I got two interesting, and related, questions from readers recently.
The first concerns when to buy a stock. The second concerns when to sell. I'll address both of these questions in turn.
Q: My problem is I just can't seem to pull the trigger on a stock purchase. Do you just jump in, hope the share price stays up, and bask in the dividends? Or do you carefully await bad news to buy in at a lower price?
A: Different investors have different approaches.
The late fund manager John Templeton used to keep a wish list of stocks and prices at which he'd buy them. He'd leave orders with his broker so that if the price fell to his target, the trade would be executed automatically. The beauty of this approach is that it removes emotion: When stocks are selling off many investors are too scared to jump in, yet this is often a good time to buy.
It doesn't always work, however. More than once I've picked a target price, only to watch the stock rise and never come back. Clearly, in such cases it would have been preferable to have entered a market order.
To my mind, if you're a long-term investor – and you should be if you're in the stock market – you needn't be too concerned if you buy a stock at $50 instead of $48.50, or $33 instead of $31. What's more important is that the company has a strong competitive position, solid balance sheet, growing revenues, earnings and dividends, and a reasonable valuation.
If it satisfies all of those criteria, then you should feel comfortable pulling the trigger. But remember one of the unwritten rules of investing: When you buy a stock, it will almost always go down immediately. (I'm joking, but it does seem that way sometimes.)
So it's important to stay focused on the long term and, as long as the company remains sound, not to let short-term moves rattle you.
If buying stocks still makes you anxious, another option is to consider dividend exchange-traded funds such as the S&P/TSX Canadian Dividend Aristocrats Index Fund (CDZ), Dow Jones Canada Select Dividend Index Fund (XDV) or BMO Canadian Dividend ETF (ZDV). ETFs have low costs and provide diversification, which is important if you're just starting out and don't have a lot of money to invest.
A final tip is to keep some cash on hand. Stocks sell off for various reasons, such as lousy economic news, geopolitical fears or earnings that miss analyst estimates by a penny or two. Selling often begets more selling, and suddenly a great company you've been watching is down 10 or 20 per cent, even though nothing has fundamentally changed in its outlook. That is often a great time to buy, which is why you'll want some cash.
Q: Is there any negative to holding dividend stocks until they reach a certain capital gains goal and then selling them? My fear is that my stocks may be up 25 per cent but some ugly market correction could wipe that out in a flash. So I'm happy to collect the dividends while I wait to reach the arbitrary number and then I'm itching to sell. Then I move on to my next pick.
A: While I can understand your desire to "lock in" paper profits, I can see problems with this approach.
The first is that you might sell a great company only to watch its shares move higher. Just because a stock has gained 25 per cent – or whatever number you pick – doesn't mean it's overvalued or vulnerable to a major pullback. It may in fact be undervalued or fairly priced. Now, if you have the skill to value a company and you conclude that there are better opportunities elsewhere, that is another matter, but a price change alone won't tell you that.
A second problem is that by selling stocks frequently, you will pay more in commissions and – if you're trading in a non-registered account – capital gains taxes.
Third, you'll have to spend a lot of time watching your portfolio. Not only will you have to decide when to sell, but you'll then have to figure out what to buy. If you do this long enough, you may find yourself considering stocks that you used to own, but which are now trading at higher prices!
Don't get me wrong. There are sophisticated investors who can trade effectively, but I'm not one of them and I have no interest in trying. My approach is to think like an owner – a very lazy owner. I buy solid, growing businesses that I know will be around 10 or 20 years from now (or longer), and I sit back and collect the rising dividends. If revenues and profits are growing, the share price will eventually follow.
This approach works best with relatively conservative sectors, such as utilities, power producers, pipelines, real estate investment trusts, banks, telecoms and entrenched consumer businesses.
The only time I consider dumping a position is if something has changed fundamentally in the company's outlook. I still have to watch my portfolio, of course, but it's not nearly as stressful as if I were culling my winners and redeploying my capital frequently. Because it keeps me invested in great companies, cuts my trading costs and minimizes my taxes, I believe the "hands-off" approach is ultimately more profitable.
If you still think you'll still be "itching" to buy and sell stocks, you might consider ETFs such as the ones mentioned above. The temptation to trade them may not be as strong as with a portfolio of individual companies.