Investing in a Shaky Market

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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

Broker's Lunch Break
Image by Nick Douglas

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

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

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

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.

Evaluating Risk

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

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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

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7 thoughts on “Investing in a Shaky Market

  1. I’m a big fan of dollar cost averaging. It keeps you from some of the volatility of the market. It’s systematic and a great habit to form when investing in the market.
    .-= Ken´s last blog ..Weekend Roundup =-.

  2. I too firmly believe in dollar cost averaging. Two questions:

    1. (rhetorical) Why is it that stocks are the only thing people have an aversion to buying when they are on sale?

    2. Have you ever tried the old “Invest in the Dogs of the Dow” strategy, Bret? I’m just curious if you have, but if you haven’t, would you ever consider trying such a strategy? (I guess that is really two and half questions.)

    Best,

    Len
    Len Penzo dot Com
    .-= Len Penzo´s last blog ..The Best of the Best in Money and Personal Finance #11 =-.

    1. Len,

      These are some great questions. Here are my thoughts.

      1. I have always bought stocks on sale and it has really paid off for me. Even when I was young and foolish, I figured out quickly that you get a lot more shares for your buck when the market is down. And, despite the drama of the latest catastrophe, the market always seems to come back.

      But, there is a herd mentality that permeates the market, which is probably related to our “flight or fight” instincts. It takes a lot of courage to buy when the market is dropping like a rock and no one knows where the bottom is. Traders call it “catching a falling knife” because it can be painful.

      Dollar Cost Averaging takes the pain out of this, because you aren’t trying to find the ideal time to get in or out. You just keep buying every month and it averages out the ups and downs.

      2. I am familiar with the Dogs of the Dow strategy, but I don’t use this myself. It’s hard for me to get excited by Kraft and AT&T, when there are some great new industries being formed. Last year, I bought Ford, Dell and B of A, because they were just too cheap to resist. But, I like to invest in the small to mid-cap stocks. That’s where most of the growth is.

    1. Daddy Paul,

      You and I think alike.

      I have noticed that small and large cap stocks seem to trade popularity. And, I know smaller cap stock appreciate faster on average than large caps. But, I didn’t realize they outpace large caps at the beginning of a rally.

      Thanks for the tip.

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