‚ÄúThe big money is not in the buying or the selling, but in the waiting.‚Äù-Charlie Munger, Business Partner of Warren Buffett
It‚Äôs natural to worry about daily fluctuations in the stock market, especially if your money is invested in it. But many people turn those worries into mistakes. Some try to buy the hottest new stock at the lowest possible price. Others sell because they think the market is peaking. But the truth is that nobody can ever be certain what the market will do next. So instead of bringing out your crystal ball, trust that in the long-term, the market has historically always trended upwards. So how can you take advantage of this fact? First, you need to understand why the market fluctuates.
Volatility and Timing the Market
Volatility is simply a word used to describe fluctuations in market prices. The market fluctuates daily because you have large groups of people, all of whom have different investment goals and strategies, selling and buying stocks. Therefore, microeconomics often ends up determining daily stock prices instead of the quality of the businesses behind those stocks. When people see a ‚Äòsale‚Äô, they are inclined to make a purchase thinking they are getting a good value.
In investing, this blunder is called ‚Äòtiming the market‚Äô and has nothing to do with value. In fact, the average investor will underperform the market‚Äôs overall average growth due to this mistake. Luckily, there‚Äôs a way you can do better by doing nothing at all.
The Buy and Hold Strategy
There‚Äôs a saying in the finance world, ‚Äúit‚Äôs not about timing the market, it‚Äôs time in the market.‚Äù Truer words were never spoken. It‚Äôs why the buy and hold strategy is recommended for most investors. Typically, this strategy involves buying an index fund (i.e. buying all the stocks in the stock market) and holding it for as long as possible. By following this approach, you‚Äôll do as well as the market does, and as we already know, the market does better than the average investor in the long-term.
Although staying fully invested no matter what might feel like riding a roller coaster, it pays off‚Äîstatistically and financially. Not convinced? Take a look at what happens when you miss a few good days by buying and selling frequently.
As you can see, missing even a few days of strong performance can eat into your annual returns. So, forget about trying to time the market and you‚Äôll do fine. But what if fine isn‚Äôt good enough to reach your financial goals?
Is Outperforming the Market Possible?
While legendary investors like Warren Buffett might practice the buy and hold strategy, they certainly don‚Äôt buy generic index funds. If they did, they would never be named legends; getting the same returns as everyone else investing in funds. Instead, they pick stocks they deem to be valuable for whatever investing philosophy they follow. For instance, Warren, like Emperor Investments and myself, invests in dividend paying stocks.
It‚Äôs important to understand that dividends are just a redistribution of cash to shareholders. Stocks that pay dividends tend to have higher earnings, which means they are more likely to increase in value over time. Higher earnings could lead to larger dividend payments, or higher growth meaning a larger overall return. Even if they don‚Äôt, the ability to manage capital and continue paying dividends for a long period of time shows stability. And in the ever-volatile stock market, stable companies are hidden gems. But what does that mean for your investments?
It‚Äôs hard to imagine that dividends could actually make a big difference so here‚Äôs an example. Say you‚Äôre 35 years old and you want to retire at 65. Let‚Äôs assume you reinvest your dividends and your annual dividend yield is 2.5%; the average for an Emperor portfolio. What would happen to your money over 30 years if we ignore stock market fluctuations?
By reinvesting your dividends, your initial $10,000 investment would grow to over $20,000! In this example, you didn‚Äôt need to invest more money, or worry about buying or selling stocks at the right time. You doubled your money and all it took was time and the ability to ignore the news.
Dividend Payments vs. Stock Growth
You might be thinking that a 2.5% return isn‚Äôt amazing, but there are companies that have paid consistent dividends regardless of what the stock market was doing at the time. While dividends cannot be guaranteed, you can think of them as a more stable return paid in cash. That means on top of whatever returns you‚Äôre getting from a historically increasing market, you‚Äôre also getting a dividend boost. Coupled with an automated savings plan, you could do wonders for your wealth.
Now your only problem is picking stocks that are likely to pay dividends and figuring out how to reinvest your earnings without trading fees. Luckily, Emperor Investments can do all of that for you and more! You can learn more about their online dividend investing platform here.
Martha Brown Menard, PhD, is a research scientist, financial coach, and dividend income investor. She takes a smart beta approach to building her own portfolio, and likes seeing her income stream grow.