4 New Rules for Investors
Here are four tips for earning a decent return even if stocks stay in a funk for years.
It’s no longer the stock market -- it’s the stuck market. Or at least that’s what it seemed like for much of the summer and fall as the Dow Jones industrial average meandered between roughly 10,500 and 11,600, despite a series of harrowing one-day moves. We expect this kind of back-and-forth pattern to continue in 2012 and for a few more years beyond.
What’s upsetting is that all this motion doesn’t earn you much. The major market indexes and your investment balances end up flat after weeks or months. The stock market has been known to travel within a narrow band for years, as the Dow did between 1966, when it first crossed 1000, and 1982, when it finally flew past that barrier for good.
How do you cope with a trading-range market? It won’t be enough simply to put your money into a broad stock-market index fund and forget about it. Here are four tips for earning a decent return even if stocks stay in a funk for years.
1. Buy on weakness, sell into strength.
This goes counter to your natural instincts, which are to withdraw money from stocks during a downturn and put it back once share prices rebound. Once stocks drop 15% or more, it’s almost always too late to sell. Instead, buy some stocks or stock funds if you happen to have the cash. Similarly, after stocks roar for a month, as they did in October, it’s too late to go on a buying binge. But it’s not too late to cash in some profits to arm yourself for the next decline. Don’t confuse this with market timing. Consider this a hedging exercise designed to let the market’s rhythms work for you, not against you.
2. Focus on dividends.
Dividends are a bonus in up markets and provide comfort during slides. Over time, dividends have provided about 44% of the U.S. stock market’s annualized total return of 10%. And they are sure to remain an important component of returns if appreciation is hard to come by in coming years, as we expect. Thanks to dividends, you can make money even if the market essentially goes nowhere. Consider this: From 1966 through 1980, Standard & Poor’s 500-stock index generated an annualized total return of 6.7%. And although there are always exceptions (see bank stocks in 2008), dividend-paying stocks tend to hold up better than non-payers in down markets. (See SLIDE SHOW: 12 Stocks to Get Dividends Every Month.)
3. Set low-ball limit orders.
If your strategy includes building stakes in companies that regularly raise dividends, you’d be wise to add more shares as time passes. Here’s a tip: Even if a stock has been weak of late, enter a limit order to buy shares at 3% off its current price. There’s a good chance you’ll get your price as soon as traders create some drama because of the euro, the budget deficit, slowing Chinese growth or whatever else floats their boats on a given day. Every percentage point or two you save on your buys adds to your return later.
4. Avoid high-octane, all-or-nothing mutual funds.
Sometimes, aggressive managers make brilliant investments and deliver spectacular results. The problem is that most investors buy and sell these funds at just the wrong time: They buy after spectacular performance and they sell after a fund craters. That’s no recipe for success. For more on the perils of turbocharged funds, see Dump These Former Star Funds?