Human nature tends to work against us when the stock markets turn.
Now is one of those times, particularly for readers who have turned to stocks reluctantly as the only way to stay ahead of inflation. As share prices have moved wildly and largely lower this year, concern has mounted. Some think they should sell now, which may be the worst time to do it.
On Wednesday, the U.S. Federal Reserve raised interest rates for the first time in nearly a decade, and the news offered another example of a day of lurches. North American stocks sank before the announcement, then soared once the hike was official. Both Toronto and New York ended the day with triple-digit gains.
The last two trading days aside, it’s been a pretty lousy year for investors. The main index on the Toronto Stock Exchange is down 10.7 per cent on the year as of Wednesday’s close, largely because of the commodity and energy rout, which hurts many areas of our economy. The Dow Jones in New York has fared better, but is still down a little less than half of 1 per cent.
Toronto reader P.N. has had a small portfolio of stocks for 30 years. She wanted a higher return without too much more risk, so her adviser put her into a portfolio of dividend stocks.
She doesn’t need the quarterly dividends for day-to-day living, so instead of cash she opted for a dividend reinvestment plan (DRIP), which adds the equivalent of the dividends as shares. But as the face value of her holdings has fallen, she wonders whether it’s smarter to take the money.
“With the erosion of the stock market, I admit to feeling some anxiety,” she wrote. “I feel I should stop the DRIP method and receive the dividends in cash.”
After some to and fro, P.N. has decided to stand pat, reasoning that her DRIPs buy more shares as the stock price falls. And given the high quality of her holdings, the companies she owns will fall least and rebound first. They will also pay dividends along the way, so there’s no reason to sell.
Her thinking is similar to Brampton reader S.W., who has watched his portfolio shrink almost 10 per cent in the last few months, losing $107,000 on paper, he says.
His holdings are also top-quality. They include large real estate investment trusts (REITs) and preferred shares of Canada’s banks. All pay monthly or quarterly dividends. S.W. wanted to know whether he should hang on. He uses the dividend income to live on, but does not need to touch his seven-figure capital. He has also decided there’s nothing to be gained by selling, and believes his holdings will rebound.
Diversification and investment quality are the keys to long-run investment success and if you have both you’ll come out ahead. But we live in the short run, where are emotions are always at play.
Bernard Baruch, a Wall St. financier and adviser to five U.S. presidents, once noted that emotions constantly set traps for our reasoning powers. We tend to react to the urgency of today’s news and lose sight of our goals.
Here are a few things to keep in mind.
• Stocks can seem risk-free for long periods, but they aren’t. When they fall, it can be a rude shock for those who are in the markets as a last resort. If you need to preserve capital, you shouldn’t be there. If you can accept some risk, high-quality funds and shares offer a higher return.
• Market sell-offs always set the stage for recovery, although as Baruch observed, it’s human nature during bad times to think the good times will never return.
On Black Monday in October 1987, U.S. shares fell 22 per cent in one day. They recovered all of that in a few months. Crashes in 2000 and 2008 were all followed by big rebounds.
For example, shares of TransCanada Corp. tumbled following the U.S. rejection of its Keystone pipeline. A year ago, the shares were worth $52.83 with a dividend yield of 3.6 per cent. The shares closed at $48.30 Wednesday with the dividend yielding 4.3 per cent. On top of that, TransCanada raised its dividend this year, a sign of confidence in its outlook.
This is not to say that sell-offs don’t hurt. It’s just that if can look beyond them you often find that better things lie ahead.