Becoming a successful dividend growth investor requires learning how to win the mental game. We can have the greatest investing approaches, plans, and strategies but if we lack the requisite psychology, it’s all for not—we will underperform.
As Mark Douglas, author of The Disciplined Trader and Trading in the Zone, has aptly noted that 80% of trading is psychological and only 20% is technical or skill based—a fact that explains the high (roughly 90%) failure rate of traders.
While investing is arguably distinct from trading, I would assert that the Douglas hypothesis holds true for investing as well—it is 80% psychology.
What else explains the abysmal results of retail investors over the past 20 years—a period of unprecedented bullish market activity?
While the broader market (viz., the S&P 500) has returned an annual compound growth rate of 5.6% over the past twenty years, the average retail investor has only produced a measly 1.9% return—less than the rate of inflation!
Despite the market handing investors money on a silver platter, retail investors found a way to blow it and miss the rewards. Clearly, psychology and the mental game play a huge role in this poor performance.
Are there simple methods you and I can utilize to become better investors and win the mental game? Can we shift from underperforming the markets to outperforming them? The answer is yes! Specifically, we need to focus on sharpening our self-discipline and emotional control. We can find investing Zen in the sweet spot between them.
Thankfully, there are 6 simple but practical and highly-effective ways we can do just that:
Let’s take a closer look at each of these methods for improving our investing and winning the dividend growth mental game…
The first step to winning the investing mental game is becoming a specialist in one facet of the overall investing game.
There are lots of ways to invest and each form is unique. Each requires a different mindset with different tools, strategies and behaviors. When we try to be investing generalists—dabbling in a multitude of investing approaches, we not only muddy the waters for ourselves but we (1) exponentially increase the level of knowledge, skills and abilities we need to acquire and master and (2) place greater psychological loads on ourselves.
Rather than trying to be a jack of all investing trades, we should focus on being specialists at just one form of investing—in this case, dividend growth investing.
Furthermore, we should then seek to mirror this within dividend growth investing itself on a smaller scale. This means becoming a specialist in one subset of dividend payers, for example a sector or industry. Preferably, this should be an area we have more knowledge and understanding of, as well as an interest in or passion for.
This is one of Warren Buffett’s primary investing rules: Know what you are investing in. When we are investing all over the playing field, it is hard to have a solid understanding of all those businesses in play in our portfolio.
When we specialize, we define the rules of the game and the parameters in a way that is advantageous to us—greatly increasing the likelihood that we will win the mental game.
Here’s a great older clip of Warren Buffett talking about his approach to specialization:
As Buffett so eloquently puts it, the market provides an infinite number of potential opportunities—you don’t need to (nor should you) swing at every one of them. Filter the opportunities to those that perfectly fit into your specialized wheelhouse and knock them out of the park.
Once you have become a specialist in one area, then you can expand into another. If you skip step one and proceed straight to step two, you are setting yourself up to lose the mental game.
The second way to win the investing mental game is to understand that investing is an intellectual and independent (solitary) process—you must trust yourself and not others.
Investors that try to simply follow the herd are rarely successful. Either lead the herd or go your own way. You will never outperform the markets as a follower. You will either be a fickle follower, jumping ship at the first sign of trouble for the herd (almost always at a loss)… or unwaveringly follow the herd off a cliff or into a crocodile-infested river (almost always at a loss).
That’s what the average retail investor does and that’s why they have a 1.9% return over the last 20 years—despite one of the longest and strongest bull markets in history!
Investing is neither a team sport nor a popularity contest. You are not going to be right ten years from now because 100 people agree with you… nor are you going to wrong because 100 people disagree with you. You don’t get bonus points for style or the number of “likes” your plan gets—this isn’t social media!
Perform your due diligence, build your investment thesis, and then trust it for the long run.
Don’t jump on the popular bandwagon or buy the flavor of the day. If you do so, you are investing in something you don’t understand—you didn’t do the homework, you haven’t fully vetted the investing thesis, and you don’t know the reason behind why others are doing something. It may make sense for them; however, their motivations and strategy may be a horrible fit for yours.
Likewise, don’t discount your investing thesis because others don’t agree.
If you’ve done your work developing your thesis, then you are thinking independently, understand your investment, and will be prepared to weather the storms over the long run—three keys to winning the mental game.
The third key to winning the dividend growth investing mental game is always staying focused.
First, you need to stay focused on developing your craft. You have identified your area of specialization, now develop the knowledge, skills and abilities you need to master it. For example, how you value a REIT is very different from how you value an industrial conglomerate. Stay focused on becoming an expert in your area of specialization.
The more of an expert you become, the better your investing theses will be, the more you will be able to trust yourself, and more likely you are to win the mental game.
Second, you need to stay focused on your specialty. Again, the market (and the media) will present you with a never-ending stream of opportunities. To win the mental game, you have to focus on the ones that fit you and ignore the ones that don’t.
In other words, don’t go chasing waterfalls! Don’t suffer from shiny object syndrome or FOMO—they only lead to buyer’s remorse and underperformance.
This is a trap so many new investors unwittingly fall into. It never fails that as you’re surfing the media (whether it be cable news, social media, or investing websites) trying to learn and develop your craft, you will continually identify (or be marketed) new opportunities. When this happens, stay focused!
The grass is not greener everywhere else. And when you start chasing the next, greatest investment opportunity, you (1) begin investing in things you don’t know or understand and (2) spread your capital to thin. Develop your craft and invest your capital into your area of specialization—it provides you with the best opportunity for success, both in terms of performance and the mental game.
Ignore the noise and ignore short-term price action. Dividend growth investing is about the long game—not short-term swings in price due to fleeting catalysts. Define your investment thesis and then stay the course.
The fourth component to winning the investing mental game is to always manage your risk. The truth is that this rule could easily be considered rule number one!
Nothing—and I mean nothing—will damage you psychologically and cause you to lose the mental game faster and stronger than failing to manage your risk!
First, you and I must fundamentally accept the risk inherent in investing. We are dealing with a probabilistic system—meaning results will always vary. You can have the best investing thesis in the world and still lose. Likewise, you can have the worst thesis and get lucky and win.
Thankfully, with a probabilistic system, we can become specialists and manage our risk in a way that we put the odds (or the statistical edge) in our favor. That’s the goal and that’s what differentiates investing from gambling. If we are investing, we should always have a positive expected outcome over enough time and occurrences. For more on this, I encourage you to read my article Fundamental Reasons Why Investing is NOT the Same as Gambling.
However, we must accept that an overall positive expected outcome does not ensure a positive outcome every time. Furthermore, to achieve that outcome, we must allow time to work its magic. This means trusting yourself, ignoring the noise, and staying the course.
Second, we must understand and accept our own personal risk tolerance and profile. Each of us has a unique psychological makeup and financial situation. Furthermore, we all have different investment goals and time horizons. These variables work together to create a unique risk tolerance and profile.
Our risk tolerance is the amount of risk (or volatility) we are comfortable with. Some investors are perfectly comfortable stomaching large volatility in their portfolios, while moderate volatility can cause others to lose sleep.
Our risk profile is the amount of risk we both can and are willing to accept in order to achieve our investing goals. For example, if an investor has (a) a large degree of risk capital, (b) high investing goals, and (c) a long investing time-horizon, then they may have a risk profile that is able and willing to take on more risk. Conversely, an investor with limited risk-capital, a shorter time-horizon, and/or less demanding goals may want to take on less risk.
You need to understand both your tolerance and your profile… and live within them. If you attempt to exceed your tolerance or profile, you are increasing the likelihood that you will lose the investing mental game. Things will inevitably go wrong at some point and you will lose your self-discipline and emotional control. When that happens, you will make bad investing decisions and lose. This is why the average retail investor failed to even outperform inflation over the past twenty years.
Don’t put yourself in that position. Take control over your investing and win the mental game by always managing your risk.
It is important to note that staying focused and specializing doesn’t mean you can’t (or shouldn’t) diversify. You absolutely should employ diversification to manage risk. If there is an area you are not knowledgeable on, you can always utilize an ETF targeting that market segment while you focus your active efforts on your identified specialty.
As you grow as an investor and branch out into new areas over time, you can then develop those areas in your portfolio in a more company-oriented way.
To learn more about managing risk through diversification, I encourage you to read my articles Idiosyncratic Risk: Is Your Portfolio Really Protected and Sector Rotation: The Case for Dividend Growth Diversification.
The fifth key to winning the investing mental game is to be highly objective.
Obviously, investing is both an art and a science. While the art component will develop for you as you build experience, the key to winning the mental game is never violating your “science.”
For example, if your investing plan entails certain filters (e.g., a limit on dividend payout ratios), then always remain objective and never violate that filter—no matter how much emotion tells you to do it!
Plan your investments and invest your plan. The second you allow emotion to take you off-script, you and the car you’re driving are headed for the ditch.
Clearly, there are assumptions that must be made in dividend growth investing—like when valuing a company. However, you should make your assumptions objectively and always try to maximize the science side of the equation. When valuing companies, I personally try to identify best-case and worst-case estimates and then never exceed the mean. This conservative approach maximizes my safety margin and ensures I have the best chance of winning the mental game over the long run from a risk tolerance perspective.
To remain objective, I always employ this method. I don’t change my formula because I really “think” (emotional) that a given company is different or better. In other words, I don’t let my desired outcome impact the calculation; rather, I let the calculation determine my investing thesis. I stay objective and consistent.
Because dividend growth investing is a long-run game, we will live with our decisions for a long time. It is far easier to second-guess decisions that were made based on emotional rather than objective grounds. Stated differently, it’s far easier to trust yourself in the long run when your underlying investment thesis is predicated on an objective, data-driven model rather than a knee-jerk, emotional reaction. And, the less second-guessing you do down the road, the more likely you are to win the mental game.
Winning the investing mental game is about behavior. As such, the final method for psychological success is to stay as mechanical as possible.
We want an investing approach that is as consistent and repeatable as possible. This is especially true for dividend growth investing—because it is greatly impacted by compounding over time.
I highly recommend setting up automated funding with your investing account. This is predicated on the sage advice to always pay yourself first. This ensures you are consistently building your portfolio value and fully-leveraging the benefits of compounding.
Failing to do this increases the likelihood that you will lose the mental game and fall short of your investment goals.
The truth is that other “needs” will always surface and tug on your purse strings. If you invest on what’s leftover, you will never get where you want to go. Auto-invest and build positive financial habits that will last a lifetime and reward you well.
I highly recommend using M1 Finance for your dividend growth investing. Their platform provides an excellent user experience (e.g., powerful, intuitive and easy to use on both desktop and mobile), is completely free, enables you to leverage fractional shares, can be easily setup for auto-investing and auto-reinvesting, and you can get started building your portfolio with as little as $100!
I personally use M1 for all my dividend growth portfolios—including our site’s passive-income portfolio that we share with the public.
If you’re interested in starting your own M1 Finance dividend growth portfolio, please consider using our referral link https://mbsy.co/sZVS3 and we’ll both get some free cash!
Additionally, I recommend establishing clear sell triggers for your holdings. While, as dividend growth investors, we only buy what we intend to hold for a very long time, there are valid reasons to sell. However, we don’t want to make those decisions based on emotions. Rather, we want to be mechanical and methodical—following an objective investing plan.
To learn more about developing your own sell triggers, I encourage you to read my article 3 Reasons to Sell a Dividend Growth Stock… And When NOT To.
Finally, remember that “time in” always trumps “timing” when it comes to dividend growth investing. You want to deploy an investing approach that embraces a “set it and forget it” mentality. Stay mechanical, ignore the noise, trust yourself and win the investing mental game!
Given that an estimated 80% of investing is psychological, there are 6 simple ways that we can achieve investing Zen and win the dividend growth investing mental game. These methods center on developing self-discipline and emotional control. While they are simple in concept, they are practical and highly-effective!
By building these behaviors into our approach to dividend growth investing, we can win the mental game—enabling us to both enjoy our investing journey and outperform not only the average retail investor but the markets in general.
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