2023-08-21 08:00:00 ET
Summary
- Famous investors' quotes about buying the dip are easy to agree with in theory, but investors often don't follow their advice in real market downturns.
- Buying stocks during market selloffs requires fortitude, but historically, those who held on through the chaos and bought more have seen huge returns.
- Buying the dip in dividend stocks leads to higher starting dividend income as well as higher future dividend income, especially when reinvesting dividends.
- Be smart. Be selective. But also be bold!
Investors and especially financial writers love to quote the famous quips of successful investors like Warren Buffett, Charlie Munger, Benjamin Graham, Sir John Templeton, and others.
Think of sayings like:
When it's raining gold, reach for a bucket, not a thimble . -Warren Buffett
and
Buy when there's blood in the streets, even if the blood is your own. -Nathan Rothschild
and
Be greedy when others are fearful and fearful when others are greedy . -Warren Buffett
and
To buy when others are despondently selling and sell when others are greedily buying requires the greatest fortitude and pays the greatest reward. -Sir John Templeton
In a vacuum, outside the context of a real market environment, it's easy to nod your head in agreement with these ideas. We can look back at history and see that the best time to buy stocks was after they had fallen sharply.
But when the rubber hits the road, or when the, ahem, stuff hits the fan, investors tend to act differently than they had planned to during the good times.
Every single one of those fantastic buying opportunities in the past came with it some real and menacing cause of fear. By necessity, market selloffs happen because of investors' collective fear, pessimism, or uncertainty. Stock prices don't have a mind of their own.
In the early 2000s, the tech bubble burst, and investors had no idea how long or how far stock prices (especially for the tech stocks in the Nasdaq index ( QQQ )) would fall. After months and months of seeing stock prices continue to drop, many investors threw in the towel, saying "Forget it! All I've done is lose money in the stock market. I'm out."
Imagine buying QQQ at around $60 before the tech bubble began in earnest in late 1999. You enjoy a nice doubling of your investment in a few months, then the price begins its steady decline. That steady decline lasted nearly three years, making new low after new low.
It would truly require the "greatest fortitude" to hang on and keep buying on the way down as stock prices continued to drop.
But those who held on and kept buying more, believing in the value and growth potential of American tech companies, made roughly 15x their invested dollars over the next 20 years.
In 2008-2009, home prices had already been falling for over a year, while rising interest rates and an abundance of adjustable-rate mortgages triggered a meltdown in financial markets that had been propped up by risky financial products.
Since so many of those risky financial products were all based on the housing market, no one knew how deep the contagion would go or how much damage it would wreak. No one knew when stock prices would stop falling or if they'd ever recover.
And since the root cause of the crisis seemed to be real estate, nearly all real estate investment trusts ("REITs") were seeing their stock prices drop like rocks. The Vanguard Real Estate ETF ( VNQ ) lost 2/3rds of its value from August 2008 to March 2009, and that was after shedding 1/3rd of its value from the early months of 2007 to August 2008!
But assuming you pushed away the fear and uncertainty and bought when others were despondently selling in April 2009 (near but not right at the very bottom), you would have nearly quintupled your money by now -- even after the recent selloff in REITs.
And at the beginning of 2022, at the top of the real estate cycle, you had sextupled your money! (Yes, "sextuple" is a word -- meaning to multiply sixfold.)
But that is just if you invested in the broad index, including the best performing companies and the worst performing companies.
If you chose your investments very intelligently and picked some of the better performing REITs, you performance since the Great Recession would have been even better.
It's useful to remember that even high-quality REITs like Sunbelt industrial owner/developer EastGroup Properties ( EGP ), diversified net lease player Realty Income ( O ), and coastal apartment giant AvalonBay Communities ( AVB ) suffered steep stock price declines during the financial crisis.
But for those who kept buying right up to the bottom, in the years since the GFC, your invested money would have more than quintupled for O and AVB, while nearly noncupling for EGP. (Also a word, meaning to multiply ninefold.)
Of course, it's very important to do your due diligence and pick higher-quality companies with top-tier assets, skilled management, good positioning in their industries, and strong balance sheets.
You can't buy just any stock and expect it to quintuple if you hold it long enough!
But if you've chosen your investments wisely, the power of buying the dip can't be overstated.
Dividend Compounding: Starting The Snowball Effect With A Bigger Snowball
All of the above is especially true for dividend growth investors.
When it comes to dividend stocks, buying the dip is akin to rolling a bigger starting snowball down a snowy hill. It will gather even more snow as it rolls than it would have if you'd started with a smaller snowball.
Imagine a great, dividend-paying company that has a consistent track record of growing its dividend at around 5% per year and expects to keep that pattern up into the future. Imagine that this company normally trades at a dividend yield of about 3%, but after a dip in the stock price, the company yields 5%.
If you invested $10,000 at the 5% yield instead of 3%, not only would your starting dividend income be higher, your dividend income after 5 years and 10 years would be much higher.
But you might object that this is just a hypothetical example, so let's use a real-world one.
Take the Vanguard High Dividend Yield ETF ( VYM ), which owns above-average-yielding dividend stocks that are still relatively high-quality.
Most of the time, including before the Great Recession of 2008-2009, VYM trades at a yield of about 3%. But during the financial crisis, the ETF's price plummeted, causing its yield to spike up to 5% (actually as high as 6%, but only very briefly).
If you had bought VYM in early 2008, before the stock market collapse, you would have gotten a starting dividend yield of about 3.25%, but after all the intervening years of dividend growth, your yield-on-cost would have surged to 7.0%.
Not bad!
But if you had bought VYM in early 2009, near the stock market's trough (i.e. peak fear, pessimism, and uncertainty), you would have gotten a starting dividend yield between 4.5% and 5%. Better yet, your yield-on-cost based on today's dividend payout would have surged to between 11% and 13%.
And this doesn't even consider the effect of reinvesting your dividends! Reinvesting dividends would of course compound the growth of your income further, allowing you to buy more shares and generate more dividends in a virtuous cycle.
But, you might object, what about the reason for the selloff? It's easy to say "buy the great company at a higher yield instead of a lower yield," but this doesn't account for why the stock is selling off to begin with.
This is where your individual conviction comes in.
- Do your due diligence thoroughly
- Read research by smart and honest analysts or financial writers
- Assess the risks as best you can
- Don't be Evel Knievel with any money you can't afford to lose
- Trust your research and convictions
- Ignore the noise of the stock price and what other investors are saying and doing
If you are doing these things, then buy the dip, let the dividends drip, and wait for the stock price to rip.
(Was that rhyme as painful for you to read as it was for me to write?)
Bottom Line
We are all human. We all fear making mistakes and losing money. And psychology tells us that we feel the pain of losing money far more acutely than the pleasure of making it.
I am not recommending being stupid and going full Diamond Hands on just any dividend stock that now offers a higher yield than it did a year or two ago.
But opportunities for a dividend growth investor to supercharge their dividend snowball to this degree don't come around every day!
Utility stocks ( VPU ) are nearly 20% lower than their high, while REITs as represented by VNQ are ~30% off their high and renewable energy power producers like Brookfield Renewable Partners ( BEP ) are down even more.
Now is the time to supercharge your dividend snowball by buying the dip.
Be smart. Be selective. And then be bold!
For further details see:
Buy The Dip: It's Time To Supercharge Your Dividend Snowball