Investing is a snap when stock prices are rising. You just sit back, watch your portfolio grow and feel like a genius.
When prices are falling, on the other hand, all sorts of unpleasant emotions come into play – fear, regret, anger. As your portfolio shrinks, the "genius" in you starts to feel like a doofus.
These feelings are natural – every investor experiences them at one time or another. They're also dangerous. The trick is to not let them sabotage your investing plans.
With that in mind, here are some tips to help you ride out the volatility that's swept markets this summer.
Focus on things you can control
Unless your name is Ben Bernanke, you don't have any influence on bond yields. Nor can you control inflation, unemployment or economic growth. These things are out of your hands. However, you can control how much money you spend and save, how diversified your portfolio is and the proportion of equities vs. fixed income that you hold. By focusing on factors within your control, you'll be better able to manage stress.
Stick to your strategy
I'm a dividend growth investor – I buy strong companies that raise their dividends regularly. Other investors may prefer an indexing approach, for example, or focus on companies with strong growth or attractive valuations. The important thing is to have a strategy and stick with it. Otherwise, you'll be tempted by whatever stock or investing style is the flavour of the month.
Focus on the long term
For dividend investors, time and compounding are your biggest allies. Short-term market volatility is the price you pay for the superior long-term returns of stocks. A few years from now, market setbacks like the one we've experienced recently will look like mere blips on a long-term stock chart – if you can see them at all.
Keep some cash on hand
It always pays to have some cash available so that you can take advantage of bargains when they come along. That way, you'll see market sell-offs as opportunities instead of disasters. Having cash also helps you meet unexpected expenses without having to sell an investment prematurely. Remember, however, that it takes discipline to hold cash back when markets are surging.
Invest in solid businesses
Remember Warren Buffett's 10-year rule: "If you aren't willing to own a stock for 10 years, don't even think about owning it for 10 minutes." By focusing on companies with staying power – those with a strong brand name, entrenched market position or some other enduring competitive advantage – you'll minimize mistakes. Utilities, pipelines, banks and large consumer companies often meet the 10-year test.
Count your dividends
Instead of obsessing about stock prices, focus on the annual income your portfolio is generating. Unlike the stock market, this number won't bounce around from one day to the next, but should grow gradually if your stocks are raising their payments and you are reinvesting your dividends or adding new cash to the portfolio. Tip: Use a simple Excel or Google Docs spreadsheet to track your dividend income.
Resist the urge to sell
Anyone who sold during the 2008-2009 market meltdown locked in steep losses and missed a powerful rebound. If you hold high-quality businesses, selling them after a market setback is usually a bad idea. It may make you feel better in the short run, but in the long run it's counterproductive.