Aversion to losses is one of the major psychological barriers that investors face when thinking about allocating capital to equities.
The fact of the matter is… all equities, regardless of quality, brand recognition/equity, historical results, dividend growth streak, etc, etc, etc…are risk assets.
So yes, when buying stocks there is always a chance that you’ll lose money. There’s no way to avoid this reality. However, it’s also important to note that with all risk comes reward and over the long-term, there are very few asset classes which have outperformed U.S. equities.
This is especially the case when it comes to blue chip stocks. It’s amazing how much wealth simply buying and holding onto best-in-breed companies has generated for investors who’ve been patient and disciplined enough to do so. And, while the past is not an accurate predictor of future returns, I continue to believe that blue chip U.S. equities are the best show in town when it comes to building wealth, climbing the social ladder, and most importantly, reaching financial freedom.
Now, with that being said, it saddens me a great deal when I see people scared away from the equity markets because they’re far too concerned with the threat of negative volatility in the near-term.
Even investors who are willing to allocate capital to equities often make what – in my opinion – is one of the worst mistakes that investors can make in the markets: allowing fear to inspire them to lock in short-term losses.
It’s amazing how frequently I see investors buying shares of a company that they apparently love, only to sell those shares days, weeks, or months later, because the share price didn’t immediately roar higher.
Relationships in the stock market shouldn’t be so flippant and fickle.
Here’s a quote from Warren Buffett’s 1996 letter to Berkshire Hathaway shareholders which has made a big mark on my personal strategy as an investor:
“Your goal as an investor should simply be to purchase, at a rational price, a part interest in an easily-understandable business whose earnings are virtually certain to be materially higher five, ten and twenty years from now. Over time, you will find only a few companies that meet these standards – so when you see one that qualifies, you should buy a meaningful amount of stock. You must also resist the temptation to stray from your guidelines: If you aren’t willing to own a stock for ten years, don’t even think about owning it for ten minutes. Put together a portfolio of companies whose aggregate earnings march upward over the years, and so also will the portfolio’s market value.”
Source: 1996 Berkshire letter; I added the emboldened emphasis.
As I’ve said many times before, short-term share price movement is generally based upon market sentiment and therefore, it’s rarely rational. Therefore, I don’t believe that investors should allow short-term volatility to dictate their decision-making when it comes to selling shares.
I consider myself to be a fairly staunch buy-and-hold investor (because I appreciate the power of long-term compounding in the markets). But, even so, from time to time I do sell shares of stock.
It’s important to note, however, that those decisions are never based purely upon share price movement. Instead, they’re based upon fundamentals.
Unfortunately, I don’t have a crystal ball and every now and then a fundamental growth thesis that I have breaks. When this happens, I am willing to part ways with stocks and move onto greener pastures. I dedicate countless hours every week performing due diligence on individual companies and the industries that they operate in, but sometimes, I still get something wrong.
Even with very high quality standards and conservative risk management practices in place, that’s unavoidable. But, a broken thesis every now and then (and let me be clear, when we’re talking about blue chip dividend growth stocks, these events are quite rare) doesn’t dissuade me from putting cash to work in the stock market because overall, blue chip dividend growth stocks continue to generate stellar results.
I’m writing this article to help readers avoid potential pitfalls regarding fearful sales. I hate the idea of locking in losses (it’s important to note that unrealized losses always have the potential to turn into gains; they’re only permanent once an investor locks them in with a sale). This is especially the case when those losses are caused by irrational behavior in the markets, which, given enough time, is very likely to correct itself.
Look, I know that losing money is a scary thing. We all work hard for our savings. Time is the most valuable resource that every mortal being has and being that most of us have to trade time for money, we certainly don’t want to later lose it on a risk asset. But, I think it’s also very important to acknowledge that a durable passive income stream has the ability to replace an active income stream (the paychecks that you work for) and therefore, risk assets like dividend growth stocks have the ability to free up a lot of time in the long-run.
That’s what financial freedom is all about.
So, how can you better deal with the threat of losing money and the fear associated with it?
Well, in my opinion, focusing on dividend income, instead of share price movements, is a simple and easy way to achieve peace of mind while maintaining exposure to equities.
A simple way to look at it is this…lower share prices equal higher dividend yields (and more passive income falling into our pockets).
I know some investors are averse to averaging down into holdings (for fear of getting cut deeper and deeper by a falling knife); however, I love doing so.
Why?
Well, every time that I buy shares below my cost basis, I’m increasing my yield on cost. And being that I never buy shares of a stock unless their past, present, and future fundamental growth outlooks pass my dividend safety screens (largely focused on profit oriented metrics), I always feel comfortable averaging down.
Actually, I feel more than comfortable averaging down into blue chips…I love taking advantage of the opportunity to do so!
Stocks fall out of favor for no-good-reasons all of the time. Here are a few recent examples that come to mind….
I was buying defense stocks heavily throughout late 2020 and 2021 into massive weakness. Investors feared that Democratic leadership in Washington D.C. was going to hurt long-term spending by the Department of Defense and therefore, top flight defense companies were seeing their multiples contract. Eventually, the market realized that wasn’t going to be the case. And then, the Russian invasion of Ukraine occurred and look at the prices that defense stocks trade for now. These have all been huge winners for investors who focused on fundamental growth as opposed to speculative negative sentiment.
Ironically enough, many bio-pharma stocks underperformed throughout the 2020 COVID-19 pandemic (largely due to the fact that hospitals were forced to cancel/postpone a lot of elective procedures because of the influx of COVID cases). However, I’d seen similar bearish stories play out before in the healthcare space. Obamacare and the 2016 Presidential election both caused short-term sell-offs in this space because of fears surrounding healthcare reform. And yet, the popular dividend growth stocks in the big pharma space continued to print tons of cash. Today, names that I was buying heavily into weakness throughout 2020, such as AbbVie (ABBV) and Bristol-Myers Squibb (BMY) are both selling at 52-week highs. Has anything changed for these companies, operationally speaking, over the last 12 months or so? Not really. But, the sentiment surrounding them certainly has.
In early 2021, we saw a huge rally in the renewable energy space (once again, related to political speculation revolving around the Biden Administration’s infrastructure plans). Well, the market darlings in that area of the market quickly became dogs as the size of proposed infrastructure legislation shrunk. A favorite stock of mine in the space, Brookfield Renewable Corporation (BEPC) saw its share price rise from $30 up to $60 and then back down to $30, all in the span of a couple of years, largely due to market sentiment. Throughout this period of time, BEPC’s fundamental growth story remained steady, however. Therefore, I was pleased to buy the dips and now shares are rallying again, back up above the $40 mark, having risen more than 15% thus far on a year-to-date basis.
I could go on and on telling stories like this. But, the general theme remains the same…
The market has a bad habit of ignoring fundamental growth, and instead, allowing speculation and emotion (fear and greed) to result in a herd mentality that drives share prices to irrational places (both to the upside and the downside).
And, when the irrational herd is pushing prices lower during periods of time where a company’s underlying fundamentals continue to rise (which is often the case when we’re talking about blue chip dividend growth stocks), that often turns out to be a great buying opportunity.
Every dividend-paying share that I accumulate in my portfolio is another step towards financial freedom. And, when those shares have higher than average/expected yields attached to them because of irrationally low prices being applied to them by a fearful market, well…the market’s folly is my opportunity to fast track my journey towards a comfortable retirement.
This is why I love buying into weakness.
The fact is, no one is ever able to perfectly time bottoms or tops of markets perfectly. Oftentimes, even though I do my best to buy shares with an attractive margin of safety attached, they continue to sink lower in the short-term. But, this doesn’t bother me.
Instead, I view short-term dips as an opportunity.
All in all, I believe that long-term investors should do their best to avoid fear and the urges to sell into short-term dips (especially when bullish fundamental theses remain intact) and focus on safe, sustainable, and reliably growing dividends, instead.
Selling too early could lead towards major regret. And, more importantly, allowing fear to inspire you to avoid the stock of wonderful companies could not only delay your arrival to the promised land (in terms of financial freedom), but cancel the arrival altogether.
This article is intended to provide information to interested parties. As we have no knowledge of individual circumstances, goals and/or portfolio concentration or diversification, readers are expected to complete their own due diligence before purchasing any stocks mentioned or recommended. It does not guarantee that securities mentioned in this newsletter will produce profits or that they will equal past performance. Additionally, we are not an investment advisor and do not offer securities or tax advice. Although all content is derived from data believed to be reliable, accuracy cannot be guaranteed. Nicholas Ward, contributors and staff members of Wide Moat Research may hold positions in some or all of the stocks listed.
Disclosure: Of the stocks discussed in this article, Nicholas Ward is long ABBV, BEPC, and BMY.
Nicholas Ward is a research analyst who currently writes for Seeking Alpha, The Dividend Kings, iREIT, and Forbes Real Estate Investor. Before that, he was Founder and Editor-in-Chief of The Dividend Growth Club, as well as the Income Minded Millennial. Nicholas has also contributed to Sure Dividend, Investing Daily, and The Street, where he covered stocks in Jim Cramer's Action Alerts PLUS Portfolio.
Nicholas holds a bachelor of arts from The University of Virginia, where he studied English and studio art. Prior to transitioning into the financial industry, he managed a vineyard in the foothills of the Blue Ridge Mountains.
