Use the bottom-up investment approach to pick the best stocks for your portfolio and maximize your wealth-building over time

Our Successful Investor philosophy employs the bottom-up investment approach. That’s when you focus on what particular stocks are likely to do. You avoid the more complex task of figuring out the entire economy. That’s “top-down investing,” and it’s when you try to figure out the so-called “big picture” and pick out the stocks that are likely to profit best within it.

In any one year, the most successful investors tend to follow a top-down approach. But over longer periods—several years or more—the winners tend to be using a bottom-up investment approach. Bottom-up investors have fewer spectacular years, but they avoid a lot of devastating losses. So, they wind up with better long-term returns.

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Use the bottom-up approach to investing to pick the best stocks for your portfolio  

We think that most investors are far better off with “bottom-up investing” as opposed to “top-down investing.” The bottom-up investment approach is where you look closely at individual stocks and single out those with a history of sales and earnings, not to mention dividends. Then you buy a diversified, balanced selection of stocks that represent prosperous businesses with a strong hold on their markets.

We advise you to invest this way within the framework of our three-part Successful Investor portfolio strategy (see below).

As we mentioned, over periods of five years and beyond, top investment honours generally go to members using the bottom-up investment approach. That’s partly because bottom-uppers tend to make fewer big mistakes. This lets their gains accumulate. This also leads to longer holding periods, which provide greater tax deferrals and lower brokerage costs.

Sometimes, a top-down idea acquires way too much influence on way too many investors. A classic example was the intense interest that built up for many months in 2012 over Greece’s debt crisis and a possible eurozone economic collapse, if not a worldwide collapse. Week after week, in almost every newspaper or online news source you could find one or more articles delving into how that might occur, and the devastating financial results that would follow.

Practice patience with the bottom-up investment approach for better long-term rewards

Losing patience can cause you to sell your best bottom-up choices right before a big rise.

All too often, investors buy a promising stock just as it enters a period of price stagnation. Even the best-performing stocks run into these unpredictable phases from time to time. They move mainly sideways in a wide range for months or years before their next big rise begins. (Stock brokers often refer to these stocks as “dead money.”)

If you lack patience, you run a big risk of selling your best choices in the midst of one of these phases, prior to the next big move upward. If you lose patience and sell, you are particularly likely to do so in the low end of the trading range, when stock prices have weakened and confidence in the stock has waned.

Bonus tip #1: To achieve the best long-term investment results, we think you should stick with our three-part Successful Investor philosophy:

1. Invest mainly in well-established, dividend-paying companies, with a history of rising sales if not earnings and dividends.
2. Spread your money out across most if not all of the five main economic sectors: Manufacturing & Industry; Resources & Commodities; Consumer; Finance; Utilities.
3. Downplay or avoid stocks in the broker/media limelight. When stocks spend time in the limelight, they tend to become overpriced, and this leaves them vulnerable to a sharp downturn on any hint of bad news. Instead, look for stocks with hidden value that are less widely recognized—at least so far—as attractive investments.

Bonus tip #2: Here’s how to fine-tune your individual portfolio diversification

If you diversify as we advise, you improve your chances of making money over long periods, no matter what happens in the market.

For example, manufacturing stocks may suffer if raw-material prices rise, but in that case your Resources stocks will gain. Rising wages can put pressure on manufacturers, but your Consumer stocks should do better as workers spend more.

If borrowers can’t pay back their loans, your Finance stocks will suffer. But high default rates usually lead to lower interest rates, which push up the value of your Utilities stocks.

As part of their portfolio diversification strategy, most investors should have investments in most, if not all, of these five sectors. The proper proportions for you depend on your temperament and circumstances.

For example, conservative or income-seeking investors may want to emphasize utilities and Canadian banks in their portfolio diversification, because of these stocks’ high and generally secure dividends.

More aggressive investors might want to increase their portfolio weightings in Resources or Manufacturing stocks.

However, you’ll want to spread your Resource holdings out among oil and gas, metals and other Resources stocks for diversification and exposure to a number of areas.

 Do you practice both the bottom-up and the top-down approaches to investing or do you stick to only one?