Wednesday, October 22, 2014

Time in the market is more important than timing the market

There is so much mental energy spent by investors, media and gurus spent on “guessing” the market top, market bottom, and whether we are in a bull or bear market, it is exhausting for me to watch. Frankly, in order to be successful in investing, one needs to keep it simple, and follow common sense principles. You do not need to successfully pick tops or bottoms in order to be successful, but have goals, and patiently hold quality companies for the long term that shower you with rising dividend income every year. If you have goals you want to achieve, you only need to develop a strategy to achieve it, and then stick to your plan through thick and thin.

Time in an investment is more important than perfect timing based on following fluctuations in the stock price. This is because if you hold a quality company purchased at a fair price, and then let the power of compounding do its magic over a long stretch of time, you will do really well. Those who are always looking to buy at the bottom or sell at the top end up missing out on the compounding of their income and capital. This is because noone can correctly buy at the top or sell at the bottom, except for a lucky accident once in their lifetime. At the end of the day, even a broken clock is right twice per day. Those who can tell you they can consistently do it, are either liars, are trying to get famous by being right once, or are trying to sell you an expensive investment service.

I did a quick experiment using Yahoo Finance historical data, where we have two investors buying shares of Johnson & Johnson (JNJ) between 1/1/1980 and 12/31/1989. The first investor has $1,200 to put to work each year, and manages to buy Johnson & Johnson shares at the lowest monthly close for each year. They reinvest dividends into more Johnson & Johnson shares with each payment from the company. This investor manages to get this lucky for 10 years in a row. They then stop adding new money, reinvest their dividends automatically into Johnson & Johnson stock and hold on to the end of September 2014. The first investor thus ends up with a stake worth roughly $1,011,000 million, which generates approximately $26,600 in annual dividend income.

The second investor simply puts $100 per month, every month between 1/1/1980 and 12/31/1989. They also reinvest those dividends in more Johnson & Johnson stock in the accumulation phase. After that, no new money is added, although dividends keep getting reinvested automatically. By September 2014, the second investor has a portfolio worth roughly $875,000, which generates approximately $23,000 in annual dividend income. As you can see, while the second investor ends up with a little lower final portfolio values and annual dividend incomes, their returns are much more realistic and achievable by ordinary investors. Again, the goal is to try and keep a simple plan to stick to. It is highly UNLIKELY that someone will be able to allocate money at the lowest point in a company for 10 years in a row. Most keep trying, and as a result end up missing the big moves. The important thing in the case of Johnson & Johnson was to buy the shares, and then patiently reinvest dividends for decades, and let the power of compounding do the heavy lifting for you.

This example is where you have an edge in investing, that noone else on Wall Street has - you can hold patiently to your passive portfolio of quality dividend paying stocks, and collect those rising dividends through thick and thin. You do not care about high frequency traders, irrelevant relative performance bench-marking against some index over a meaningless time frame of a month or an year. If you have patience, you are very likely to successfully fund your long-term goals.

My goal is to reach a certain level in dividend income by 2018 – 2019. In order to reach this goal, I know that I need to save a certain portion of my paycheck, and then invest it every month in quality dividend paying stocks. As those dividend paying companies pay me more in dividend income, I then reinvest that income into more dividend paying companies. Life is much easier when you create a positive loop.

You can see that my strategy is only dependent on finding enough quality dividend paying companies to invest in each month. Therefore, it does not matter whether we are in a bull market, bear market or sideways market. As a dividend investor, I am a stock picker, not a market timer or prognosticator anyways. I focus on individual businesses available at attractive prices, which can earn more over time and thus afford to increase my dividends regularly. The only difference that a bear market makes to me is that there are more companies that are attractively prices. Since my timeframe for holding those companies and living off those dividends is approximately forever, my success is determined on letting those dividends compound over time into a meaningful stream of income to live off forever.

The toughest part of my plan is patience. As Munger Says, the most difficult thing a person can do is sit alone and do nothing. Given the fact that I am constantly bombarded by useless chatter from the media about the economy, shares, the FED, the world etc, I feel inclined to do something when in reality no action on my part is needed. I believe that investors should tune everything out, and just stick to their plan. At least that’s what I am doing. I know that the odds for success are very high for the investor who buys stakes in quality blue chip dividend payers every single month, reinvests dividends selectively, and then patiently sits on those companies for the next 20 – 30 years.

For example, did you know that if you started investing in in blue chip companies at the start of the great depression in 1929, and you reinvested dividends you broke even within 6 years. You did pretty well if you held on for 30 years. Even if you bought shares right at the top in 1972, and held on for 30 years, you made a lot money as well. The lesson is very clear – keep holding to quality dividend paying companies through thick and thin, keep adding money to dividend portfolios every single month and keep reinvesting those dividends. If you are unwilling to hold through a company through a 50% correction in the stock price, you should not be investing in stocks. 50% corrections would not bother me, as I see them as opportunities, since my dollars buy more shares when prices are lower. I also try to invest in companies, where I would not be afraid to hold, even if the stock market was closed for a decade.

The lesson to long-term investors is clear; it doesn't matter whether we are in a bull market or bear market. The goal is to dollar cost average each month in quality dividend growth stocks selling at attractive valuations, reinvest dividends, and hold patiently for the next 20 – 30 years. I cannot emphasize quality factor, since the quality companies are more likely to survive a deep recession unscatered, and continue paying and growing dividends, even during the hardest of times. If you are already retired, then you shouldn’t really care about stock prices anyways – just withdraw those growing dividends and enjoy life. Dividends are more stable than capital gains, they are always positive, which makes them an ideal way of living off a nest egg.

Full Disclosure: Long JNJ

Relevant Articles:

Dividend Investors Will Make Money Even if the Stock Market Closed for Ten Years
Let dividends do the heavy lifting for your retirement
How to retire in 10 years with dividend stocks
My Dividend Goals for 2014 and after
Dividend Investors Should Ignore Price Fluctuations

8 comments:

  1. Right On, DGI! In fact, one hopes for a bear market, especially as they get closer to retirement, so they can pick up more "quality" companies for cheap prices.

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  2. Great post. I know exactly what you mean by all the noise -- there is so much more of it now, and coming at you at Internet speeds. Really tough to turn a blind eye towards all of it, but we must if we are to succeed at this long game.

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  3. Great post, can't agree more. Jumping in and out will only cost you in the long run.

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  4. DGI,

    Great post. Couldn't agree more, as you probably already know. I invest month in and month out, regardless of what the stock market is doing. I obviously try to invest a bit more aggressively when the market is turning sour, but other than that it's business as usual.

    Timing the market is absolutely impossible, and not necessary anyway as your JNJ example proves. The key is to formulate a realistic goal for your needs and then consistently invest in order to reach that goal. It just doesn't need to be that difficult.

    Best regards!

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  5. I want to start dividend investing and wanted to know which broker do you guys use prefer for regular 1000 dollar investing in different stock? Etrade transaction costs are too high for small amount investing

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  6. Great post but what if this "50% correction" is accompanied by dividend cuts? I know that a lot of companies still managed to maintain or even increase their dividend payments during the recent crisis, but others weren't able to - among them companies I don't hesitate to call "quality companies", e.g. GE.

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  7. I use Interactive Brokers. A 100 share limit order trade cost me only .60 cents under their cost plus commission structure.. IB gives back rebates the broker gets from exchanges for liquidity provided orders. Negative is that IB charge $10 monthly minimum for accounts below 100K equity and live market data is also charged (but i dont think market data subscription is all that needed).

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  8. Thank you for reposting this message.

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