It’s only when the tide goes out that you learn who has been swimming naked. – Warren Buffet
Warren Buffet says it best in this famous quote. For investors, the only true thing we have to help us build successful portfolios is learning and being prepared. Investors learn in many different ways – by reading books from other successful investors, by learning from past experiences (and mistakes), and by learning from other people who have done some learning along their investment journey. This post will be about the things that I learned over the years about dividend investing. I still have many more things to learn, but at least to this point I can safely say that I have come a long way since I started investing in mutual funds when I was 18 years old.
1. Dividend Investing is All About Compounding Returns – There is no question about it, compounding returns is where the real money is made. Reinvesting those dividends provides that the vehicle for those compounding returns in a dividend portfolio. The following chart shows us why.
2. KISS – Keep It Simple Stupid – Over complicating things such as your portfolio’s asset allocation or investment style only leads to confusion and wavering. You need to do your research ans set your portfolio properly, but don’t make it so complicated that even you won’t be able to remember why you made a particular decision.
3. You Are Doing Something Wrong If You Aren’t Beating an Benchmark – It doesn’t really matter what benchmark you use, whether it is the S&P 500, Dow Jones, or another blended index, as long as you are comparing your investment performance to that benchmark. If you are not beating that benchmark, then you need to figure out why or simply move to an index based portfolio.
4. Emotions Only Lead to Irrational Decisions in Investing – Emotions such as anxiety, doubt, and regret can all lead to making poor decisions. Just think back to when the market was crashing (like we have seen a couple of times in the past few months) and how you felt. It can get pretty scary. However, that does not mean you should act on those emotions. When you invest in something, have a plan and stick to it.
5. Crappy Data in, Crappy Data Out – When doing research on dividend stocks, don’t rely solely on one source of data. Always verify key research points, especially if you are using sites like Yahoo! Finance or MSN. They can be susceptible to human error so check and double check your data before making a decision – especially when it comes to earnings.
6. Keep Your Commissions and Fees Low – Large MERs on mutual funds and high commissions on buying dividend stocks can eat away a lot of your returns. Why waste money on high MERs on mutual funds that can’t even beat the market? Why pay $29.95 per trade to buy a stock when you can get it for $4.95? These things are commodities nowadays so don’t throw your money away. Consider this chart when you are considering paying a high commission rate, even for that dividend growth mutual fund:
(Source: Gummy Stuff)
7. Do Research on Dividend Stocks – And I don’t mean just looking for a rising dividend! Remember the rules of investing: Rule 1: Don’t Lose Money. Rule 2: Don’t forget rule #1. If you just buy stocks because someone else did you are not investing, you are speculating. Always looks at things like earnings, revenue, valuation before buying a stock.
8. It is OK for an Investor Who Invests in Individual Stocks to Also Hold Index Funds As Well: There is no shame in supplementing a portfolio of individual stock picks with an index fund or ETF. Just be sure to watch out for over exposure to certain sectors or stocks. In fact, if your portfolio is lagging your benchmark, then it is probably wise to start adding some index funds into the mix.
9. You Need to Be Diversified to Sleep at Night – The rule is simple – the fewer stocks you have the more likely you are to experience greater volatility than the market, and the more stocks you have the less likely you are to experience greater volatility (Source: Lowell Miller, The Single Best Investment). Research I have read suggests that 12 to 18 stocks is the right number, assuming you are choosing stocks that are in different companies and different industries.
10. Never Consider Just One Outcome for a Stock, Consider the Worst Case Scenario as Well – Determining whether you are going to invest in a stock or not is all about trying to predict the future based on historical data. In other words, you are trying to predict the future from things that have happened in the past, and your educated guess will probably be wrong. Make sure you consider a few different outcomes for the stock, including the worst case scenario and decide if you are still comfortable buying that stock.
I am sure there are things that I have forgot to include on this list, and I know there will be future learnings, but it was good learning in and of itself going through this excersise. Let me know some of this things you have learned in your investing travels by using the comments below.
(Photo Credit: Steve Woods)
#3 (beating a benchmark) is hard to follow because it’s only valid over a long period of time. If growth stocks outperform for the next ten years then a value investor won’t beat the index over that time period, but that doesn’t mean they are doing anything wrong.
The Dividend Guy
Thanks for the comment – I agree and I actually have an upcoming post that addresses the issue of tracking to a benchmark – you need to make sure that you are comparing apples to apples.
However, if growth stocks do outperform and all you have is value stocks then is there not lost opportunity there? I would suggest a diversified portfolio is crucial in this regard. Overall though, if you are trailing the overall market on a consistent basis then you have a problem don’t you? Maybe I am misunderstanding what you are getting at…
No, I think you got it.
You’re right – a diversified portfolio is necessary.
I enjoyed reviewing these basic principals of investing. Many of these will come in very handy during volatile periods in the market such as today.
I think you should show a table that shows the income from a stock when the dividend is increasing, since you are always harping about increasing dividends (which I like as well). I made up an example in excel about a week ago which I’d be happy to share and discuss with you.
The Dividend Guy
Hi BC – I would love to see the chart – please email me at firstname.lastname@example.org.
A very good post. #4 is a very important point that many new investors miss out on. Emotional investing is bad investing. You may get lucky and be right once in a while with an emotional decision, but its never the right move.
Let's Discuss Money
Very good article. One thing I would add is that you should be slightly wary of companies that have very high dividend yields as they may be in trouble, and dividends may well be cut in the future.
Very interesting… as always! Cheers from Switzerland.
Very interesting… as always! Cheers from -Switzerland-.