The Best Mindset to Have when Investing – How to Invest in Stocks and Sleep at Night


So you want to invest in stocks but you are nervous.  You know it is the right thing to do, but watching the ups-and-downs of the market each day and listening to the commentators just keeps you on edge.  How do you save for retirement but still sleep at night?

In a previous post I went into the worst mistake a 20-something can make, which is not investing in equities while you are young and able to sustain the gyrations of the market.  Even if you are a great saver, if you put all of your money into bank CDs and don’t take advantage of the high inflation-adjusted growth rates of equities you are really missing out. Worse, the likelihood of saving enough to enjoy a comfortable retirement if money is kept in the bank is very small.

That said, many individuals find it difficult to deal with the changes in market value experienced when invested in stocks.  Using the “river analogy” I commonly use, it is like white water rafting.  Some enjoy the excitement of the tossing and turning, while others would rather be floating on a placid lake.  Even if you know you need to get on the river to reach your destination, there is understandable timidity in the lake-types.  The secret to getting over this fear of the markets is to develop the correct mindset for investing.

Here are several ways the timid can deal with the turbulence of the markets:

1. Look at the companies and not Mr. Market.  Mr. Market is a fictional character created by Benjamin Graham, a famous investor who was a mentor to Warren Buffett.  Mr. Market is always out there calling out prices for things.  The prices he calls are due to all sorts of factors and can vary wildly from day-to-day or minute-to-minute.  To see how wild Mr. Market can be, look at his calls for Aflac stock: ( http://finance.yahoo.com/q/bc?s=AFL&t=5y&l=on&z=l&q=c&c=)  In 2008 Mr. Market declared that Aflac Stock was worth almost $70 per share.  Three months later, he declared it worth less that $15 per share.  Six months after that it was worth almost $60 per share again.If one had been paying undue attention to Mr. Market and holding Aflac stock, one would have thought the world was coming to an end and sold out in panic in January of 2009. 

A calm look at the fundamentals of the company, however, would have painted a very different picture.  One would have seen that the housing crisis, while it might have some effect on the company’s ability to sell insurance policies, really wasn’t that big a factor.  Also, while the company’s investments may have taken a bit of a hit in the stock market downturn as well, there was nothing critical that could have happened that would have caused the company to lose that much value.  The investor who was looking at the fundamentals of the company would have been buying shares hand-over-fist at less than $20 per share and made out well once Mr. Market started calling better prices.  Mr. Market is often driven by fear and greed.  Those who follow Mr. Market will sell at the bottom and buy at the top.

2.  Bury your head in the sand.  Believe it or not, the nimble trader who is constantly watching the market and jumping in and out of stocks will actually do worse than the individual who just buys stocks and forgets she owns them.  If you can’t stand to see the changes in account value, just don’t look.  Maybe glance at the statement once in a while and see how things are progressing.  If what you see worries you and causes you to freeze like a deer-in-the-headlights, it’s perfectly fine to just drop the statement in a drawer and wait for the next one.  Once the damage is done, there is no reason to worry about it.  If you move out of stocks there is no way you can regain the former balance.

In investing, time is your friend.  Witness how those who panicked and sold off in 2009 would have been far better off if they had just ignored their accounts since the market recovered all of the loss over the next year-and-a-half.  Often, the best action to take is no action.

3.  Think of yourself as a partner.  Looking at a portfolio as a bank account, one would get nervous to see the account balance drop from month-to-month.  Instead of thinking of your stock account as a bank account with a balance, think of yourself as a venture capitalist who is funding various ventures you feel will do well.  You understand in doing this that some of the ventures will not work out, but those that do will more than make up for losses on those that don’t.  Also, you aren’t interested in the results from any one quarter or year.  You know that there will be some bad times along the way, as there are with any business, and it will take time for profits to grow.   As long as the company has a good concept and is executing it well, there is no reason to move money out.

Note that this same philosophy can be used with funds rather than individual stocks.  When you’re buying an S&P500 fund, you’re buying 500 large-cap US stocks.  If there are a few bad quarters in the economy that cause the price of the index to drop, that does not really matter.  You are holding interests in a substantial portion of the American economy.  Unless the entire US economy collapses, businesses will recover and grow again.   If you own a large-cap fund, a small-cap fund, and an International fund, eventually one of them will grow and provide a good return.  You just need to sit back and lett all of those great entrepreneurs work for you.

Follow on Twitter to get news about new articles.  @SmallIvy_SI

Disclaimer: This blog is not meant to give financial planning advice, it gives information on a specific investment strategy and picking stocks. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing

The Worst Investing Mistake a 20-Something Can Make


If you’re in your 20’s, having graduated college and started your new job in the early to mid 2000’s, you probably have a bad impression of the stock market.  After all, you have seen the bursting of two of the biggest economic bubbles America has ever seen.   First, at the end of the 1990’s, after about seven spectacular gains in the market, the creation of a whole new market sector, and seeing whole companies full of people become millionaires overnight, you watched those same companies disappear into dust in a matter of days.  Even the most dominant companies – Amazon, Priceline, ETrade – fell 80-90% or more from their highs.

At that point Bush cut taxes and people debated for the next several years over whether those tax cuts revived the economy or caused the deficit, but things in the economy and stock market became better.  People were spending money like crazy, companies were making money.  People were becoming millionaires as their houses went from $300,000 to $1.3 M in  a few years.  Stocks were also doing fine, hitting new highs and recovering some of their former glory.  Again, the bottom fell out, stocks dropped 40-60%, and there was talk on the news about the Great Depression (although we’ve seen nothing like what they saw back then).

After living through one or both of these events very early in your investing life, you have the right to be a bit gun-shy and to pull your money out of stocks.  Maybe you even have it invested in eight different bank accounts and a mayonnaise jar buried in your backyard just in case the banks fail.  While equities may seem scary right now, you are actually making one of the worst investment mistakes you can make and are setting yourself up for a cold and very uncomfortable retirement by not having everything (except an emergency fund of 3-6 month’s expenses and other money you’ll need in the next 10 years) invested in equities.

Understand that that bank account, while it may seem nice and safe, is about the most unsafe place you can place money for long periods of time.  No, no one is likely to come and steal it from you, and no it is unlikely that the bank will default, but even without either of these things happening you are losing money every year that your money sits there.  While we have not seen significant inflation since the early 1980’s – ten years before you were born – even at the relatively low 3% rates we have seen your money is dropping in value each year in the bank since they are only paying 0.25% interest if you’re lucky.  If inflation picks up they may start paying a few percent more, but it will always be less than the rate of inflation.   Over a lifetime of saving that will add up into $500,000 or more in lost value.  With that kind of depreciation it is unlikely, even with a lifetime of saving, that you will have enough to have your money last through your retirement.

Worse yet, you are missing out on the opportunity to invest your money and see it actually grow – even beyond inflation.  This is income for which you don’t need to work.  You receive it because you are willing to partner with others who do the work for you (and themselves).  If you are buying stock in established companies, you are partnering with individuals who have shown that they know how to grow a business and that they have a concept that works.  Doing this while you are young makes the most sense because you don’t need the money right away.  You have the time to wait for the various ideas the company has to be enacted and reach their full potential.  You can also afford to wait out bad periods in the economy when company profits are down.

So bite the bullet and get back into equities.  The best way if you’ve pulled it all  out is to wade back in slowly – maybe put 25% in now and then 25% every few months or after a significant market decline.  Then start investing money regularly.  Know that you have no other choice.  WHile there is uncertainty and account values will decline during some periods of time, it is absolutely certain that you will lose money if everything stays in the bank.

In the next post I’ll talk about the mindset needed to avoid being nervous while investing.

Follow on Twitter to get news about new articles.  @SmallIvy_SI

Disclaimer: This blog is not meant to give financial planning advice, it gives information on a specific investment strategy and picking stocks. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing

How Does Inflation Affect Stock Dividends


 

Ask SmallInvy

 

Dear SmallIvy,

I have a bunch of dividend paying stocks I use for current income.  How will inflation affect these dividends?

Thanks,

Chuck

Dear Chuck,

Investors require a certain return (yield), after inflation, for the money they invest in stocks.  In inflationary times they will require higher yields since the amount they actually receive (after inflation) will be less unless the yield from the stock increases to account for the increase in inflation.  For example, a stock paying 3% with no inflation will provide the same return as one paying 8% with 5% inflation.  Because one is effectively locking in a yield when buying a stock, investors may actually require higher yields to account for the risk that inflation may increase further during periods when inflation is increasing (like now). 

The way that investors increase yield from a stock is to buy it at a lower price (assuming the dollar amount of the dividend remains the same).  In other words, they may only be willing to pay $80 for a stock at 5% inflation that they would be willing to pay $100 per share for at 0% inflation if the stocks pays a dividend of $5.00 per share per year.  This means that if you own dividend paying stocks and inflation increases, the price of the stocks will tend to go down.  This will be a temporary thing since eventually the company will start paying a higher cash amount since the dollar amount they will start receiving from their business will be more, therefore allowing a larger cash amount be paid out for a dividend.

If you don’t need the principle of your investments anytime soon, the best thing to do would be to stay put – eventually stock prices will recover and the effective yield you will be getting from the stock will increase.  Also, if inflation doesn’t increase for a long time, you won’t miss out on all of those dividend payments while inflation is low and the stock price remains stable.   If you have some money in cash to invest, however, given the current inflationary climate you may want to hold it off to the side while we see what happens with inflation.  If inflation kicks in, you would then be able to buy stocks or even bonds at high yields and low prices.  You can then lock in a great dividend and hope inflation drops back down to recent levels.  Imagine if you had bought bonds when interest rates were 18% in the 1970’s and then held them when rates fell – you would have a nearly guaranteed return at a rate much greater than the return of the stock market.

If you do need to principle soon, you should probably sell some stock and take the money you need out of the market.  If inflation increases, the near-term effect on stock prices won’t be pretty.

SmallIvy