The beginning of this century was gut-check time for investors. Many (myself included) weak-kneed investors watched the S&P 500 lose 50% of its value and the Nasdaq shed nearly 80% of its value. Individuals (such as my father) who thought they'd cashed in on JDS Uniphase
Were you one of those panicked investors? Here's a test to find out: Do you remember how much money you made or how much money you ultimately lost? If you remember what you lost, then you also remember the pain.
And painful it was. Years ago, Nobel Prize-winning psychologist Daniel Kahneman and his research partner Amos Tversky found that humans are innately loss-averse, particularly when it comes to money. Kahneman and Tversky's prospect theory research also demonstrated that losses hurt us more emotionally than gains please us -- and that the regret that comes with financial loss can be crippling.
But the solution is not to jump solely into bond funds (even good ones such as Managers Fremont) or index funds such as the Spiders
You have the stomach to beat the market. Why am I so sure? Because it is possible to beat the market without assuming huge risk. I know because it's being done.
The special sauce
The secret? Dividends. That's no secret, actually; there is plenty of data that proves dividend-paying stocks outperform non-payers. But that's not the entire truth. To outperform the market, you have to find financially strong, well-managed, undervalued companies that pay dividends. Why take a chance on Joe's Next Generation e-Hot Dog Stand -- with its jumpy beta and 50/50 chance of going bankrupt -- when you could invest in a stable ship that returns profits to shareholders and provides capital returns over the long term? It's a tried-and-true formula, and if you follow it, you'll have the stomach to beat the market.
Mathew Emmert, lead analyst of our Motley Fool Income Investor newsletter service, is a believer in the dividend strategy. Using a combination of outsized yields and capital gains, his picks have beaten the market by more than 5% since inception two years ago. Moreover, 36 of the 44 Income Investor picks have made money for investors. That's 82% accuracy in a field where most are happy batting anything over .500.
With that kind of accuracy, you do have the stomach to beat the market -- and the potential to beat it by a heck of a lot. Take Procter & Gamble
Today's income opportunities
Finding great dividend payers isn't as simple as merely screening for yields. As with any investment, it's crucial to scrutinize a dividend payer's financial statements, management team, and business model. Determine how the dividends are being financed, what the payout ratio is and how that might affect future growth, and what the prospects for dividend increases may be. Next, calculate what a share of the company is worth to ensure that your dividends come with the chance at return-enhancing capital gains. This can be hard work, but rest assured that the dividends left standing will reward the patient investor year after year after year.
A poster on our Foolish discussion boards recently asked about selling his solid 10% yield. The stock price had appreciated near his estimate of fair value, and he wondered about the ideal time for him to get out and take his gains. My quick answer: Never. Since he locked in a market-beating yield at a bargain price, he should keep holding on. Why give up an automatic 10% annual return? To date, the Income Investor newsletter sports more than 40 buys and does not yet have a single sell.
That poster's stock is Annaly Mortgage
Then there's Sonoco
The Foolish bottom line
Before investing, you must question your tolerance for risk. Do you have the stomach to watch your savings drop? Don't be ashamed if you don't. You're in the majority. The good news is: You can beat the market without a stomach of steel. Dividends will help you do it.
Join our ship of dividend-loving Fools with a free 30-day trial of Income Investor. There's no obligation to subscribe, and a trial includes access to all back issues and previous picks, mid-month reports, current risk-adjusted values, and the Income Investor discussion boards, where Mathew posts regularly and where you'll find hordes of like-minded investors sharing wisdom, ideas, and analysis. Click here to learn more.