The stock market has been on a downward spiral lately, mostly caused by the low crude oil price and concerns on Chinese economic growth. Not surprisingly, our stock portfolio has been decreasing in value over the last few weeks as well. I'm not going to lie, it's tough seeing our portfolio gains evaporating over the last few weeks, at the same time, the market downturn provides a good reminder on why we're investing in the stock market in the first place.
What motivate you to invest?
Is it because you want to create passive income to get your money to work hard for you?
Is it because you want a better life?
Is it because you want to help the less fortunate?
Is it because you want to be able to afford things that you want?
Is it because you want to achieve your dream life?
Is it because you want to make conversation with people around you?
Is it because you want freedom?
For us the top reason is freedom. The reason(s) can be different for each individual. Whatever your reasons are, when it comes to investing we all need to remember the following:
- We must have the right psychology
- We must be able to control risk
Having the right psychology
Psychology is listed as the number one thing to remember because it is the toughest part to be good at. When it comes to investing in the stock market, our psychology can be a major obstacle on whether we're a successful investor or not. We can call this psychology factor our ego. Unfortunately, our ego is not our amigo, it often works against us and "helps" us make stupid decisions. Why? Because fear is in our mind.
Consider this scenario and tell me whether it makes sense or not. Sometimes we are afraid of losing money with our investment so we stick with ultra-conservative types of investments and chase the 1%-2% gain. At the same time, we have no problem going out to a brand new restaurant with zero review and spend $100 without knowing how the food is, before we go in. We have fears about investing money in the market but we have no fear "investing" money in the new restaurant. This happens simply because we are typically not familiar with the stock market, so we become more conservative with our money.
We all fear that we are wrong. We hate being wrong. When we're wrong about our investing decisions, our ego gets damaged and we are afraid to admit to ourselves that we have failed.
The reality is, we as investors need to be reality based. The market does not care about who we are, what we do, or where we are in life. The market will do whatever it has to do to screw us! Although we can maybe suck up to our boss in our job, we can't suck up to the market. We simply need to take responsibility for ourselves and stop lying to ourselves. Investing in the stock market is filled with uncertainties. When we're working in a job, we usually get trained, but this is unfortunately not true when it comes to investing. We don't get trained by someone on how to invest, we need to train and educate ourselves. That's why knowledge is power. Read up on books and various great blogs on the internet. The more knowledge we have, the less likely we'll end up in an emotional roller coaster on our stock investments.
Controlling risk becomes very important when it comes to investing. Here's an interesting stat... if we start with $100, flip a coin 10 times and bet $10 each time, there's a 93% chance that we'll get wiped out before you get to the 10th flip. If we start with the same amount but bet only $1 each time, our chance of losing all of the money is reduced to 3% only. By betting less money each time, we have significantly reduced our risk. This is why we all need to diversify our portfolio across the different asset types, different stock sectors, and weigh our holdings accordingly. We don't want to put all of our money in one specific sector, and we certainly don't want to put all of our money in one or two stocks only.
Diversification through asset classes (bonds, stocks, real estate, GIC's), sectors, and weighing of our holdings make sense. But there's another way to diversify that perhaps not many people consider - diversification through time.
Time can work for you and against you, depending on your investment horizon. If you're older and close to the typical retirement age of 65, a bear market can cause havoc to your retirement plans. In a bear market scenario being close to retirement age, hopefully you have already diversified your portfolio through asset allocation. When you're relatively young and have a long investment horizon like 10 years or more, you can diversify your investment portfolio through time. Timing the market becomes less important when we're talking about diversification through time. Time in the market becomes the most important factor. The longer we can stay in the market, the more we can take advantage of the power of compound interest. In our case, because we're in our early 30's and we are still in the accumulating phase of building our portfolio, a downturn in the market is a welcome event. Why? Because it allows us to purchase high quality stocks at a discount. Not to long ago, I was having a tough time pulling the buy trigger because many stocks seemed overvalued. Can you believe that we can now buy strong Canadian banking stocks like Bank of Nova Scotia, Royal Bank, and TD at over 4% dividend yield? Why do I have such high confidence in Canadian banks? Let's not forget the strong dividend histories that these three companies have demonstrated - Bank of Nova Scotia has been paying dividend since 1833; Royal Bank has been paying dividends since 1870; TD has been paying dividends since 1857. Similar stories can be found in many high quality dividend stocks like Johnson & Johnson, Procter & Gamble, Chevron, Exxon Mobile, and 3M, just to name a few. When you can diversify through time, it becomes a very important allies to us because we can enroll in DRIP to purchase more shares with dividends received and deploy fresh capital to buy more shares. We can ignore the daily/weekly/monthly noises happening in the market and just focus on our end goals. For us, that means reaching a point where our monthly dividend income exceeds our monthly expenses. By my calculation, if we can get roughly $4,000 dividend per month, we will be golden. Of course, this estimate can change due to many different factors, like having more expenses as Baby T grows up, having another kid, and increasing insurances and housing costs.
When it comes to investing, we all need to remember to invest only with money that we do not need in the short term. It is crucial to ask ourselves these 3 key questions prior to committing to any investment. Some people get into trouble during a down market because they bought shares on margin, hence are forced to sell. Some people invest with money they need in the short term and are forced to sell at an undesirable price. We do not want to get ourselves into such a situation. Consider the upsides and downsides of your investment decision prior to pulling the trigger so you're prepared for both scenarios.
The recent market pull back meant our dividend portfolio is down by roughly 15% compared to a few months ago. Mentally we're already prepared to see some negative growth in our net worth at beginning of next quarter (we track our net worth every quarter, not monthly). But a negative growth due to market environment is OK. We encountered something similar during the financial crisis and years later we've grown our portfolio and net worth significantly. Long term portfolio/net worth growth is more important than the short term movements. When you chart out your portfolio/net worth on a chart over 10, 15, or 30 years, the 15% drop becomes a dot on the chart.
So stop worrying the day to day movements. Take a deep breath and relax. The stock market might be falling for the next little while but the world is not ending. The stock market will eventually rebound and grow.