Wednesday, August 19, 2015

Successful Investors Take The Emotion Out

Deep-down in my soul, I am a contrarian. Significant market run-ups convert great dividend stock buys into 'ok' buys (at best). Sure the increase in your portfolio's value leaves you with a warm and fuzzy feeling, but as a long-term investor, I would much rather buy stocks at a deep discount. Often it appears that investors' emotions are driving the market.

To that end, a November 2009 article in Forbes discussing investor emotions caught my attention. The salient takeaway from the article was:
The assumption that investors are rational agents is bunk. We are not rational. We're human. Even the most brilliant investor can be swayed by emotions into making irrational decisions that result in financial loss.
This is quite easy to illustrate just by looking at the stock market in any given year. Logic has very little to do with movements in most stocks. Knowing this, there are some things that long-term buy-and-hold investors can do to profit from from these irrational moves in the market.

I. Dollar Cost Average In

When the market is rallying, we generally should be buying fewer shares than when it is declining. Our emotions left unchecked will lead us to do the opposite of what we should be doing. Investors are often compelled to buy when the market is rallying, then sell when it is declining. So how do we guard against this?

Dollar cost averaging [DCA] is one way. DCA is a strategy of investing equal dollar amounts on a regular basis over specific time periods. For example, you might choose to invest $2,000 each month in your income portfolio, no matter what the market is doing. This will lead to more shares being purchased when prices are low and fewer shares purchased when prices are high. The overall effect is to lower the total average cost per share of the investment, over time.

II. Keep A Watch List Of Great Stocks

Unfortunately, great stocks that perform well over an extended period are noticed by the market and will often carry a premium that makes them difficult for a value-based investor to purchase. Consider these dividend stocks from year-end to the end of July 2015 (on a dividend adjusted basis):

Avago Technologies Limited (AVGO) Up 25.1% (Yield 1.3%)
Yum! Brands, Inc. (YUM) Up 22.3% (Yield 2.0%)
UnitedHealth Group Incorporated (UNH) Up 21.0% (1.7%)
Leggett & Platt, Incorporated (LEG) Up 13.7% (2.6%)
Apple Inc. (AAPL) Up 10.8% (1.8%)

Are these stocks 10%-25% intrinsically more valuable at the end of July 2015 compared to the end of December 2014? I don't think so. We as investors must understand valuation and be prepared to act.

III. Have a Plan and Follow It

You need to have an investment plan. More importantly you must have full confidence in your investment plan. Otherwise, you will be a slave to emotion which will lead to very undesirable results in your portfolio.

Long-term buy-and-hold dividend investors look at bear markets as their friends. It is a wonderful time to add quality companies at great prices and increase our average yield.

Full Disclosure: Long LEG in my Dividend Growth Portfolio. See a list of all my dividend growth holdings here.

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(Photo Credit)



  1. Thanks for posting this helpful three point plan. Keeping emotions out of investing is something I struggle with.

  2. Excellent and very useful information. It is written precisely and to the point. Highly thankful to you for providing this info.


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