Eight years ago, we collectively watched the beginning of a downturn that cut the S&P 500 in half and dropped the Nasdaq nearly 80% from its highs. It was a maddening time for investors. Telecom and energy executives were caught with their hands in the corporate cookie jar. Technology shares plummeted, with hundreds of companies vanishing from sight. Very few bear markets in U.S. history have hurt so much. Silicon Image
Just how painful was it? Ask Nobel Prize-winning psychologist Daniel Kahneman, who proved that humans are innately loss-averse, particularly when it comes to money. Emotionally, losses hurt us far more than gains give us pleasure. Naturally, then, those massive declines crippled tens of thousands of investors, many of whom will -- sadly -- never throw the one-two punch of savings and investment again.
Fast-forward to today, and we're seeing the same cause and effect. The Wall Street Journal recently reported that many individual investors are just saying "To heck with the stock market." That decision will have serious negative ramifications for their long-term savings. Even worse, it doesn't have to be that way.
Win with moderate risk
The solution is not to bail out of the market altogether, nor to seek shelter exclusively in bond funds. With the right perspective and useful tools, you can strengthen your stomach and beat the market -- because you'll do so without assuming huge risk. I know that's true, because it's being done every year by the world's master investors -- from Buffett to Lynch to Tillinghast to Miller.
Those who take the biggest risks and buy what's hot today usually take the biggest hits in down markets. In the meantime, a host of methodical, smart, and contrarian investors ring up great returns, even through tough markets, by adhering to Warren Buffett's first rule of investing: Preserve capital.
Today, I want to focus on one sweet way to preserve capital and beat the market. The general principle is simple: Buy stocks that have paid uninterrupted dividends for years.
Consistency to victory
Let's investigate this idea by looking first at BB&T
Even more impressively, BB&T actually increased its dividend in August, despite the ongoing economic crisis. When stocks like this temporarily decline, as they have recently, owners still get the dividend payment, inspiring all of us to be patient and calm -- two of the primary traits of the world's greatest investors.
This sort of investing success is happening every day in our Motley Fool Income Investor advisory service. Using a combination of outsized yields and capital gains, analyst James Early is beating the market by four percentage points since the newsletter's 2003 inception.
But James isn't picking just any old high-yielder. He believes that 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, battered balance sheet, 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 save yourself from the market's volatility.
A monster income investment
Let's look at two of James' top ideas. Income Investor recommended Tupperware
More recently, the Income Investor team has been looking abroad to lock in non-dollar-denominated dividends. One of these picks is Philippine Long Distance Telephone
There are loads of great dividend-paying stocks, but they're not the market's most popular. In fact, you usually have to go digging to find them. But if you can, maybe -- just maybe -- you can come through this crazy market without any massive losses. If you need a little help, you can see all our picks and research at Income Investor by clicking here for a free 30-day trial. There's no obligation to subscribe.
This article was originally published as "Do You Have the Stomach to Beat the Market?" on June 10, 2005. It has been updated.
Tim Hanson does not own shares of any company mentioned in this article. BB&T, Tupperware, and Philippine Long Distance Telephone are Income Investor recommendations. No Fool is too cool for disclosure.