For many investors, 2018 seemed like a horrible year that just proves the stock market is a dangerous rigged casino at which they can’t possibly win.
In fact, the exact opposite is true IF you rig the game in your favor with three key strategies.
Don’t fear intense short-term volatility, prepare for it and embrace it as your greatest ally.
Maximize the chances of earning great returns and meeting your long-term needs by choosing a time tested and winning investing strategy.
Most of all, never forget that getting rich over time is mostly about avoid massive losses, not hitting grand slams.
2018 was a year that many would rather forget. What started out as a continuation of 2017’s freakishly strong and low volatility rally soon transformed into a year with not one but two corrections. In fact, the September to December correction saw the S&P 500 (SPY) close 19.8% from its all-time highs on December 24th.
That means it was not only the worst correction since 2009 but came within a stone’s throw (literally 4 points) of ending the longest bull market in US history.
For many investors, this seems to prove that Wall Street is nothing more than a “dangerous and rigged casino” at which regular people can’t possibly make money. The truth is the exact opposite. In point of fact, the stock market is the best way for long-term investors to exponentially grow wealth over time.
(Source: Credit Suisse)
But it’s certainly true that to “win” on Wall Street it helps to “rig the game”. So here are the three easiest ways you can stack the odds so far in your favor that with enough time and patience you are all but assured to mint money in the market.
1. Embrace Volatility Like A Lover: It’s Your Greatest Ally
First, it’s always important to keep investing in the proper context. It’s 100% true that 2018 was the worst year for stocks since 2008. BUT that’s only because we’ve had an epic run of nine straight years of gains.
2018’s -4.4% total return might be disappointing to many, but it’s hardly another 2008 meltdown. But what about the “crazy” levels of volatility we saw? Doesn’t that prove that you can’t easily make money in the market?
During corrections, high volatility is to be expected. And in truth, using the popular VIX (volatility index) as our measure, the recent correction was actually the mildest major one we’ve seen in a decade.
(note this table shows intraday declines, not closing prices)
What about full-year volatility though? We had a crazy year with two corrections after all.
Actually even factoring in all the chaotic swings we faced in 2018 annualized volatility was just 17%. That’s compared to an average of 16.3% since 1928.
In other words, despite the S&P 500 being in its worst December in history (on December 24th), and in its 11th worst month ever, the market’s actual volatility last year ended up just 4% above its historical average.
But I want to point out the above table to make an even more important point. Not just that high volatility is actually normal (2017’s was the lowest volatility since 1964 and the second least volatile year in history), but that volatility is the perfect time to make money.
(based on closing prices on Dec 24th)
Christmas Eve appears to have been the bottom of this correction, and on that day the market saw its worst Christmas ever in history, with a 2.7% market decline. At which point almost every sector was trading at deep discounts (on a forward PE basis) to its 20-year historical average. That dark day was followed by the best post-Christmas day rally ever (5% for all major indexes and a day I personally set a new one-day profit record of $14,000, or about triple my previous best single-day gain).
That kind of huge volatility to the upside is actually normal. In fact, the market’s best days (which account for nearly all long-term returns over time), tend to cluster within two weeks of its biggest losers.
How could have investors known that December 24th was the market bottom? Well, there is no way to know for sure, but keep in mind that at the time it was the 11th worst month for the S&P 500 in history and the worst December ever. The only months to ever suffer bigger declines occurred during the height of the Financial Crisis (October 2008) or during the Great Depression.
Anyone paying attention of the actual macroeconomic or corporate earnings data would have known that we were not on the verge of financial or economic apocalypse, and thus the market’s historically low valuations were attractive relative to the actual fundamentals. Or to put another way, blind market panic meant that stock valuations became totally disconnected from their intrinsic values.
How attractive were valuations in recent weeks? Well consider this. While 12-month stock market returns are always hard to predict, according to research from JPMorgan (JPM) the forward returns on December 24th, when the forward PE of 14.5 was pointing to a 12-month total return of about 17% and five-year annualized forward total returns of about 15%.
Or how about looking at historical returns from the market’s worst quarters? On December 24th the S&P 500’s quarterly total return was -19.2% making it the 5th worst quarter since WWII.
S&P 500 Worst Quarter Forward Returns
(Source: Wealth Of Common Sense)
The average one year following such quarters (including during recessions and bear markets) is 23%. Similarly, if you’d known that since 1926 the average 12-month rally from a correction’s lows was 34% (not counting dividends, so 36% in today’s case), then you might have realized that this massive fear-based sell-off was likely a great buying opportunity.
But what about the fears that we were in a bear market, despite a lack of recession (cyclical bear market)? Those certainly happen.
(note includes intraday lows)
Since 1929 there have been 20 recessions, 45% of which occurred during economic expansions. But note that the average bear market decline during cyclical (non-recessionary) bear markets is far lower than during periods of negative economic growth.
Since WWII (thus excluding the Great Depression) we’ve had 16 bear markets and eight cyclical bear markets. The average non-recessionary bear market takes about 7 months to bottom (vs 15 months for all bear markets) and sees a peak decline of 25% compared to 36% for all bear markets. In other words, as long as the economy is growing and a recession isn’t looming (it’s not) then bear markets tend to be about half as long and far less severe.
This means that even if we were in a cyclical bear market, then we were relatively close to the bottom, especially given how attractive valuations looked relative to actual fundamentals.
That’s especially true given that thanks to tax reform (a permanent boost to corporate profits), 2018 saw the second largest PE contraction in the last 40 years.
Ok, so maybe being comfortable with volatility and even embracing it as your ally can help you find great bargains when fundamentals become totally disconnected from reality. But what exactly should you buy? That’s where the second simple rule to minting money in the market comes in.
2. Choose Time Tested Long-Term Investing Strategies With The Best Probability Of Success
Since 1960 academics have scoured historical market data looking for so-called “alpha factors” or attributes of companies that lead to market-beating returns over time.
While there are 452 alpha factors researchers have found over the decades, ultimately a handful of long-term strategies have stood the test of time and can be tailored to suit your individual needs.
Alpha Factor Returns Vs S&P 500 Over Time
(Source: Ploutos Research)
Seeking Alpha contributor Ploutos is a national treasure who has spent years compiling data to help investors select the best alpha factor to suit their individual goals. You can mix and match various strategies through the use of low-cost ETFs.
Alpha Factor ETF Returns Vs S&P 500 Over Time
(Source: Ploutos Research)
Personally, I’d rather have finer control over my portfolio which is why my two favorite alpha factors are dividend growth investing (so I get paid exponentially growing income no matter what the market is doing) and value. I apply these strategies for selecting individual companies both for my own portfolio and to recommend to readers.
I like to combine the two approaches using dividend yield theory or DYT. This was popularized by asset manager/newsletter publisher Investment Quality Trends in 1966.
(Source: Investment Quality Trends)
IQT has achieved decades of market-beating returns (in all time frames) with 10% less volatility to boot, by exclusively comparing a stock’s yield to its historical norm. Unless a business model fails (thesis breaks) yields tend to be mean reverting and approximate fair value over time. Thus they can be a good way to determine if a company is historically overvalued or undervalued.
And another reason for IQT’s success since 1966 is because dividend stocks tend to naturally have lower volatility over time (though individual stocks frequently fall off a cliff which is the reason for such great investing opportunities).
That’s both because dividends are far more stable than share prices during a recession, but because income investors naturally are less prone to panic selling. As long as dividends are safe and growing they have an easier time riding out downturns (dividends make disciplined investing easier).
Which brings me to the most important rule for earning great returns from the stock market over time.
3. Offense Wins Ball Games But Defense Wins Championships
There’s a common but incorrect belief that only high flying growth stocks are the way to get rich on Wall Street. In fact, the easiest way of all to mint money in the market is through a more conservative defensive approach.
Dividend Aristocrats Vs S&P 500 Over Time
(Source: Ploutos Research)
Since 1990 the famous dividend aristocrats (S&P 500 companies that have grown their dividends for 25+ consecutive years) have managed to beat the market by 25% per year while delivering 18% less volatility. Remember that lower volatility is a proven alpha factor, which brings me to an important point.
The aristocrats don’t just happen to outperform over time while being less volatile but outperform specifically because they are less volatile. By falling less during sharp downturns, the aristocrats in particular (and dividend growth stocks in general) have less of a hole to climb out of when stocks start rising again.
Or to put another way, the secret to the aristocrats’ success is not stupendous gains during a bull market, but merely in matching the S&P 500 during good years, and outperforming during bad ones.
That is the crucial thing that investors often fail to realize. That while offense might win ballgames (make you money), it’s defense that wins championships (makes you rich over time).
This final principle is the cornerstone of my new Deep Value Dividend Growth Portfolio or DVDGP. This portfolio is made up of the best quality, undervalued low-risk dividend growth stocks of any given week. The underlying portfolio strategy was built by standing on the shoulders of giants, including the most successful investment strategies over time (alpha factors), and adapting the most effective valuation and total return model techniques I’ve yet found (taken from IQT and Brookfield Asset Management).
Ultimately, the goal of this portfolio is simple – build a high-quality, low-risk portfolio that will generate above average yield (4.2%), achieve faster than market payout growth (about 11% vs 6.4% for the S&P 500) and only buy top quality dividend stocks at great prices (based on dividend yield theory).
The market’s historical data says that this approach, which involves zero return chasing or “swinging for the fences” should not just beat the market over time, but do so precisely because of less volatility during market downturns.
While the portfolio is still new (launched 3 weeks ago), in that time we’ve seen both the worst weekly market decline in 10 years, as well as two solid weekly rallies (with lots of daily volatility for good measure).
Here is the outcome so far:
- DVDGP total return since inception (December 12th, 2018): 4.8%
- S&P 500 total return: -5.8%
- Outperformance: 10.6%
Now obviously three weeks is hardly statistically significant, and that level of alpha is not sustainable (my long-term goal is to beat the market by about 20% over time or 2% per year). But the point is that DVDGP has achieved that not by betting huge on a handful of “hyper growth” stocks or one or two sectors (the portfolio has 50 stocks in all 11 sectors). The portfolio is managing to deliver great returns purely from a low-risk, value-focused and diversified approach to buying quality dividend stocks at great prices.
In other words, “being greedy when others are fearful” but also only on sleep well at night or SWAN stocks (including a lot of dividend aristocrats and kings). These are companies that will pay you steadily growing income, supported by recession resistant cash flow, in all economic, industry and interest rate environments. Thus they will allow you to remain disciplined enough to let the incredible power of long-term investing work its magic and allow you to achieve your financial goals.
Bottom Line: Getting Rich Over Time In The Stock Market Is Easy…IF You Follow These Simple Rules
Warren Buffett once said, “Investing is simple, but not easy.” By which the greatest investor in history meant that the proven principles of how to get rich over time are easy to understand but far harder to put into practice.
Or to paraphrase Family Guy “good investing is like making love, simple to do, but takes a lifetime to master.” We’re all human and subject to the same fundamental emotions that make disciplined long-term investing challenging, especially during times of peak fear, uncertainty, and doubt (like we’re in now).
But I’d like to point out my all-time favorite Buffett quote, which I consider to be the ultimate cornerstone of all good investing.
We live in a golden age for investors. There’s literally never been a better time to learn how to harness the incredible wealth-building power of stocks, including obtaining great actionable ideas and the fundamental data you need to achieve your financial dreams (often for free).
Literally, all you have to do to get rich over time is live beneath your means (so you have investable savings) and then follow the three easy to understand principles I’ve outlined above. If you can learn to not just tolerate volatility (which is normal), but embrace it as your ally (volatility is the reason stocks do well over time), and then apply your savings to time-tested and proven investing strategies during times of peak fear and low valuations, then minting money in the market is actually easy.
And to help you control your emotions (and thus avoid panic selling along with everyone else) don’t forget that you don’t need to aim for grand slams (like finding the next Amazon). A well-diversified portfolio of quality stocks can be built that can not just meet your financial needs (such as providing safe and growing income during retirement) but also beat the market over time through a defensive focus.
That means that rather than “swinging for the fences” you can achieve great (and market and professional money manager) beating returns merely by declining less during downturns and then keeping up with the bull market over time.
My 23 years of investing experience (I’ve been investing since the age of 9) have taught me the right way to invest. Mind you, not because I started out perfect and am now a multi-millionaire at the age of 32. Rather because I tried every get rich quick scheme in the book, and thus learned the hard way that it’s not how much you make in the short-term that counts, but what you keep in the end that matters.