The summer, and now autumn of 2011 has proven to be extremely volatile in the stock market, and in asset markets in general. Stocks, bonds, and commodities all have seen dramatic fluctuations, both up and down. Triple digit moves in the Dow (DJIA) that were once rare have lately been the norm. This type of volatility can be a boon to active traders, but it can be frightening, even downright dangerous for everyday “retail” investors.
Any novice investor will tell you that the key to successful investing is to buy low and sell high. Seems simple right, and in concept it is, but in practice it can be very difficult to actually accomplish. The emotion and psychology of the stock market can often be at odds with the psychology of self-preservation that is very much at play when people are making critical financial decisions. When investing, similar to other aspects of life, people tend to follow a herd mentality; generally selling in times of panic, when stocks prices have already fallen and are low, and buying in times of euphoria and hubris, when stock prices are elevated.
So what do you do? How do you preserve or attempt to grown your capital under these conditions? Well the first thing to do is to consider your situation, and be clear about your goals. What might be good advice for a younger investor with a higher risk appetite could be very poor advice for someone closer to retirement, with less ability to sustain potential losses.
Lets look at the two ends of the spectrum. For a younger investor with a longer-term investment horizon, high market volatility can be a good time to take action. High volatility almost always coincides with downward pressure on equity markets, which will at some point create good buying opportunities. Have a shopping list of stocks, do your research, and buy with discipline. Pick an entry point and begin to buy up a portion of the overall position that you want to hold long term. You should then continue to purchase on market dips until you have completed your position, if the market continues lower you will lower your average cost as you purchase the remainder of your position. If the market moves higher, your position will appreciate in value, albeit with fewer shares than you may have intended.
Once you have accumulated your position the toughest part may be to stand your ground. A given during times of high volatility is that the markets may well overshoot fair valuation, and continue down to levels that are irrationally low. If you still believe in the fundamentals of the companies in which you’ve invested, then the only thing to do is stand your ground. You have to be willing to accept the potential for a short-term loss on paper, knowing that in the long term you’ve made a wise purchase.
On the other end of the spectrum, what do you do if you have a low risk tolerance and you’re anxious because of market volatility? The best advice is to review your portfolio, and make sure that your asset allocation and risk stance is appropriate to your life situation. Especially if you haven’t rebalanced your portfolio recently, it may be time to carefully readjust. Although it may be a precarious time to be moving around your holdings it is an excellent time to seek the advice of an investment professional, and make certain that your portfolio matches your current needs. A good financial adviser will seek to understand your needs, and help you to develop a plan that aligns you asset allocation to your future needs given current economic conditions.
High market volatility, big moves up and big moves down are good at creating headlines, good at churning stomachs, but in general not very good at creating wealth for retail investors. Even for experienced investors, turbulent markets can cause serious heartbreak (consider all the hedge funds reporting staggering market losses for the past quarter). If you have dreams of being a hero, make sure you can afford the potential for loss. If you want to come through high market volatility without increasing your risk, talk to your financial professional, seek only the advice of the most level headed people you know, and remember that often the safest course is to sit tight and ride out the storm.
Investing ideas come and go, the best are time tested and never fall too far out of favor. Dividend investing is just such a strategy, and it’s one that has come back into vogue.
Given the current Federal Reserve’s monetary policy and the recent declines in the equity markets, bond markets have been on fire through the end of the third quarter and into the beginning of the forth. As bond prices have risen yields have fallen sharply (bond prices move inversely to bond yields). How does this affect the average investor? It means that the interest return on bonds has fallen, and therefore holding bonds in a retirement portfolio will generate less income. This has caused money managers and individual investors to seek yield elsewhere.
As of the close of the third quarter (Q3 2011) the dividend yield of the S&P 500 at about 2.15% exceeds the yield on a 10 Year Treasury which stands at 1.80%, by more than a quarter of a point. This is something that does not happen often, and is clearly due in part to the current monetary policy in place by the Fed, which has pushed down interest rates to historic lows. It is likely also due in part to stocks being cheap in relative historic terms. If you believe in the strength of the U.S. economy over the long term, these facts would suggest that it is a very good time to be investing in large-cap stocks with attractive dividend yields.
There are some things to keep in mind while investing for dividend yield, among them; dividends are not guaranteed. In particularly difficult times, especially in an acute credit crunch as was experienced in 2008, companies may suspend dividends. And the suspension of dividends can punish a stock’s price, which causes a two-fold loss: the loss of the dividend income, as well as a decline in the value of the stock. For this reason it is important to know when investing in a company that it is financially strong, and has the cash flow to be able to support future dividend payouts.
Diversification is also an important consideration in putting together your dividend portfolio. Exposure to too few industries or sectors can create several risks, and these risks are among the very exposures we’re trying to avoid, especially in times of heightened uncertainty. Consider the 2008 financial crisis, when financial firms halted dividend payments en mass. Having been over-invested in financial firms would have caused dramatic losses in both portfolio value as well as income stream. At the same time a well-diversified portfolio of dividend-oriented equities would have fared relatively well.
Dividends that are unsupportable should also be a big red flag. Dividend yield is the percentage of the share price that is paid out annually as a dividend (Annual Dividends per Share / Stock Price per Share). So a stock with a $1 annual dividend per share, which traded at the last dividend date at $20 per share had at that time a 5% yield. That same stock, trading today at a $10 share price, would have a 10% yield. The very high yield coupled with the steep share price decline is likely to be a warning that this hypothetical company could be in dire straights, and that dividend may not be sustainable. Suffice it to say, that as with all things in life, “If it seems too good to be true, it probably is.”
One should also consider that if the economy and stocks enjoy a significant recovery, these sectors might lag the broader recovery. History however tells us that a well-diversified portfolio with a strong dividend yield will show strong compounded gains over time.