Occasionally, I get questions from investors who ask: “Victor, I have been investing for many years, but I keep losing money in the stock market. What should I do?”
That’s a good question. But when I take a look at their stock portfolios, they usually own more than 50(!) companies and the majority of them are companies with weak business models and poor fundamentals that were usually bought based on recommendations by friends or brokers.
I was fortunate, together with Rusmin, that during our early years of investing, we were tasked to turn around a stock portfolio that was down around S$400,000. We had to review every stock inside and decide which to keep and which to junk, and along with injecting our own picks, the portfolio managed to turn a profit of S$2.3 million three years after we stepped in.
Combining this previous experience and the more we’ve learned about investing in the years since, we realise that there are certain ‘rules’ to follow if you want your stock portfolio to perform overall. So even if your portfolio is deep in the red at the moment, don’t worry. Because while we can’t unwind any mistakes we’ve already made, we can definitely turn things around moving forward.
Here are five things to do if you keep losing money in the stock market and how you can turn you stock portfolio around.
1. Compound your winners, not your losers
Investors with a losing portfolio usually hold on to their losers and hope that one day their investments will turn around. When I talk about losers, I mean companies that have weak business fundamentals, rather than a stock that you’re currently making a loss on.
In order to turn a losing portfolio around, you have to clear these losers first. The logic is simple: investing is a game of probability. We can’t predict the future for certain, but we can be sure that a company with strong business fundamentals is more likely to outperform one with weak business fundamentals. So by eliminating your losers first, this will give you ample cash to focus on the better companies that can allow you to make back your losses and, eventually, give you a profitable return.
The first step is to classify all the companies in your portfolio into four categories: do they have recurring or non-recurring earnings, and a weak or strong business model:
My goal is to keep companies that have a strong business model and eliminate those with weak business models. Companies that have a strong business model and earn recurring income is the ideal kind of company you want to keep. If you apply this process, you should be able to unlock extra cash from your portfolio as you divest your losers.
2. Always invest in good companies
The second step is to ensure that you do not repeat the same mistake and invest in those losers again! With the cash you have now, you have the resources to invest in good companies that can compound your returns.
When I talk about good companies, I mean companies with a strong business model that preferably earn recurring profits, and have a dominant market position. They make good return on equity with little debt and generate strong cash flows that allow them to return excess money to shareholders as dividends. Companies like these give you a higher probably of success and allow you to turn your portfolio around.
But do note that investing in a good company also depends a lot on getting a good price. A good company can still be a bad investment if you pay too much for it — that’s one of the most common ways people keep losing money in the stock market! So never overpay for a stock and learn how to value a company properly.
3. Diversify, but don’t over-diversify
Portfolio diversification is very important as it help us to minimize our non-market risk. Non-market risk is something that an investor can control unlike market risk. Non-market risk is directly linked to the company’s performance, while market risk is linked to macro events like recessions, changes in interest rate, natural disasters, etc.
Unless you’re an index investor buying ETFs, some investors over-diversify by having more than 50 stocks in their portfolio. Let’s be honest, how many of us can consistently monitor 50 companies as a retail investor with a regular full-time job? Even as a professional investor, that takes a lot of time and focus.
In the book Modern Portfolio Theory and Investment Analysis, authors Edwin J. Elton and Martin J. Gruber concluded that in a portfolio of 20 stocks, non-market risk was reduced by approximately 80%. By adding more stocks, the reduction in risk was negligible. This means there isn’t a need for most investors to own a portfolio of more than 20 companies. Ideally, 10-20 stocks are good enough for diversification.
4. Give your tree time to grow
Investing in a company is just like growing a tree. Even though it could be small now, as long as it is deeply rooted (strong fundamentals), it will continue to climb. You’ll monitor the tree’s progress every few months to ensure the roots, stem, and branches remain healthy. As the tree grows bigger, you’ll eventually get to enjoy the shade and the fruit (dividends) it bears. The growth of a tree takes time and we don’t expect a sapling to grow into a big tree overnight.
It is exactly the same with investing. We should not expect a stock to suddenly shoot up in price (even though it can happen sometimes). Good companies will continue to build their economic moats year after year and this requires time to achieve. Since companies are like trees, it is important to be patient and to focus on the long term, despite tough economic conditions, in order to reap future gains.
5. Opportunity is key
When investors have a sizeable cash hoard, they usually get itchy and want to deploy their money quickly because they fear losing out on any potential gains now. But to achieve a profitable portfolio, opportunity is the key to your success. You should only invest when the opportunity arises. Events such as a stock market crash, economic crisis, or temporary setback that causes a company’s share price to plunge – all these are opportunities to own a stock at discount prices and maximise your returns. So be patient and wait, the next opportunity will always come around. Just keep your eyes peeled for them.