5 Dividend Investing Mistakes That Keep Even “Smart” People Broke
Do You Make These Dividend Investing Mistakes?
So, let me guess: when you started dividend investing, you probably rifled through a few publications, picked out a couple of stocks, and punched the “Buy” button on your brokerage account, right? After all, you have notched some pretty impressive accomplishments in your career. Surely you can figure this stock market thing out, too.
But for most of us, it doesn’t take long for Wall Street to deliver a blunt reality check to our ego. As soon as you scoop up a few shares of some business, the price sags like a deflating balloon. While everyone else gets rich, your picks keep dropping lower and lower.
You didn’t expect to be the next Warren Buffett, but you didn’t think dividend investing would be this hard, either.
At this point, some investors fall into a vicious loop. You buy at the top only to sell again when prices begin to drop. And as if by magic, shares begin to rise as soon as you get out.
What the heck is going on?
Here’s the big reason why you’re struggling in the stock market: Every instinct, and I mean EVERY instinct, in your body will lead to failure in the financial world.
Our brains evolved over millions of years on the African savanna to find food, escape predators, and live in tribes. Homo sapiens only encountered financial markets in the past 200 years or so. And for the most part, they remained a purview only for the rich during most of that period. So surprise, surprise, the operating system between our ears can’t handle the stress of dividend investing.
It’s a bit like flying a plane. In aviation, going faster and higher actually makes you safer. If you fly too slow, the wings of your aircraft won’t generate enough lift and you’ll begin plunging towards the ground.
In these situations, which pilots call a “stall,” your instincts say to pull back on the stick, aim the nose up, and start gaining altitude. That reaction, in fact, will only turn you into an accident statistic.
Pilots train to do the opposite: aim straight for the ground. As they start picking up speed, they can pull themselves out of the dive.
So, today, that’s what I want to write about. Let’s inoculate ourselves against some of the most common psychological mistakes that plague investors. Because, if you can master these ideas, you greatly improve your odds of avoiding dividend investing mistakes and of achieving success in the stock market.
1. Seeking Confirmation for Your Own Beliefs
Information that confirms our existing beliefs is almost the equivalent of crack cocaine for our brains. Your mind loves “proof” of how smart and right you are; we’re wired to seek and believe information that validates our existing point of view. Our propensity for confirmation bias is only made worse in the modern world, where we can live in online echo chambers.
This mistake can bite you as an investor. By only seeking out information that backs your opinion on a particular stock, you miss red flags. The solution: welcome ideas that make you uncomfortable. If you’re a conservative, talk to more liberals. If you’re a pessimist, read more optimistic points of views. If you’re a technophobe, open up a copy of Wired magazine. The best investors seek out contradictory opinions from people they trust.
2. Reading Too Much into Recent Trends
Most people believe that the world of tomorrow will look much like our world today. In psychology circles, they call this “recency bias.” It means we tend to over-weigh recent events when evaluating the odds of something happening in the future. For example, investors thought real estate represented a sure path to riches in 2006; by 2009, real estate was the quickest way to lose your shirt. The reality, of course, turned out to be somewhere in the middle. If our memories are short, what can we do to protect ourselves? Re-balance. Commit to a set portfolio allocation (i.e. 60% stocks and 40% bonds) and then re-balance on a regular schedule. This strategy will allow you to sell overpriced assets automatically and move towards better opportunities, even when your brain screams not to.
3. Betting on Lottery Tickets
Investors love swinging for the fences. We all love the idea of getting in early on the next Apple, Inc. (NASDAQ:AAPL), Amazon.com, Inc. (NASDAQ:AMZN) or Microsoft Corporation (NASDAQ:MSFT). That urge to get rich quick fuels endless investments in penny stocks and junior mining companies. But be warned: these lottery-ticket-type investments as a group actually underperform their boring, blue-chip counterparts.
According to a study by Ned Davis Research, Inc., a $100.00 investment in a portfolio of dividend-paying stocks back in 1972 would be worth $5,227 today. The same investment in a portfolio of non-dividend payers, by comparison, would have only grown to $305.00. For each Amazon scratch-off that pays off, hundreds of exciting companies fall by the wayside. The trick here is to find a sustainable investment strategy and stick to it over the long haul. Winning the game of building wealth doesn’t come from a one-off home runs, but from collecting lots of singles and doubles.
4. Just Sticking to What You Know
Most people have a tendency to invest in things they’re familiar with. In the financial world, we call this “home bias.”
For example, Canadians keep about 60% of their stock portfolios in their home country, even though Canada represents only a tiny slice of the global financial market. Other examples are people from California tending to over-weigh the tech sector and workers often keeping the majority of their retirement in shares of their employer.
This mistake can wreak havoc on your returns if you bet on the wrong country, industry, or company.
The solution here comes down to diversification; by diversifying broadly across countries and assets classes, you’ll likely earn respectable returns in a variety of environments.
5. Negativity Bias
Evolution has wired our brains to worry. And for the most part, this paid off in our days as hunter-gathers. Flirt with the wrong girl and the chief might split your melon; fail to harvest enough game and your family will starve come winter.
So when markets begin to plunge, fear takes over and we begin to act on impulse. Our amygdala, the brain’s alarm system, floods our body with stress hormones as the losses start piling up. We want nothing more than to sell everything, usually right when the market is about to bottom.
That’s where preparation fits in. By writing out your investment strategy ahead of time, you have something to hold your hat on when things get ugly. It also helps to turn off the television, stay off of Twitter, and log out of the brokerage account. Refreshing the computer screen praying your stocks started ticking higher won’t do much to help your mental state. But by having a plan in place, you’ll sail through the next financial crisis.
Great investors know they’re wired to fail. Therefore, they design systems to protect themselves from their worst impulses. The biggest threat to your financial well-being is you. You can pick all the right stocks, you can minimize fees and taxes, and you can diversify your portfolio, but if you don’t master the psychological game of investing, your odds of success drop to zero.