How To Act In Anticipation Of And During A Market Downturn?

Most companies in my portfolio have been reporting their fourth quarter results lately and in the meantime the stock market has continued its journey upward. Buying opportunities are getting fewer and far between, which has made the Watch List look less exciting than in a long time.

Longing For The Market Downturn
I can honestly say that I long for a general downturn. It may seem strange to some, but for us who want to buy quality companies at a discount, and in the process increase our dividend stream significantly, the scenario is tempting. 

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I have started to contemplate whether or not I should seize with the monthly purchases and await the coming stock market downturn. Because a significant drop in stock prices will come sooner or later, the big question is when. Maybe I'll have to wait a month or so, maybe until next year or even longer. 

The question is if I'm prepared to stay outside the market for as long as it takes? And how would I act if the stock market started plummeting today? How many positions would have time and the courage to take before the stock market climbed back to previous levels? 

How Did Things Turnout In 2007?
If we look at history, the major stock market crashes have become steeper and steeper and the recovery time has become shorter and shorter. In connection with the last major downturn, the Swedish index OMXS30 hit bottom, October 27 2008, after about 4 months and the market stayed at that level for about 6 months. The time one had to buy bargains was in other words more limited than one might think. OMXS30 had after about 20 months recovered to the same levels as before the crash.

I'd like to think that I would have bought large amount of shares in great companies during the 6 months we stayed close to the bottom.The likelihood however is that this wouldn't be the case if the stock market crashed today. I probably would burn too much ammunition early on and not have much left once we reach the bottom.

In Summary
What then can we conclude from the reasoning above? Well, atleast the following - We don't know when the next stock market downturn will begin, nor when we will have reached the bottom, or for that matter how long we will stay there. What I know for certain is that I'll lose money if I stand outside the market for extended periods of time. If I continue to buy regularly and disciplined  as the market falls chances are I will still have some firepower left when the stock market has plunged more than 30%.

What's My Plan Going Forward?
I will continue to purchase stocks with regularity. When the market starts to fall, I will increase the frequency, but not to the point that I burn all my capital at once.
When the stock market has once again recovered I will revert to, something in the line, of one purchase per month. I know that the thought of a market crash seems unlikely to many at this point in time, but that's exactly why we should mentality prepare for one.

Work Less And Let Your Capital Work Overtime

There are many of us in Sweden, and the rest of the world for that matter, that get into our cars each morning and drive to an office with colleagues that we haven't chosen. There are many of us that can't slow down because we are solely dependent on the funds that our employer transfers to our bank account at the end of the month. 

For me this is not the life I want until I turn 65 (or whatever the retirement age will be at the time). The government in Sweden has of late proclaimed the need for us to work more and retire later in life. I find this to be somewhat of a paradox since the need for labor is lower than ever before historically, thanks to technological developments in IT and engineering.

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But is it really such a bad fate to be forced to work until 65 or longer? What if I get more responsibility and more control over my work or even become manager? 
Sure, with a higher position you are likely to be able to influence your work situation, but the fact remains that someone else still decides who your colleagues are, where your office is located and the objectives you must meet. The downside to taking on more responsibility is also that the time you are expected to work and be available often tends to increases. 

A passage from one of Bob Dylan's lyrics is applicable in this context:

Might be a rock 'n' roll adict prancing on the stage

Might'll have money and drugs at your commands, women in a cage

You May Be A business man or some high degree thief

They May Call You Doctor Or They May call you Chief.

But you're gonna have to serve somebody, yes indeed

You're gonna have to serve somebody,

Well, it May be the devil or it May be the Lord

But you're gonna have to serve somebody.

There will always be someone to whom we will be held accountable, whether we work full time, part time or are self-employed. My goal however is that the ones that I have to serve are mainly my family and not a manager until I'm in my seventies.

Does this mean that I hate to work and want nothing more than to lie on the couch and watch TV all day? Of course not. I want, like most of us, to work, but not because I have to. I want to be able to take time off without feeling stress or anxiety. That is why mine and my family's goal is to have a passive income amounting to our living expenses, so that we can control our time.

What then should wage workers like myself do to improve our situation?
Those of you who read this blog already know the answer to the question - invest our savings in stable dividend companies with solid track records and competitive business models. The beauty of investing in stable companies with growing dividends is that the invested capital is put to work instead of you needing to work overtime.

Companies in a well-balanced dividend portfolio will ensure that profits and dividends in the long run increase, giving you protection against inflation. By also reinvesting the dividend the growth of the passive income accelerates further. So what are you waiting for? Put your money to work so you do not have to work overtime in the future!

Does A Dividend Investor Have More Options?

A company can choose to reinvest all its profits in the business or to distribute some of the profits to the shareholders in the form of dividends. Dividends gives us shareholders a cash flow regardless if the price of the stock goes up or down. A cash flow that is to our disposal to do with as we see fit.

I got a intresting comment from a reader a time ago, who argued that dividend investors through the cash flow from dividends have more choices than investors who buy companies that don't distribute their earnings. The number of options are grater for the dividend investor he argued.

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I agree, not surprisingly, with the statement, but what are these options that a dividend investor have? Shareholders of dividend companies can choose to do one of the following with the dividend they receive:

- Buy more shares in the distributing company. This option is recommended if the original investment was done right from the beginning and you have invested in a company with a stable earnings dividend history. A company that has distributed dividend over a long period of time tends to have an proven business model and strong competitive advantages that allowed them to grow large and remain viable for such a long time.

- Buy shares in another lower valued company of similar quality. The market will never be perfect and there will always be companies that due to irrational market concerns are undervalued relative to their fair value.

- Invest money outside the stock market - fine art and real estate are viable investment options. However, I believe that stock investing is by far the best form of investing for us who are employed and I will therefore for the foreseeable future have most of my capital invested in stocks worldwide.

- Cover daily living expenses or indulge in a little everyday luxury. Using the dividend for any type of consumption is not something I plan on doing in the near future, but the possibility is there non the less.

- Transfer the dividend to a savings account in anticipation of better buying opportunities - which I partially done recently. It's no secret that I and many others feel that the stock market is overvalued and that there are few buying opportunities right now.

In addition to financial instruments such as options and warrants dividends are the only way for a private investor to make money from a stock without selling off their shares in the company. 
The beauty of dividends is that they are passive and, in most cases, a recurring income. Can you think of any more options a dividend investor has compared to those how solely own shares in non-distributing companies?

Does Owning More Stocks Always Translate Into More Work?

Inspired by Dividendmantra I have been thinking about my criteria regarding portfolio composition, and primarily the number of companies I think is reasonable to own. One of the reasons that I have set an upper limit of about 20 companies, is that I have assumed that it would be too much work to monitor a larger number of companies.

But is it really true that a larger portfolio automatically needs more looking after than a smaller one? The answer is, as usual, it depends on the circumstances. Monitoring ones portfolio to closely can even have the opposite effect. One potential drawback I can see, is that it is easier to get distracted by the amount of information we are bombarded with daily. It is easy in such a context lose focus ones strategy driven by rumors and hearsay. 

What then are the factors that determine how carefully we need to monitor our companies?

I think, unsurprisingly, that the quality of the companies that one owns determines the level of monitoring required. I can offhand identify the following key factors that I think determine how careful one needs to monitor their stock portfolio:

- Do the companies you own have sound businesses and persistent competitive advantages or is it easy for competitors to steal market share? Companies that have clear competitive advantages, are more likely to have sustainable profits than companies that run the risk of losing market share to competitors.

- What are the risks associated with the markets that your companies operate in? Are there political, regulatory and other risks that may affect a company's future earnings? Fortum is a company that, because of its operations in Russia, requires me to follow the stock more closley than I would otherwise.

- How dynamic are the industries that your holdings operate in? Companies that operate in a fast changing industry run a greater risk of seeing their business models lose strength, because off the speed in which fundamentals change. The IT industri is a good example of a dynamic industri were competitive advantages can become obsolete because of new technologies.

- What financial resources do the companies in your portfolio have? Do the companies you own have financial muscles and strong owners behind them or is the level of debt high and the financial backing week or nonexistent? When it the storms companies with strong owners and balance sheets are less likely to sink.

Conclusion

The more qualities that companies in your stock portfolio posses, the greater the likelihood is that they can withstand market downturns. Does this mean, that as long as I only invest in high quality companies with a long and stable history, that I don't need to monitor my portfolio? No, of course not, but the workload will be considerably less than if one's portfolio only consist of smaller and less established companies.

What is your limit regarding the number of stocks you feel comfortable owning and why?

What Advice Would You Give Yourself As a First Time Investor?

I got a question a while back from a young aspiring dividend investor on my Swedish blog. The question was about what stock I though would be a good first building block in his future portfolio. The question got me thinking about what advice I would have appreciated when I just had begun investing back in 2006.

Travel Back In Time

I will, for a moment, pretend that I have access to a time machine with which I can go back in time. If time travel was possible, what would my present self say to the novice I was back then? The dialogue I in such a hypothetical senario could go something like this;

Be patient - you (past me) have time on your side so do not stress. It rarely pays of to be in a hurry when it comes to investing. Investing should be boring and not very exciting or else you are taking on to much risk. 

Define clear goals of what you want to accomplish by investing in stocks. Formulate them in accordance with the SMART Criteria. A smart goal should be:

S = specific
M = Measurable
A = Accepted
R = Realistic
T = Timely

When you have your goals set, start reading as much as you can about stock investment in general and stock analysis in particular. Read, read and then read some more. 

Start your own investment blog and make an effort to analyze companies on your own. There is nothing that's as useful as forcing one's self to articulate thoughts and actions connected to the investment process. Writing a blog will also make you more inclined to stick to your strategy and achieving your goals.

Do not try to predict market movements - it most likely will lead to increased brokerage cost and low returns. Be systematic in your approach and invest for the long-term. Spread out your share purchases (once a month).

Avoid IPOs were management promises shareholders riches and glory - If it seems to good to be true i often is.

Don't invest in obscure companies with a brief history. A better option, when the market feels expensive and there isn't any clear candidates, is to put aside money in a money market fund or savings account with a decent interest rate until prices fall. 

Because prices will fall, even if it does not feel so right now. Although no one can't predict when that will happen a bear market always is succeeded by a bull market.

Do not put all your eggs in one basket, instead invest in stable companies in different industries and markets in order to lower risk.

Opt for stable companies with stable dividend history. To find stable dividend candidates it might be a good idea to start from reputable bloggers watch lists or stock screeners such Google finance or Morningstar. Seeking Alpha is another great source if you're looking for safe dividend plays.

That's the advice can give you at the moment past self. Good luck and take advantage of all the time you have on your side and save for the long-term.

What advice would you give your past self if you had my time machine?