Published September 11th, 2016 by Ben Reynolds
Decision paralysis is the inability to make a decision. Nearly everyone has suffered from decision paralysis or analysis paralysis before.
This is especially prevalent with investors new to the stock market.
This article answers the question ‘when and where do you start investing?’ for beginner investors (or seasoned investors) who are having difficulty in determining when is the right time to start investing – and what to invest in.
This article takes a Buffett-centric approach to these questions. It includes many of his quotes which eloquently sum up complex topics in one or two quotes.
After all, who better to learn from than one of the richest men in the world, and arguably the greatest investor of the last century?
We will start with the question of when to start investing.
When Should I Start Investing?
You should have started investing in March of 2009.
Source: Google Finance
This is a bit of a tongue in cheek answer. The reality is almost no one who wasn’t already investing decided to jump into the market in March of 2009 – perfectly timing the last big market bottom.
That’s not how investing works. Investing is about the long run.
You aren’t going to find the ‘perfect’ entry point. Stocks could rise for another decade while you are waiting for the exact right time.
When markets collapse potential investors tend to think they dodged a bullet rather than seizing the opportunity to invest. Don’t let perfection be the enemy of good.
Time in the market is more important than timing the market.
“Over the long term, the stock market news will be good. In the 20th century, the United States endured two world wars and other traumatic and expensive military conflicts; the Depression; a dozen or so recessions and financial panics; oil shocks; a fly epidemic; and the resignation of a disgraced president. Yet the Dow rose from 66 to 11,497.”
The power of the market to compound wealth over long periods of time is amazing. Trying to ‘improve’ on it by hemming and hawing over the exact perfect time to invest is counterproductive – and a waste of time.
There is a one word answer to when you should start investing: Now.
Yes, the S&P 500 is historically overvalued. It is trading at a price-to-earnings ratio of around 25. It’s historical average price-to-earnings ratio is 15.6. Interestingly, the market might be a bit undervalued when one factors in interest rates.
Yes, the world is unstable. There’s conflict in the Middle East. Russia is unpredictable. Europe and the United States are heavily in debt with sluggish economies.
Yes, interest rates could rise. Or inflation could occur. Or even stagflation.
But none of it really matters.
That’s because great businesses will continue being great regardless of the economic or political environment.
Great businesses have strong and durable competitive advantages. They are likely to continue growing earnings-per-share and dividends over long periods of time. They are compounding machines.
This brings us to the second part of the question: Where to invest.
Where Should I Start Investing?
There are two parts to ‘where’ you should start investing. One is in regards to account type. The other is in regards to specific securities to hold.
Investors should seek to maximize after-tax returns. Retirement accounts are more tax efficient (if used for their intended purpose) than non-retirement accounts. Because of this, investors should look to fully fund their 401k or IRA before focusing on non-retirement accounts.
What securities should you hold in your IRA or 401K? That depends on what is offered. First check to see if you can open up a brokerage window to invest in individual stocks.
If a brokerage window is not available, investors looking to maximize returns should look for low cost equity funds. Fees matter. The less fees you pay, the more your investment will compound.
The preferred investment vehicle is individual, high quality businesses. There are no management fees for investing in individual stocks.
I prefer high quality dividend growth stocks. There are many reasons to be a dividend growth investor. Perhaps the best reason – dividend growth stocks have averaged better total returns with less volatility over the last ~40 years.
Source: An Economic Perspective on Dividends by Nuveen
Warren Buffett’s portfolio is filled with high quality dividend growth stocks. In fact, his top 4 holdings (which make up ~60% of his portfolio) are all dividend stocks with an average yield of around 3%. Buffett clearly lays out what he looks for in an investment with the quote below:
“We select such investments on a long-term basis, weighing the same factors as would be involved in the purchase of 100% of an operating business:
(1) favorable long-term economic characteristics;
(2) competent and honest management;
(3) purchase price attractive when measured against the yardstick of value to a private owner; and
(4) an industry with which we are familiar and whose long-term business characteristics we feel competent to judge.”
In short, high quality businesses trading at fair or better prices.
Where can you find high quality dividend growth stocks? Two excellent sources are the Dividend Kings and Dividend Aristocrats lists.
The Dividend Aristocrats Index is made up of 50 businesses that have paid increasing dividends for 25+ consecutive years. You can see all 50 Dividend Aristocrats here.
The Dividend Kings List is even more exclusive. It is made up of just 18 businesses with 50+ years of consecutive dividend increases. You can see all 18 Dividend Kings here.
Investing only in dividend growth stocks with long histories of dividend payments significantly narrows down the field of what to invest in. You are focused on businesses only with strong and durable competitive advantages (as shown by their long streaks of rising dividends).
The next step is to determine which ones are trading around fair value – or better.
Valuation is an art not a science. Comparing current price-to-earnings ratio to historical price-to-earnings ratio is a good start in determining value. A business trading below its historical average price-to-earnings ratio is likely a good value – especially in today’s inflated market.
But you shouldn’t obsess over value.
“It’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price”
– Warren Buffett
When and where should you start investing?
You should start investing in high quality dividend growth stocks (preferably in a tax-advantaged account) as soon as possible.
The market is made up of individual stocks. Even when the overall market is overvalued, there are individual securities trading at fair or better prices.
The longer your money is invested, the more time it has to compound. You aren’t going to find the ‘perfect’ time to buy. And you won’t know it was the perfect time until after it has passed.
It’s better to invest in great businesses for long periods of time than it is to wait on the sidelines and think of how great it would have been to invest in X stock at Y price Z years ago.