I believe that if you want to be a successful long-term investor, you'll want to have control over your emotions. Letting your inner greed or fear run amok simply because Mr. Market is feeling particularly manic or depressive on a particular day is a surefire path to destruction of capital over the long haul.
I took great interest in the psychological aspects of investing in stocks right from the outset. Although I'm not inherently any "better" than anyone else out there in regards to controlling my emotions, I have realized that I'm in the minority when it comes to seeing the prices on the stocks I own declining in price - and the fact that when this happens I'm flooded with a sense of joy.
There are many investors out there that cringe when the S&P 500 is down big for a day, a week or a month at a time. They may look at assets they own and see the prices on those assets decline, and with it their net worth. This can be understandably discouraging. These investors might be those who have saved up for an entire lifetime and are now selling off assets to produce income and fund their lifestyle. Investors in low-cost index funds would fit in this category, for instance.
However, I don't view events that cause the prices on stocks I own declining as negative at all. Rather, I look forward to watching the prices of shares in high quality companies that I'm a part-owner of go down. It should be noted, however, that my perspective comes with a big caveat: I only enjoy watching these prices decline as long as the long-term fundamentals of the companies remain the same. Deteriorating fundamentals would indicate that lower valuations are warranted and are a sign to investigate further and / or possibly sell.
I'm going to explain why I enjoy watching stocks I own decline in price:
Share buyback programs are more effective, enabling companies to buy back shares at cheaper prices.
International Business Machines Corp. (IBM) recently made waves in the news after it posted its sixth consecutive quarterly revenue decline. Those who do not believe in the long-term story at IBM sold on this news, and IBM has been setting fresh 52-week lows. I initiated a position in the company not long ago at what I felt was an attractive price. What do I think about the stock now trading lower from where I bought it? I'm ecstatic!
IBM has one of the biggest share buyback programs on the planet. Since 2000 IBM has reduced its share count by 35%, and they expect to spend $50 billion on share repurchases during the 2015 Road Map period. Now, if IBM plans on spending $50 billion share buybacks would a long-term investor in the company prefer shares at $212 as they were this past spring, or $175 as they are priced now? I think the answer is obvious. Long-term investors should prefer share prices to languish as a company is buying back shares. It allows all investors to benefit by increasing their ownership stake by a larger percentage as the float is reduced at lower prices, thereby allowing the company to buy back more shares for the same amount of money.
My income stays the same!
Where some investors are busy selling off their assets to fund their lifestyles, I look at my portfolio as a tree that produces bountiful fruit (dividends). I choose not to cut off the branches (sell assets), and instead harvest the dividends monthly while leaving the branches that produce the income intact. This strategy means my dividend income will continue to grow over time, even while the underlying assets producing the income also continue to grow. While I'm not financially independent yet and therefore not living off of my dividend income, I am actively and selectively reinvesting that income into attractively priced dividend growth stocks.
The great thing about this strategy is that it isolates me from the psychological madness of the stock market. Shares in The Coca-Cola Company (KO) could zoom up by 20% or fall by 30% and it won't really matter to me at all. Coca-Cola will still send me that $0.28 quarterly dividend no matter what the market wants to price its stock at. It's quite entertaining watching investors go crazy watching stock prices fluctuate wildly while I collect an income that rises constantly. It's important to remember that gains or losses on stocks are unrealized until you sell. Focusing on the income the businesses send my way allows me to keep perspective here and not sell simply because short-term prices are cratering based on noise.
I have the opportunity to increase my ownership stake for less money.
I look at every stock in my portfolio as an ownership stake in a company, because that's exactly what stock represents. I own little, tiny pieces of real-life businesses that sell real-life products and / or services to people and other businesses around the world. If a company is doing very well fundamentally, but the price declines for a myriad of reasons unrelated to the actual operations of the business, I'm more than happy to increase my stake in the company. At that point I'm able to increase my exposure to rising earnings, and with that rising dividends. This means that my passive income goes up, and I'm able to accomplish this using less capital when the prices of stocks I own decline.
Lower prices on high quality stocks means I'm able to buy more shares for the same amount of money that I'd otherwise spend when prices are inflated. And what do more shares buy me? More dividend income, because more shares means a right to more of the company's profits. And more income means I can in the future buy more shares with the reinvestment of that passive dividend income. The ability to buy even more shares compounds itself on and on and on. A lower initial price for an ownership stake in a high quality company means your compounding snowball of wealth is able to start higher up the hill and with slightly more snow. That initial inertia can carry on for a lifetime.
I celebrate lower prices as long as fundamentals remain strong.
Just like I love seeing lower prices on gasoline, food or the electricity that lights my small apartment, I also enjoy seeing lower prices on high quality assets. When I own a piece of a wonderful business and the stock market is in the mood to price that business at a level that's less than its intrinsic value, I'm quite excited. The company is able to buy back shares at attractive prices, thereby increasing my ownership percentage in the business at a larger rate than would otherwise be possible and I'm also able to buy shares in the company at attractive prices, thereby increasing my passive income for the same amount of capital. On top of it all, my income is completely unaffected by the whims of the market and the prices therein.
As long as short-term price fluctuations are not due to a negative change in long-term fundamentals I'm more than happy to increase my ownership stakes in high quality businesses. I celebrate these lower prices as the buying opportunities they historically are.
Disclosure: Long IBM, KO