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Defining a long-term investment in the stock market.
For some “long term” would mean holding a stock position over the weekend. For others, it may mean holding a security for at least 1 year for the purpose of declaring a long-term capital gain, thus saving on taxes.
The rigid definition of a long-term investment in the stock market would be holding a security for a minimum of 5 years, to as long as 30 years.
I’m going to tell you my definition of a long-term investment in a security by telling you a story. A true story!
My Mother worked as a teller in a small bank in Dover, New Jersey. The name of the bank was called The Dover Community Bank. While working at the bank (she eventually became a branch manager) she enrolled in the bank’s dividend reinvestment plan, making purchases of the stock through pay-roll deductions from her paycheck. She continued purchasing the stock through the years, having the dividends from her shares in the bank reinvested into more shares every quarter. By the time she left the bank (in the early seventies) she had accumulated around 300 shares of The Dover Community Bank.
My Father, when he retired, had the dividends from those shares sent home – to help ends meet. When my Dad passed away at age 80, my brother and I inherited over 7,600 shares of The Bank of New York, all originating from those 300 shares of what was once called The Dover Community Bank.
So, through this individual experience I have adopted my own opinion of what is called a long-term investment in a security. It is simply this – securities should be purchased with the intent of providing dividend income to help ends meet during retirement, with the understanding that no one can successfully retire without financial freedom. So every investment now in a security would be purchased with the intent of holding that security (and adding to it during the years) until the dividend income from that security is ample enough to ease the loss of income from retiring from my job. Now, I not only provide for myself during my retirement years, but will leave this earthly realm knowing that I will also be able to relieve some financial burdens for those I’ve left behind.
With this definite, concrete purpose for investing in mind, a definite, concrete plan would need to be created (and can be found in my book The Stockopoly Plan) to achieve this long-term investment goal. My Mother invested in only one stock and got lucky – a considered plan would diversify.
So if I am going to hold a security position forever, what criteria should I be looking for in that security? Certainly dividend income – that’s a given! And since I never intend to sell the security, capital gains may not even be an issue (more on this later).
So then, what else? I would argue that a company that just pays a dividend isn’t good enough. Instead, I will only purchase those companies that have a long history of raising their dividend every year. This will eliminate a whole bunch of risk. It would eliminate the possibility that the company is ‘cooking their books;’ after all, the money has to be there to pay the shareholder. And because this company has been raising their dividend every year for many years, it eliminates the risk of investing in a start-up company that may not even be around in a year or so.
Also, the rising dividend every year would help off-set the risk of inflation and the risk of a lower stock price during the year would actually accelerate my income from the security.
Since I would want my position in the stock to grow through the years, thus increasing my dividend income, all dividends would be reinvested into the stock, until retirement. A lower stock price, therefore, would purchase more shares, at a higher dividend yield and would simply accelerate my dividend income.
Now the question may arise, when would I want to sell a stock? Certainly not because a Merrill Lynch has downgraded the whole sector – that’s a blessing in disguise – a temporary lower stock price just means a higher dividend yield, allowing my dividend to purchasing more shares.
The question of when to sell a stock puts me in the mind of a quote I once read by Jacobsen – “Judgment is the one thing you cannot learn at college. You either have it or you don’t have it.” The time/reason to sell a stock varies. If there comes a time when you have so much money tied up in just one stock position that it’s making you feel uncomfortable, sell some of it. If the company you purchased stopped raising its dividend you may want to lighten up and/or divert the funds you were putting into that security into one that is continuing its program of increasing their dividend every year.
A company may trim their dividend – when and if this happens (and it does) my advice is not to be overly anxious to sell the stock. Find the reason why the company is trimming their dividend. It may be to reduce debt or for the possibility of acquisitions. The company’s dividend yield may have been around 6 percent, and all their peers’ dividend yields are around 4 percent. Certainly do not add to your holdings in this company, but give management a chance to see how they handle the extra cash, since they appear to have better use for the money, other than to pay their shareholders. The resulting growth in that company may make up for the lower dividend yield and two or three years later you’ll get a better perspective on whether to sell the company or not (or to continue adding more shares through new monies, or simply to allow the dividends to continue purchasing the stock).
For more excerpts from the book ‘The Stockopoly Plan’ visit http://www.thestockopolyplan.com
Charles M. O’Melia is an individual investor with almost 40 years of experience and passion for the stock market. Author of the book ‘The Stockopoly Plan’, soon to be released by American Book Publishing.