I’m in a terrific mood today.
Before you ask, no, I did not win a lifetime supply of 2-ply toilet papers, nor did I get an invitation to collaborate with Shawn Mendes on a pop ballad.
I’m happy simply because I am sitting in my dining room with a glass of apple juice in hand, and writing this post.
This will be a somewhat lengthy Q&A post that dives into how I invest in the stock market.
Ahh, how I love this topic! I’ve been wanting to write about it for a while, and am glad to finally do so.
As a fellow income investor, I thought I’d chime in and share my two cents as well.
Question #1: Which stocks should you buy and why?
In theory, I would buy almost any stock at the right price, with strong caveats.
In practice, most of the stocks I end up buying are dividend aristocrats (i.e. companies that have increased their dividend payouts for at least 25 consecutive years) and REITs (which stands for “real estate investment trusts”).
I love dividend aristocrats because these are established companies with wide moat (i.e. strong ability to maintain competitive advantages) that usually produce steady profits, even during recessions.
To give you a few examples of dividend aristocrats: I am sure you’ve heard of 3M Company (which has an impressive track record of increasing its dividend payouts for 61 consecutive years), Coca-Cola Co, and Johnson & Johnson. They’re among the safest companies to hold long-term.
You can find the complete list of S&P 500 dividend aristocrats in this Wikipedia article.
In terms of REITs, their main appeals to me are:
- Portfolio diversification
- An inexpensive way to invest in commercial real estate
- High yields (it’s not uncommon to find quality REITs that yield more than 8%)
- History of outperforming other asset classes
According to a Forbes article on this subject, REITs have returned more than 12% annually between 1977 and 2010, which dwarf the 10% return of the S&P 500. Financial Samurai, a fellow (albeit much more popular) personal finance blogger, has provided more comparative data that further proves the superiority of REITs in terms of annualized returns.
Question #2: How should you evaluate the merits of the stocks you are considering?
As I briefly alluded to in my previous answer, whether I buy a stock depends largely on its valuation.
To keep it short and sweet, the following criteria are what I choose to focus on:
- Quality of the company: a lot of research is done to ensure that the companies I invest in have wide moat, a top notch executive team, and a great business model
- Compound Annual Growth Rate (CAGR): a measure that I use to distinguish the “alphas” from the rest
- Historical dividend payout: consistent dividend payouts and increases are always preferable
- Dividend safety: dividend payout ratio of 60% or less is usually ideal
- P/E ratios (including forward and trailing): I look for companies with P/E ratios of 20 and lower
- Debt-to-EBITDA ratio: this ratio measures if companies can comfortably cover their debts, as too much debts could spell trouble for dividend safety down the line
- Industry health: some industries are unfortunately on the decline, and it would be wise to avoid them
Question #3: When should you invest more money into new stocks or the ones you already own?
I get phone notifications whenever stocks on my watch list drop to certain prices (usually close to their 52-week low).
That’s my cue to do more research to dig up the reasons for the price drop.
If those reasons do not affect company fundamentals, and if buying doesn’t make me more overweight in a sector or stock, I would consider adding to or starting new positions.
Question #4: When should you sell your stocks?
Lately, I don’t think about selling stocks as much as I should.
I suppose if several of my criteria are no longer met for a certain stock, I wouldn’t be opposed to liquidating my position.
Question #5: Should you be worried when the market and prices are going down? Why?
As someone who checks her portfolio almost every single day, I’ve become fairly immune to market swings.
Since stock prices don’t affect my dividends, I can’t say that I’m ever worried.
That’s the beautiful thing about dividend investing.
Question #6: Should you diversify into other stocks, sectors and markets?
Absolutely. Diversification is necessary to reduce risks.
Investing without diversification is called gambling.
Question #7: Should you worry about asset allocation and rebalancing? Why?
Yes. But how much time and mental energy you should devote to asset allocation and rebalancing depends entirely on your age, risk tolerance (i.e. your ability to stomach investment losses) and investment horizon (i.e. how long you plan to stay in the market).
If you’re relatively young and can withstand market volatility, holding less fixed-income investments would likely help you maximize your returns. As you age, you’d want to do the opposite in order to protect your principle in the event of a downturn.
For reference, I’m in my early-30s with a fairly high risk tolerance and a 50-year investment horizon. At the moment, 3.6% of my portfolio consists of VGLT (an ETF that invests primarily in government bonds). Another 7.2% is invested in municipal bonds that will mature at the end of 2019.
Question #8: Should you worry if your stocks don’t perform as well as the market? Why?
Although the ultimate goal of investing is to maximize returns, I’d caution against putting too much pressure on always beating the market, as it might jolt you into making irrationally risky bets.
I wouldn’t sweat a few years of underperforming the S&P 500, as long as you’re generally keeping up with it.
Depending on which day you look at the market, I could be wildly overperforming or severely underperforming the market, or somewhere in between.
What keeps me sleeping soundly at night is that my holdings pay regular dividends, at 4.14% yield-on-cost (counting dividend reinvestments in costs).
Question #9: When should you invest in ETFs, mutual funds, bonds and GICs?
ETFs: almost always, especially index-tracking ones (my baby‘s RESP only holds index-tracking ETFs)
Mutual funds: never
Bonds: yes, age-based asset allocation is key
GICs: I personally prefer putting money in high-interest-rate savings accounts over buying GICs
Question #10: How do you determine how well your stocks are performing?
I use Google Sheets (that automatically pulls data from Google Finance) to track everything from profit/loss to dividend income. I will soon make the template available for everyone to download.