Congratulations on deciding to invest some of your money in stocks. Owning a portfolio of blue-chip companies or low-cost funds is one of the best long-term investments you can make. Over time, you will be amazed at how much wealth you can build.
That's the good news.
Now for the bad news: There will be days when you think owning stocks was the stupidest decision you ever made. At times, you might even feel like throwing up.
Take last Wednesday, for example.
Triggered by the chaos in Washington, stocks took their biggest one-day tumble since September. A lot of investors were wondering: Is this the start of something really terrible? Should I sell now and avoid bigger losses later?
But look what happened: The market rebounded on Thursday and Friday.
That brings us to rule No. 1 when facing market volatility: Never sell out of fear.
Here's the key thing to remember: The market's path over the long run is up. In the short run, however, it is all over the place. Nobody can consistently time these short-term moves. Even if you got lucky and sold before the market tanked, you would then have to decide when it's safe to get back in. Good luck with that.
Buying and holding through good times and bad is a much more effective – and less stressful – way to participate in the market's long-term growth.
But what, exactly, should you buy and hold?
On to rule No. 2: Invest only in high-quality companies.
In my own portfolio, I buy only in companies that a) pay a dividend and b) raise their dividend regularly. Is it a perfect strategy? No. Has it worked pretty well over the years? Yup.
By sticking with dividend growers – such as banks, utilities, telecom and pipelines – I've watched my portfolio's value and income rise steadily while mostly avoiding investing banana peels. (For examples of the stocks I own, read my latest Strategy Lab model dividend portfolio update.
Not comfortable owning individual stocks? No problem. Investing in low-cost index mutual funds or exchange-traded funds is an equally worthy strategy.
But whether you own stocks or diversified funds – or a mix of both – you'll need to learn how to accept market volatility. One way to do that is to embrace rule No. 3: Look on the bright side of market setbacks.
Nobody likes watching their stocks fall in price. I get that. But on a strictly rational level, a market sell-off is actually a gift.
If you're in the wealth-accumulation phase of your life – that would apply to most people, given that 77 per cent of Canadians are under the age of 60 – you should welcome market drops because they let you buy companies at lower prices.
Warren Buffett discussed this concept in his 1997 letter to Berkshire Hathaway shareholders.
"If you expect to be a net saver during the next five years, should you hope for a higher or lower stock market during that period? Many investors get this one wrong. Even though they are going to be net buyers of stocks for many years to come, they are elated when stock prices rise and depressed when they fall," Mr. Buffett wrote.
"This reaction makes no sense. Only those who will be sellers of equities in the near future should be happy at seeing stocks rise. Prospective purchasers should much prefer sinking prices."
This leads us to rule No. 4: Keep some cash on hand.
For dividend investors, the great thing about a falling market is that it allows you to buy more dividend income for the same amount of money. But you can only do that if you have some cash to spend (unless you want to borrow, which I recommend only for experienced investors). Consider pipeline operator Enbridge (which I own personally). At the end of 2016, the shares traded at $56.50 and paid an annualized dividend of $2.12, for a yield of 3.75 per cent. Two things have happened since: Enbridge has raised its dividend twice and its share price has fallen. As a result, the yield has grown to 4.56 per cent, meaning that a $10,000 investment in Enbridge today would generate $456 in annual income, compared with $375 at the end of 2016.
Now, we come to rule No. 5, which is the most important rule of all: be patient.
If you try to get rich overnight by investing in high-risk, speculative stocks, you will almost certainly fail. Building wealth with a portfolio of conservative stocks or funds takes time and commitment. There will be occasions when the market plunges or goes sideways for long periods of time, but this is completely normal. Roll with it. You'll like the results in the end.