A shaky stock market can scare investors away at precisely the time when they should be investing. A booming stock market can lure investors in at precisely the time when they should be selling. So, how do we know when to go all-in and when to get out?
The answer is, no one really knows. There is always someone who claims to know. And, there are even a few who were right about the last bull or bear market. But, no one has been proven to consistently time the market. So, I don’t recommend this approach. There are more reliable ways to make money in a shaky stock market, without a crystal ball.
Dollar Cost Averaging
Most investors know about Dollar Cost Averaging. This is where you invest the same dollar amount every month. Most financial advisors recommend it, because it benefits both the customer and the advisor. The big promise of Dollar Cost Averaging is that it forces you to buy when the market is down, so you are “buying low” as you invest in a down market. The bad news is that it also forces you to “buy high” in an overpriced market.
Here is why I like Dollar Cost Averaging and have been doing it for decades. Investing consistently is the key to accumulating wealth. It’s not so much the averaging of the share prices as the habit of investing that is the secret. Once you get used to investing every month, that habit quickly replaces the habit of spending all of your money. This is the first step on the simple path to wealth.
Index investing has gotten very popular over the past couple of years. This is where you buy a mutual fund or an ETF based on an index, such as the S&P 500. The big promise of index investing is that the stock market indexes beat most of the actively traded ETFs and mutual funds. And, there are usually low fees, solid stocks and low trading costs in an index fund or ETF.
Although this logic may seem to make sense, there is a reason why I don’t invest in indexes. Simple economics (Macro vs. Micro) dictate that what works on an individual basis doesn’t always work for the masses. Like any other investment scheme that comes into vogue, once enough people start to jump on board, these stocks become overvalued and due for a correction. That’s why I believe the stocks in the indexes got trashed so soundly in the last crash, just as the tech stocks did in the crash before.
Dividend investing has also seen a resurgence in popularity. Unlike the days of the tech bubble, investors are starting to appreciate a company that pays a regular dividend. And this makes a tremendous amount of sense, especially for long-term investors. Instead of expecting the stock price to appreciate rapidly, investors can count on a dividend payment from their investment. And, this makes even a modest gain in the share price add up to a solid return.
I own mostly dividend paying stocks. Although, I must admit that I hadn’t paid quite as much attention to the dividend at the time I had purchased them. Going forward, I plan to give a lot more weight to the dividend, as a measure of the quality of the company behind the stock. Any company that consistently makes a profit and distributes a dividend is also likely to appreciate in value.
Value investing is also a popular strategy, thanks to successful investors, like Warren Buffet. The big promise of Value Investing is if you can find good companies at an attractive stock price, they are bound to go up. And, they are less likely to come crashing down, because they are already undervalued. But, it’s not easy to determine what is a good undervalued company or to find any bargains when the market is overvalued.
Lately, I have scooped up some great bargains, such as Dell, Ford and Bank of America. But, this wasn’t so much Value Investing as it was Bottom Fishing. And, I took some big lumps from speculating in GM and Fannie Mae, which both went bankrupt. So, I have vowed to be more disciplined in my selection of value stocks and to pay more attention to the fundamentals and less to the share price. I consider Value Investing to be the most promising long-term strategy to make money in the stock market.
The first rule of investing is to not lose money. So, it is prudent to choose investments that are least likely to loose value as you hold them. However, there is also a risk of being too conservative with your investments. So, it’s important to seek a long-term return that exceeds inflation, currency loss, taxes and fees combined. Otherwise, there is a 100% chance that you will lose money and risk your capital needlessly.
I generally look for investments that yield around 10%. So, I avoid bank accounts, CDs, money markets and treasuries as investments. This often places me in investments with high-volatility, which is not suitable for all investors. However, I have been investing for 25 years and am 20 years away from retirement. So, I have a higher tolerance and capacity for risk. If I was older or had a short-term need for the money in my investments, I would invest it conservatively.
Fees & Commissions
It’s a known fact that fees and commissions directly affect your investment results and the higher your investment fees, the lower your return will be on average. The reason this is so critical is because it’s possible for everyone to get paid but you. The fund company and government take their cut and inflation takes the rest. Of course, none of this is visible, except for the taxes. So, it’s very difficult to calculate the effect. Over the long-term, a 2% difference in return can make a huge difference in the size of your portfolio.
I choose to invest without the help of an advisor. I use a discount online broker and no-load mutual funds, with management fees of 1% or less. This approach is not for everyone and I have learned some expensive lessons along the way. However, I avoid fees and commissions as much as possible. Most important, I like to avoid the conflict-of-interest that exists in the financial services industry. If I ever do take on an advisor, I would consult with a fee-based advisor and not one who makes a living from commissions.
The Bottom Line
The bottom line is that there is no a magic formula for investing. And, there are no reliable statistics or indicators that can predict the future. If there were, then everyone would start to use them and they would quickly stop working. The only strategy that has proven to work throughout history, is to buy the stocks of solid companies, with good fundamentals and growth potential. Anything else is just gambling.
“You get recessions, you have stock market declines. If you don’t understand that’s going to happen, then you’re not ready, you won’t do well in the markets.”
Peter Lynch – Manager of the Fidelity Magellan Fund
This post was featured on the Carnival of Money Hacks. This is my second time submitting to the Carnival of Money Hacks and I am honored to be posted among such a talented group of bloggers