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Wednesday, December 12, 2007

* 5 Lessons Learned About Investing

Four years and one day ago on December 11, 2003, I purchased my first dividend stock. Granted my motives were not pure, nor did I have a clue as to what I was doing. Prior to that I had always been an aggressive growth investor. During my investing years, I have learned many things. However, I would rank these 5 lessons as the most important:

1. Success Can Sometimes be Dangerous
In the late 1990's into early 2000 I was pouring a significant amount of money into tech stocks. At that time most anyone one could make money in the stock market. The formula was easy: buy a tech company, wait a short period of time for it to double, sell it and buy two tech companies with the proceeds - loop to beginning.

My wife and I started planning to build a house in 1999, heavily funded by the profits I had made in the market. When she learned I was still in the market, she demanded I get out immediately and not risk losing her dream house. I begrudgingly got out in 2000 near the top of the tech run up, grumbling all the way; how dare she tell me how to invest; I am the expert. Needless to say, she was right, very right. As I watched the tech bubble burst and my former stock holdings collapse, I considered myself to be one of the more fortunate people alive by getting out when I did.

2. Life's Best Lessons are Taught With Adversity
When the tech bubble burst it caused me no pain. I was living in a paid for house, and began to rationalize the past. "Certainly, I would have figured out the bubble was about to burst and would have got out before too much damage was done," I told myself.

Still a little somber from the near-death investing incident, I eased back into investing with mutual funds. Then I moved to dividend stocks, I had read that stocks that paid dividends were more stable, you could sleep at night, etc. etc.

Not all dividend stocks are the same. Like many new dividend investors, my primary focus when selecting a dividend stock was yield - the higher the better. Unfortunately, this worked quite well for a while. I had build a portfolio of master limited partnerships (MLP), REITs, sub-primes and highly aggressive investments with double-digit yields.

With my new found dividend investing strategy, I was duplicating my prior success, or so I thought. A few of the investments started to decline in price, then they cut their dividend. I discovered that tracking the basis and filing taxes on MLPs were major hassles. I became a net seller. It looked like I was going to be able to change coarse before the losses got too bad. I still held on to a few sub-prime mortgages companies - and had the opportunity to ride them to zero. That was painful. Lesson learned.

3. Dividend Investing is About Future Yield, Not Current Yield
I was fortunate enough to accidentally buy some good dividend stocks and hold them long enough to figure out the "secret" of dividend investing. It is not necessarily starting with a high-yield investment, but ending up with a high-yield investment. This usually occurs by buying investments with a moderate yield, a history of growing dividends and letting time do its job.

4. Successful Dividend Investing is About Substance, Not Style
In my aggressive growth years, I equated dividend investing with old folks and the inept. That was simply not my style. Time and experience have taught me there are no style points awarded in building a winning investment portfolio. In the end the long-term performance (substance) of your portfolio is all that ultimately matters, not how you got there.

5. You Can't Beat the Herd, by Following the Herd
Through the years I have settled down quite a bit. Using well defined investment allocations, I have set boundaries and guidelines to ensure I don't over expose my portfolio to undue risk, and I employ a meticulous process when selecting investments.

However, with that said, I still tend to be a little more aggressive than the typical dividend investor. I take a some calculated risks by mixing in a few higher yielding stocks such as ACAS and SFI along with my traditional dividend picks. I am currently evaluating a closed-end fund that has a double digit yield (stay tuned it will be the subject of an up-coming article). I am looking for that one extra bump, that will push my base portfolio a little bit ahead of the herd.

How do you manage risk in your portfolio?

Full Disclosure: No position in the aforementioned securities. See a list of all my dividend growth holdings here.

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