6 Critical Tips for Long-Term Investors
This section covers several tips to increase your odds of long-term investing success.
Tip #1: Long-Term Investing is Simple But Not Easy
Please don’t get the wrong idea – long-term investing is not easy.
It is psychologically difficult to hold a stock when its price is declining.
Holding through price declines takes real conviction.
The nearly infinite liquidity of the stock market combined with the ease of trading makes selling stocks something you can do on a whim.
But just because you can, doesn’t mean you should.
The constant stream of stock ticker price movements also coerces individual investors into trading unnecessarily.
Does it really matter that a stock is up 1% today, or down 0.3% this hour? Have the long-term prospects of the business really changed? Probably not.
Tip #2: Stock Prices Lie, Dividends Tell The Truth
Stock prices lie…
They signal a business is in steep decline when it isn’t.
They say a company is worth 3x as much as it was 3 years ago while the underlying business has only grown 50%.
Stock prices only represent the perception of other investors. They do not and cannot show the real total returns an investment will generate.
Instead of watching stock prices, avoid them completely. Look at dividend income instead.
Dividend do not lie.
A business simply cannot pay rising dividends for any long period of time without the underlying business growing as well.
Dividends are much less volatile than stock prices. Dividends reflect the real earnings power of the business.
Don’t you care what your investment pays you more than what people think about your investment? If the answer to this question is ‘yes’, then you should track dividends, not stock prices.
Tip #3: Long-Term Investing Is Not Buy & Pray Investing
There is a stark difference between buy and hold (sometimes called buy and pray) investing and long-term investing.
Buy and hold investing typically means buying and holding no matter what. That’s not what long-term investing is about.
Sometimes there is a very good reason to sell a stock. It just happens much less frequently than most people believe.
Stocks should be sold for two reasons:
1. If it cuts or eliminates its dividend payments
2. If it becomes extremely overvalued
If you invest in a business to provide you steadily rising income, and instead it reduces or eliminates its dividend, that business has violated your reason for investment.
Cutting or eliminating a dividend is really a symptom of a cause. The true cause of most dividend cuts is an erosion in the earnings power and competitive advantage of the business.
The second reason to sell is in the case of an extreme overvaluation.
I’m not talking about when a stock moves from a price-to-earnings ratio of 15 to 25…
I’m talking about when a stock is trading for a ridiculous price-to-earnings ratio – say 40+. An important caveat is to always use adjusted earnings for this calculation.
If a cyclical stock’s earnings temporarily fall from $5.00 per share to $1.00 per share, and the price-to-earnings ratio jumps from 15 to 75, don’t sell. In this instance, the price-to-earnings ratio is artificially inflated because it is not reflecting the true earnings power of the business.
Selling due to extreme valuations should only occur very rarely, during extreme bouts of irrational market exuberance.
