filadendron
Co-authored by Treading Softly
In sports, it is important to have a solid defense, but a common phrase goes, “The best defense is a good offense.” The concept behind this phrase is that aggressively scoring points puts pressure on the opposing team to keep up. This gives you two ways to win – either through your defense performing well, or their offense making a mistake.
When it comes to the market, many investors like to play on the defensive side. Under the guise of capital preservation, they sell shares of a company that has dropped in value for no other reason than it has dropped in value. The idea is to batten down the hatches and stop all the leaks when they think the times are going to be stormy. And for this, they’re willing to accept significant losses in the name of trying to prevent further losses – but this is a Pyrrhic victory. Those losses have already occurred, and often investors would benefit by simply riding out the storm and enjoying the climb back up.
When we look at the big picture, we can see that the market crashes that felt so significant and painful at the time, are insignificant when faced with the test of time.
The history of the S&P 500 (SPY) is one of routine increase, and its returns on average are excellent. That’s primarily why we invest in the stock market. There are periods of stark drops, and if an investor were to sell out at those times, their overall losses would be even higher than those of the investor who held on through the storm.
So today, instead of focusing on how to be more defensive, let’s focus on how playing on the offense can naturally provide you with a greater level of defense.
Let’s dive in!
Play Full Court Tennis
Have you ever played tennis? It’s a game played with two opponents on either side of the court, bouncing a ball back and forth between them using rackets. Tennis is a game that requires equal parts offense and defense. As a player, you must determine the placement of the ball against your opponent while also being prepared to react to your opponent’s moves. Every aspect of the game is a direct relational battle between the two players. Some players are known to play a certain way, and their opponents play defense with that in mind. They play what’s called full-court tennis. Sarah C Paine, an author of many books on Grand Strategy – how nations act to achieve their goals – mentions that a lot of times, people play half-court tennis; they’re only focused on what they are doing and what they can do. Balls come out of nowhere, and they have to react to them instead of being able to understand what’s going on the other side of the playing field.
A big struggle that many investors have is that they play the same game. They look only at their portfolio in isolation, with a myopic view of what is going on. They then react to what they see going on within their portfolio without taking into account the bigger picture, such as the state of the market, the economy, or the global situation. For example, if you looked at your portfolio during the COVID drop in 2020, you would think that your portfolio was destined for utter disaster, and many investors prematurely sold out their entire portfolio in the name of trying to preserve their capital.
They told themselves that they would wait for more certainty. They would wait until it was clear what COVID meant for the economy, or until there was a clear sign of the end of the COVID pandemic. Those who were waiting for things to “get better”, likely caught that recovery near the end, compounding the overall losses. Whereas if they had never looked at their portfolio or taken a step back to realize the overall global situation that was occurring, they could have ridden that recovery right back up and suffered no losses.
The chart above shows that it only took three months from the S&P 500’s fall to recover all its lost value. This means that many investors, who were trigger-happy early on, suffered losses greater than if they had just been patient. Was everything better in the economy by June 2020? In June 2020, widespread “stay at home” orders were still in place. COVID was spreading rampantly through the population, and more people were dying.
I like to say that half of the battle investors face is understanding the market and the economic situation. This is one reason why I consistently encourage investors to read and research what’s going on in the economy and macroeconomics worldwide. This way, they can understand the different forces that are at play with each other. You need to identify which impacts are temporary and which might be permanent changes.
For instance, if you invest in commodities or energy stocks, you need to understand the political games within OPEC (Organization of the Petroleum Exporting Countries) itself and the long-term supply/demand dynamics. That way, you’re not caught blindsided and make poor choices based on temporary pricing changes. If you’re aware of what’s happening on the other side of the court, you can strategically prepare for any incoming balls.
Attack When Others Are Weak
The United States of America declared war on Germany in December 1941, but it wouldn’t be until almost four years later, in 1944, that the U.S. landed its first troops on the beaches of Normandy. Have you ever wondered why it took so long for the U.S. to go from declaring war to actually being actively engaged in that same war? Part of the reason was that the U.S. had positioned itself in the prior decades as an isolationist country, meaning that they did not want to be involved in other people’s battles, and they were completely on a defensive footing. So, when it came to having an offensive strike, it took them years to build up the capabilities and to have the manpower to be able to do exactly what they promised. The war in Europe was over in under a year from when the first troops landed on Normandy until Germany had declared surrender.
Over the years, many have wondered how many more lives would have been saved if the United States had been ready to actively engage in the war when they declared it in 1941 versus waiting until 1944 to land on the beaches of Normandy, seeing that the war ended less than a year.
When it comes to the market, it’s important to go on the offensive when necessary. This means having access to deployable cash when the market is down. For many, they have to sell securities to be able to turn around and fund new purchases. This means that they first have to dismantle what would be considered their defensive position to engage in their offensive moves. Others will sit with large amounts of cash in their account, sometimes for years, waiting for a crash. However, this means that the large pile of cash isn’t participating in the market during good times.
One reason I absolutely love income investing is that this strategy constantly provides me with new ammunition to use in the market. I don’t need to predict when a crash will happen or try to figure out what to sell to take advantage of new opportunities. Every week, I have cash flowing into my brokerage account from interest and dividend payments.
Imagine if you were that investor who saw the COVID drop and had to hold on to your shares because you were willing to ride it out and see a recovery but also wanted to procure more gains from the drop. Many members of my private community saw massive gains from the investments that they made during those three months while the market was still floundering and recovering. We were able to lock in massive double-digit yields on several securities that would otherwise not have been available. As income investors with regular cash infusion into our accounts, we were able to be on the offense when others were weak. While the market crashed, we were still collecting interest and dividends that could be reinvested.
When the market shows weakness, the ability to step up and buy more shares puts you on the offense. When the recovery occurs, you will not only see the valuation return to where you were previously, but also achieve new levels of untold gains because you had money pouring into your account to prudently buy the dip.
Keep on Pounding Against Your Goals
I often get asked in the comments how I continue to have money to invest in the market repeatedly. The answer is simple – I get paid massive sums of money regularly from my dividend portfolio.
The 1st and the 15th of every month are some of my favorite days because my portfolio provides me with the most income on those days, as they seem to be the most popular days for companies to make payments. I also receive dividend deposits on other days of the month. Every year, I set income goals for myself in terms of how much income I want to earn this year and in the long run.
Within our Income Method, we encourage investors to use the Rule of 42 to help their portfolio stay adequately diversified. But today, I’d like to stress the Rule of 25, which means you must reinvest at least 25% of all the dividends you receive back in your portfolio – I consider this to be a bare minimum for long-term portfolio growth. For those who are not even in retirement yet, there should be a 100% dividend reinvestment to allow your income stream to grow as rapidly as possible. If you’re able to take a dividend you receive and put it back into another security yielding similar or higher, you can rapidly see that dividend compound into additional income.
In a mental experiment, it was shown that an investor who regularly bought the S&P 500 index through dollar-cost averaging had the same long-term returns as an investor who successfully timed the bottom of every bear market. Now, it’s unbelievable to think that a single person would be successful in buying the bottom of every single bear market within the S&P 500 versus the simple exercise of dollar-cost averaging, but it shows that even if you achieve perfection in your timing, time spent in the market will outperform in the long run.
This is why I am a net buyer in the financial markets. When people tell me that the market is too expensive, I let them know that there’s always something on sale. When they think that the market is utterly going to crash, and we should wait for the bottom before we buy more, I let them know that there are still attractive yields available to me now that I’m happy to purchase. As my dividends arrive, I am actively putting them back to work.
When it comes to retirement, money is a terrible master. If you are stuck having to pay interest on big piles of debt or your bills are larger than your income that money lording over you is a terrible master. However, money is a fantastic employee, putting your money to work can help you unlock and achieve income that you never imagined possible, but you have to put it to work. Unfortunately, so many of us have money sitting around that is doing nothing and is being utterly lazy in the name of being defensive. I encourage you today to put that money to work and make your defense based on a strong offense. Your retirement will thank you for it.
That’s the beauty of my Income Method. That’s the beauty of income investing.
