to work. The small caps you have access to today might end up in the portfolios of the big fish investors a decade from now, and that’s where you stand to make mountains of cash.
Jim Fink at InvestingDaily boils Buffet’s ideas down to three requirements to earn 50 percent returns every year:
1) Your portfolio must have less than $1 million. Just about all of us (unfortunately) fall into this camp.
2) You must buy small cap stocks “before they grow up.” Fink defines small cap stocks as companies with market caps of $3 billion or less.
3) Pick companies with high returns and low spending requirements. “The best businesses by far for owners continue to be those that have high returns on capital and that require little incremental investment to grow,” Buffett wrote in 2009. For Fink, that means finding companies that generate at least $5 in cash flow for every $1 they spend.
Remember, investing isn’t about uncovering the next Apple Inc. (NASDAQ:AAPL) or Microsoft Corporation (NASDAQ:MSFT). It about finding companies that are going to reliably produce ever-larger amounts of money without dramatically increasing their costs. Find those stocks, and you’ll do just fine.
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Tags: BRK.A, investing tips, Warren Buffett
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