For some people (my father included) the idea of buying a low cost index fund like our investing all stars recommend is just not going to happen. For these folks investing and trying to beat the market is just too enticing. Let’s not forget, we’re all human and who among us hasn’t given in to temptation at least once in a while.
So if you need to buy individual stocks, here is a strategy that you might consider trying. It was recommended by Benjamin Graham in the 1970’s called the Simply Way. Before I explain it, let me mention a few things.
1. The strategy involves work on your part. You will need to research individual companies and look for financial data that makes a company a potential candidate for purchase. If you are unwilling or unable to spend the time to complete this research, then forget about it now.
2. This strategy will not work every year you try it. You may become discouraged if your results are worse than what could have been obtained by purchasing low cost index funds. If you are not willing to wait 3-4 years to see how things work out, then forget about it now.
3. You will need to purchase stocks in Canada and the US. The Canadian market is just too small and concentrated to diversify enough using this strategy.
4. This strategy is not a get rich quick scheme. It will not turn $10,000 into $100,000 in 12 months. However, Mr. Graham was able to show it consistently returned about 15% over many years and probably would do better than a low cost index fund strategy, assuming you follow it religiously, and don’t give up.
5. Despite probably being able to beat the market with this strategy, the extra return you might earn may not be worth all the effort unless you truly enjoy investing this way and can’t imagine buying only index funds. Time is money and you could be doing other things with your time.
So if I haven’t scared you off yet, here it is.
Buy 20-30 stocks from a variety of different industries with the following characteristics.
1. Price/earnings ratio (P/E) of 10 or less.
2. Total liabilities to equity of 1 or less.
3. Market capitalization of $250 million or more.
Hold the shares for 1 year or until they have appreciated by 50%, then sell, whichever comes first. Ideally, you could purchase 2 shares every month until you have your group of 24 stocks. When the first year is up, sell the first two stocks you bought and replace them with 2 new stocks that meet the criteria.
Right now, it is a challenge to find a well diversified group of stocks that meet these simple criteria. This probably means stocks are too expensive for Ben Graham’s taste. In this case, he’d probably have only 25% of his investments in stocks and the rest in cash or government bonds waiting for stocks to come down in price.
Do you have the discipline to sit in cash and wait while everyone around you seems to be making money? Are you willing to jump into the stock market when everyone else is bailing out?