What are good investment strategies for beginners? How do you choose investments when you’re just starting out?
Investment strategies for beginners include doing original research, value investing in bargain stocks, and focusing on your portfolio. When you’re just starting out, it’s a good idea to gather as much information as you can about potential investments.
Learn more about how to choose investments with these tips from hedge fund manager Joel Greenblatt.
How to Choose Investments as a Beginner
Investing firms can overwhelm laypeople with their sheer range of options: actively managed mutual funds, passive index funds, exchange-traded funds, and more. But according to hedge fund manager Joel Greenblatt, the amateur investor doesn’t need any of these options to earn above-market returns. On the contrary, in his 1997 book You Can Be a Stock Market Genius, Greenblatt details investment strategies for beginners with an approach called special-situation investing, which can yield lucrative returns that outperform the vast majority of investing funds.
To outline this approach, Greenblatt examines an array of uncommon situations in the corporate world that spawn various promising securities (financial assets that you can buy and sell) at bargain prices. He discusses why corporate spinoffs often create incredibly cheap stocks, why bankruptcies can lead to underpriced equities, and why stub stocks can provide exponential returns with limited downside risk.
As the founder and co-manager of Gotham Asset Management, a hedge fund with a $4.6 billion portfolio as of September 2023, Greenblatt distills years of concrete financial experience and expertise into his discussions about investment strategies for beginners. Having authored several other public-facing books, such as bestsellers The Little Book That Beats the Market and The Big Secret for the Small Investor, Greenblatt is skilled at making dense financial concepts accessible to the uninitiated.
In You Can Be a Stock Market Genius, Greenblatt considers the following investment strategies for beginners:
- Investing in the new securities resulting from spinoffs and bankruptcies
- Purchasing securities arising from companies undergoing acquisitions or restructurings
- Making leveraged investments in the form of stub stocks and long-term calls
In this article, we’ll focus on the foundational concepts that apply in all of these situations.
A Brief Introduction to Value Investing Strategies for Beginners
According to Greenblatt, successful special-situation investing rests on the foundation of value investing, which prescribes purchasing stocks at less than their fair value. He argues that by practicing special-situation investing, value investors can profit handsomely.
Greenblatt explains that value investing essentially involves finding bargain investments. To illustrate, imagine that you’re a baseball card collector who regularly sells baseball cards at auction and you find a card at a garage sale that costs $50. If you know that collectors have recently bought this card for around $100, then the card at the garage sale is underpriced—it’s selling for less than its true value. Thus, by purchasing the card at $50, you can make a profit of $50 by selling it for $100 at auction.
Tip #1: Invest Independently
First, Greenblatt argues that you should perform your own research to find bargain investments. He writes that this advice stems from the nature of bargain investments—because such investments are ignored and unappreciated by other investors, they’re not heavily discussed by mainstream investing sources. For example, if The Wall Street Journal ran a front-page story on an allegedly underpriced stock, swarms of investors would likely invest in it, driving its price up and making it no longer a bargain.
Tip #2: Invest Selectively
Next, Greenblatt contends that you should invest sparingly, focusing on the stocks that you’re most sure about. He asserts that by practicing this strategy, you’ll maximize your chances of finding profitable investments while excluding those you know less about (and which are therefore riskier). After all, you never have to invest, so you can wait patiently to ensure your investments are always well-informed.
Tip #3: Don’t Blindly Trust Analysts
Finally, Greenblatt argues that you should avoid deferring to analysts because their interests compete with yours. For example, many analysts are paid by stockbrokers who earn commissions on stock sales. Thus, analysts are incentivized to recommend buying companies even when these companies might be objectively unpromising. Moreover, analysts who criticize a company’s stock often lose their access to inside sources, which makes them reluctant to issue “sell” recommendations. For these reasons, Greenblatt believes you can’t trust analysts to provide you with impartial recommendations.
Exercise: Reflect on Greenblatt’s Investing Strategies for Beginners
Greenblatt’s special-situation investing is foreign to most investors, whose portfolios are typically managed by professionals in charge of investing funds. In this exercise, reflect on your own investments and consider whether these investing strategies for beginners could enhance your portfolio.
- Which stocks comprise your investment portfolio? What was your rationale for investing in these stocks?
- Of the special situations that Greenblatt mentions, which would you be least likely to invest in? Why?
- Of the special situations that Greenblatt mentions, which would you be most likely to invest in? Why?
- In light of your answer to the previous question, find and research one upcoming example of the special situation you would most likely invest in. For instance, this might involve looking at The Wall Street Journal for announcements of future spinoffs or acquisitions. Do you think this situation could provide a lucrative investment opportunity? Why or why not?