There's an adage that suggests investors should "sell in May and go away." It's based on the theory that the market underperforms from May to October. And there have been a few academic studies that have been able to detect a seasonal pattern to market performance.
There are common sense reasons why the stock market may languish over the summer months. Fewer stocks get transacted during the summer because more traders and retail investors take vacations. That can make the market more volatile, leading more investors to sell before a potentially bumpy summer. Likewise, many companies tend to produce less during the summer months, when more of their employees take vacations. It's been shown that companies are less likely to beat analyst expectations during a seasonally slow quarter.
For those who don't already subscribe to my premium newsletter, The Daily Paycheck, this is also a good time to review your goals as an income investor. So for today's essay, I've included some critical questions every income investor should ask themselves on a regular basis.
1. Do you need income now or can you afford to wait?
A number of The Daily Paycheck subscribers use my advisory to provide their current income needs. After all, the overall portfolio is yielding an average of 6.0% -- more than three times the average yield of the S&P 500 -- and many times more than a savings account.
By not reinvesting your dividends, though, you will sacrifice the benefit of compound growth. But growth becomes less important over time as current income becomes more important. That's just the natural progression of our investment timeline. And now that the average interest rate on a savings account is running around 0.5% -- who couldn't use a little more income?
2. Are you looking beyond the dividend yield?
I never just look at an investment's indicated yield. I crawl through its dividend track record. In general, I look for a company or fund that has a history of paying a stable or growing dividend. And that's just the beginning...
3. What is your risk tolerance?
Every investor's situation is different, so the risk factors of an investment may also differ. One of the most important considerations in making an investment decision is to decide whether you want an investment that offers low-risk/lower-reward, medium-risk/medium-reward or higher-risk/higher potential reward. As a rule of thumb, in many cases higher-yield investing ideas also carry greater risk.
If you're a Daily Paycheck subscriber, make a special note of our assessment of an investment's suitability for a low-risk, medium-risk, or high-risk income portfolio. We generally include this assessment in our "Outlook" or "Action to Take" section of each investment profile.
4. Am I diversified?
Use this opportunity to learn about the tremendous variety of securities and asset types you have to choose from. Consider holding a range of securities, including core holdings with steady returns, as well as some higher risk/reward investments that may lift overall returns. You may also want to consider holding a variety of different asset classes, including bonds, preferred shares, funds, trusts, and stocks. This will help you diversify your portfolio risk.
5. Am I doing my homework?
Do your own due diligence. I can't stress this enough.
Don't buy any company you don't thoroughly understand. In the course of your research, make sure you clearly understand how a company makes money and whether the economic environment seems favorable for the stock to continue to perform well and to cover its future dividend payments. Check out a security's home page, read through the latest press releases and earnings reports, and make your own decision if each security meets your investment needs at this particular time.
Remember, even if you're a Daily Paycheck subscriber, you shouldn't blindly follow every move I make. Every investor's situation is different. Plus, it's far more valuable in the long run for you to learn from me, rather than simply mimic the moves we make in my newsletter.
My advice: Go slowly, experiment at first with small amounts of capital, and be prepared to learn by trial and error. Investing is a life-long learning process -- sometimes you'll be successful; sometimes your investments may not work out as expected. In either case, if you're able to consistently build up a portfolio of income-paying investments, then you're headed in the right direction.
6. Can I make reinvestment easier by doing it automatically?
If you've asked yourself Question 1 (above) and decide you can afford to wait even just a few years to start earning income by allowing the magic of compounding to do its thing, then please make it easy on yourself. Take advantage by enrolling your investments into Dividend Reinvestment Plans (DRIPs). If a security you own doesn't offer a formal DRIP plan, then see if your online broker offers automatic reinvestment.
This way, you don't have to remind yourself to reinvest your dividends each quarter or month. Simply automate the process and take emotion out of the equation. Trust me; you'll thank me for it.
By plowing your dividends back into more shares, reinvesting dividends make it easy to harness the miraculous power of compounding. The beauty of compounding is that any little smidgen of money you can put to work now -- no matter how small -- can have an extraordinary effect on your wealth down the road. There's simply no sounder way to grow wealthy over the long term.