When we first began investing, it was a nightmare. We’d read about an “exciting stock” that we thought would be the next Microsoft and then we entered a full position (all of our cash obviously) as soon as the market opened. Then we’d actually sit there and watch the price tick up and down, all the while questioning if we made the right decision. At one point we entered and exited that same stock 3 times in a single week. This sort of behavior can be attributed to two things; stupidity and emotions.
There’s an excellent book on trading that was written back in 1923 called “Reminiscences of a Stock Operator” which is well worth a read. The main takeaway is that the key to being a successful investor is to take control of your emotions, mainly fear, greed, hope and your big fat ego if you work in finance.
When you are an investor, your timeline should be indefinite. Any other horizon starts to move towards speculation. The shorter the horizon, the more speculative the position becomes. When you have an indefinite horizon, then this should make your entry price largely insignificant. Still, you want to know that you’ve entered a positon at a fair value and that you’re not overpaying.
One way to remove emotion entirely from the equation is through “dollar-cost averaging (DCA)” which is an investment technique of buying a fixed dollar amount of stock at regular intervals regardless of what the share price does. You probably are familiar with dividend reinvestment plans (DRIPs) which are really just a form of DCA.
When you want to enter a position in a stock, never go pull the trigger and buy the full amount. Setup a recurring monthly purchase and then buy a portion of your position each month. If you think the stock is a bargain, then reduce the duration of your schedule. If you think the stock is richly valued, just increase duration.
Right now we’re accumulating 29 different positions each month for a 30-stock portfolio using “dollar cost averaging”. We’re setting our horizon to be fully vested at exactly 2 years. We’re really hoping we see a downturn in the market over the next 2 years so we can get into our positions at a better value.
Once you set that “dollar cost averaging” plan into action with specific dates to buy, you’ll find that all that stress about finding the correct entry point just evaporates away. If the stock goes up, you’re watching the shares you hold increase in value. Your ego tells you that you have done good by beating Mr. Market and the fact that you have to pay a premium now to buy shares doesn’t bother you that much. An example would be our current position in UGI Corp (UGI):
We’re stoked to be up on UGI by +28% but also not so happy that we’re paying such a premium now for our monthly purchases. On the other hand, if the market goes down significantly, you don’t like to see your position in the red but that paper loss decreases every time you make a purchase. An example would be our current position in Franklin Resources (BEN):
We’re not happy to have paper losses of -18%, but we’re very happy to be picking up some cheap shares of BEN relative to when we first started buying it.
If you still want to exercise some judgement over when to buy your positions, simply increase or decrease the amounts you’re investing each month by 20% or so. We’re often tempted by dips in stocks we’re trying to accumulate, and may pull the trigger on larger monthly buys when we think we’re getting a bargain. This is speculating. Sometimes it works, sometimes it doesn’t.
The point is this. There are trillions of dollars in institutional money that regularly look at the markets and analyze whether to buy or sell a stock. In the majority of cases, they get it wrong. Are you going to claim that your part time stock research and arbitrary yield target of 3% are anything but just another speculative gamble?
We “work in finance” and still have zero advantage over anyone else when it comes to timing the market (i.e. deciding when to buy and sell). Instead, we try and use objective methods like dollar cost averaging, Quantigence Q-Scores, and the basic rules of diversification to remove as much emotion as possible from our investment decisions.
Don’t listen to your ego telling you that you somehow have an information advantage over the millions of other investors out there, most of whom are more informed and have better access to institutional data than you do. Simply use “dollar cost averaging” and sleep better at night. You’ll thank us for it.