For the seventh time in 2015 the stock market – as measured by the S&P 500 Index – has returned to its starting point for the year after having moved +/- 2% away from it in one direction or the other. Last Wednesday’s closing value of 2061.05 was less than three points away from where it began the year at 2058.90, leaving index investors at breakeven for the year.

At least index investors haven’t incurred any trading commissions thus far, assuming they own a no-load ETF. It’s the active investors who are most at risk, gambling that their trading results will be better than at least half of the other people making the same wager. That may be the case for some of them, but every industry study ever done clearly shows that most individual investors underperform the market by a wide margin when actively trading their accounts.

Although brokerage commissions are part of the reason, an even bigger problem is the litany of human emotions that interfere with sound decision making. My colleague Bob Frick has written about that subject many times before in this space so I won’t repeat what he has already said, but suffice to say that only a small minority of investors possess both the acumen and discipline to execute a profitable trading strategy over the long haul.

However, that doesn’t mean that individual investors have no chance at beating the market; it just means they need to go about it in a more structured manner. That’s what the pros on Wall Street do, whether they are managing a mutual fund or trading with their own money. To help put the odds more in your favor, here are three quick tips for not letting the daily ups and downs of the stock market interfere with a successful investment strategy.

1. Have a clearly defined process for buying and selling stocks: This may sound obvious, but during my 28 year career as a stockbroker I met very few individual investors who used the same process repeatedly for making portfolio decisions. While they could tell me why they wanted to buy or sell a particular stock, their rationale was never the same from one stock to the next. To be clear, not every investor has to use the same process in order to be successful; they just have to use one that is valid and stick with it. Peter Lynch became a mutual fund legend by having a repeatable process for buying growth stocks, while Benjamin Graham became famous for only buying value stocks. That’s why we introduced the IDEAL Stock Rating System for our Personal Finance portfolios; it tells me when a stock has become so overvalued that it is no longer worth holding, and shows me others that have become undervalued and are more likely to appreciate. It won’t always be correct, but it doesn’t need to be for us to beat the market over the long haul.
2. Understand that you don’t need to be perfect, only pretty good: As successful as Lynch and Graham were, they recognized that that they only needed to be right about 60% of the time to outperform the overall market. For that reason, each of their processes included a mechanism for knowing when it was time to sell a loser, something most individual investors are loath to do. Nobody likes to admit defeat, but selling a small loser before it becomes a big disaster actually improves your odds of winning, so try to think of that way if it helps soften the sting of realizing a loss. There is also an opportunity cost to hanging on to a laggard too long. Sure, it may get back up to your original purchase price eventually, but that money would appreciate faster if switched into a better performing stock.
3. Remember the three ‘R’s of investing; – Rebalance, Reallocate, and Reinvest: Last week we wrote about the virtues of rebalancing, which ensure that your portfolio does not become overweighted in any one holding. So this week let’s add reallocating and reinvesting to the list. In addition to stocks, you should own other financial assets that add diversification and thereby reduce volatility. For example, in every issue of Personal Finance we include an asset allocation model at the bottom of page one which shows a portfolio of stocks, bonds, hedges, and cash. We adjust the percentage assigned to each asset class based on our perception of how much risk there is in the market at present based on bond yields, inflation, and relative value of the stock market. Yes, it’s a simple approach, but it works remarkably well over time. Finally, reinvesting dividends and capital gains back into your portfolio produces the magic of compound interest, which is almost imperceptible in the short turn but has a hugely positive effect over many years. For example, if your stock portfolio appreciates at average annual rate of 6% and pays an average annual dividend of 2%, over the next twenty years reinvesting those dividends would increase the total value of your portfolio by more than 45% (and by 75% over thirty years)!

Admittedly, sticking with a structured investment process isn’t as exciting as taking a flyer on a penny stock or hot biotech company, but it isn’t supposed to be. Over the course of my career, I met many successful money managers, and quite frankly most of them are not big risk takers. They know what they like, and they stick to their game plan even when it isn’t working very well at the moment. That’s how they make money in the stock market, and how you can make money in it, too.