In general, making money in the stock market is a long-term game. If you're looking for quick profits, you're better off finding another investment opportunity. That's not to say that it's impossible to make money in stocks in a short period of time, but despite what social media might tell you, short term stock trading is not particularly lucrative for the vast majority. Beyond the mistaken glamorisation of esoteric graphs and complicated charts, there's a dearth of information online about sensible stock market investing for the long term. So how to choose the best stocks for long term investment?
What is long term investment?
In general, investments are considered to be long term if they are held for more than a year, although we would generally extend that to 3-5 years. Stock market downturns of the past have often lasted a number of years and investing money in stocks that you might need in one year's time is not a good idea. This is why it's a good idea to consider your time horizon and make sure you have enough in a rainy day fund such that you won't be cornered into selling stocks at a loss to fund your living expenses.
Why invest in stocks?
The stock market generally captures the majority of both the value and innovation of the global economy. Private markets are responsible for many of the most disruptive and exciting advancements of humankind and it therefore stands to reason that you would want exposure to some of this. That being said, which vehicle allows you to engage with this the most effectively is the cause for some discussion.
How to choose the best stocks for long term investment
For the average person, choosing individual company stocks is generally not a good idea. A great number of studies have shown how few investors beat the overall market over the long term - and these are professionals with innumerable analysts and technology. It therefore stands to reason that the safest way for a retail investor (that's you or I) to capture some of the global economy's upside, is to invest in a basket of the world's best companies, chosen by size, reputation
What to look for when choosing stocks
There is a huge quantity of literature available online if you are still interested in trading individual stocks. We would recommend starting out with a virtual portfolio, especially if you are more intent on trading, or holding each position for only a short period of time. Bear in mind also that fees are often charged on transactions, so you can be punished for excessive volume. EToro is generally regarded as the best place to manage a virtual portfolio - its social element also allows you to track and replicate the portfolios of others.
But what you will more likely be doing when thinking about how to choose the best stocks for long term investment, is choosing a fund or funds. The question is, if so few of even professional investors beat the market, why would you want to invest in them yourself? More and more over the past few decades, the propensity of intelligent and informed retail investors has been to make use of low cost index funds, which essentially track the performance of the market as a whole.
Let's take an S&P 500 fund as an example. When you put money into that fund, that money is then used to make investments in each of the 500 companies that make up the S&P 500, giving you proportional exposure to the whole of the US market. As companies enter and leave the S&P 500 they are added accordingly. The costs are famously low and no effort is involved in maintaining this exposure.
The benefits of long term stock investing
The number one benefit of investing over the long term is that your investment has a longer time horizon over which to compound. Humans aren't predisposed to be able to accurately estimate exponential growth, and this leads us to vastly underestimate the power of compounding over the long term. When thinking about how to choose the best stocks for long term investment, the long term part is by far the most important!
For example, an investment of £5,000 growing with simple interest at 5% would leave you with £15,000 after 40 years. Growing with compound interest instead, you would be left with £36,800 over the same time period.
Investing over the long term also means you are no longer a victim to the short term drawdowns that can so often occur. Volatility happens over the short term and it is here that damage can be done by the temptation to make changes to your portfolio.
Examples of how to apply these concepts
So the final question to ask is when should you be investing? Data often hints that waiting for optimal times to invest your money is costly, but it can often be nerve wracking, especially if you invest at "the top." An oft-used alternative strategy is pound cost averaging. By investing the same monetary amount each month, you're effectively buying more shares when they're cheaper and the market is down, and less when they're more expensive. Buying low, selling high. This can feel safer and more comfortable and gets you into the healthy routine of regularly contributing to your stock portfolio.
So there it is! How to choose the best stocks for long term investment. We've perhaps eschewed traditional stock picking tactics for a more risk averse approach that bodes well for long term investors looking to save towards a large goal or retirement, but we hope that the strategies shared here have been useful. Of course, the simplest way to manage these investments as part of a targeted portfolio allocation is on the Strabo dashboard. Here you can match up your risk profile with a relevant portfolio allocation and rebalance to keep that allocation as your investments grow, to make sure that you stick to your strategy. If you have any questions around what we've covered or regarding effective portfolio construction for the long term, we would love to hear from you!