Building your own stock portfolio is one of the most exciting parts of investing. But it can also be one of the most challenging aspects of investing since you need to decide what stocks should be in your portfolio and what stocks should be left out.
In this guide, we’ll explain everything you need to know about how to pick stocks for the long term – from defining your investing strategy to researching stock picks to assembling your portfolio.
The Importance of Stock Selection
Before we dive into how to pick stocks, it’s worth thinking about why stock picking matters in the first place.
Picking the right stocks – that is, stocks that both match your investment strategy and perform well – is key to the long-term performance of your investment portfolio. If your goal is just to match the performance of the overall market, you could simply invest in an index fund. Picking stocks that are set to outperform for years to come is what gives you an edge over the overall market’s performance.
In addition, stock picking plays an important role in compounding your money over time. Stocks that are strong long-term picks are good candidates for reinvestment. So, every time you have money to invest, you can distribute it across your portfolio and feel confident that it will be invested well.
Step 1: Define Your Investment Strategy
The first step in building a long-term stock portfolio is to make a game plan. You need to define what you’re trying to accomplish by investing and establish investing principles to guide your investments.
There are several things to consider when establishing an investment strategy.
First, decide on your timeframe for holding investments. This should be related to your investing goals. You might have a shorter timeframe if you’re investing to buy a house in several years, or a longer timeframe if you are investing for retirement. Your timeframe will determine what type of stocks you’re investing in and how frequently you shake up the positions in your portfolio.
You also need to decide how much risk you can handle. Young investors who are a long way from retirement might be comfortable with more risk than someone who is planning to retire in a few years and will need to sell investments for cash. No matter what your risk tolerance is, it’s a good idea to put rules in place for when you will cut your losses and eliminate losing stocks from your portfolio.
Another thing to consider is how active you want to be in managing your portfolio. Some long-term investors invest all at once and then don’t check their portfolio for a year. Others add to or subtract from positions much more frequently.
This is also related to your strategy for entering stock positions. You can invest all your money at once, buy a few shares at a time (a strategy known as scaling), or make regular investments no matter what the market is doing (a strategy known as dollar-cost averaging).
Finally, you need to decide on the composition of your portfolio. That includes choosing how many positions it should hold, how diversified you want it to be across market sectors, and whether it should include stocks, ETFs, or a mix of both. You should also decide whether you want to focus on growth stocks, value stocks, dividend-paying stocks, or some combination of these different investing styles.
At the end of this process, you should be able to clearly summarize your investment strategy in a sentence or two. For example, your strategy could be “investing in medium-risk growth stocks for five or more years in a portfolio that holds around 20 stocks and focuses on the tech sector.”
Step 2: Research Stocks
Once you have a strategy in place, the next step is to find stocks that fit your strategy. There are many different ways to find and research stocks.
One of the best ways to start is with a stock scanner like Yahoo Finance or FinViz. These screening tools allow you to filter stocks by details like market sector, price, performance, and more. You can also sort stocks by earnings growth, price-to-earning (P/E) ratio, and other fundamental metrics that reflect a company’s long-term performance.
To dig more deeply into the companies you find using a stock scanner, you can use stock research tools designed for long-term investors. Stock Rover offers detailed stock research reports, detailed financial histories, financial modeling tools, and more for you to investigate stocks. Zacks Premium also offers research reports from professional stock analysts along with easy-to-interpret ratings for more than 10,000 stocks.
For investors who aren’t comfortable finding stocks on their own or want help choosing stocks, there are stock picking services available. The Motley Fool has several stock picking newsletters focused on long-term growth stocks and has a long history of outperforming the broader market. Services like Motley Fool’s Stock Advisor can help you skip the research stage by providing you with actionable stock picks. This saves you time and may improve your performance in the long-run (based on the program’s 20 year track record).
Step 3: Build Your Watchlist and Plan Your Entries
Once you’ve researched stocks, the next step is to create a watchlist of companies you want to invest in. Creating a watchlist is a good idea because it allows you to keep an eye on these stocks and find potential entry points.
Finding the right time to enter a stock is just as important as picking the right stocks. For example, Netflix was a great stock pick in 2010, but it looked much less attractive as a long-term investment in 2021.
You don’t necessarily need to time the market perfectly, but it’s important to balance your position size with the risk you’re taking on. Investors in Netflix in 2021 might not have known the stock would crash in 2022, but they certainly should have seen that it was highly valued. If you had started with a small position, you would have survived the crash just fine. But if you went all-in, the crash could have devastated your portfolio.
So, think carefully about what prices you’re willing to pay for the stocks you want to invest in. Then look for opportunities to invest at those prices.
Step 4: Start Building Your Portfolio
When the stocks you like reach an entry point, add them to your portfolio. Remember that you don’t need to go all-in right away and can instead add to your position over time.
Once you’ve started building your portfolio, it’s important to manage it. You can cut losing stocks, add to winning stocks, and even add new stocks that you like.
Remember that these are long-term investments, so a light touch is a good idea. Stocks might fall a little bit in the short-term. But if they haven’t exceeded your tolerance for losses and still seem like they’ll perform well over the long term, it makes sense to keep them in your portfolio.
Picking stocks for long-term investing starts with crafting a clearly defined investing strategy. After you have a strategy in mind, you can find stocks that fit your strategy and research companies to find the most promising investments. Look for good entry points into the stocks you want to invest in and be cautious about going all-in on positions at one time.
Once your portfolio is up and running, it’s important to manage it to make sure it stays on track and that you maximize the returns from your best stock picks.