By: Dividend Sensei
Recently my best friend told me he was worried that some unexpected emergency might force him to sell stocks at a loss. This reminded me of my own experiences with being a forced seller, and exemplifies why a 6 month emergency fund is vital to achieving long-term investing success.
Now I realize that saving this much cash, to just sit around and earn almost nothing at today’s interest rates, is very difficult for most people. After all, recent surveys indicate that 33% of Americans couldn’t come up with $2,000 to cover an unexpected expense, (within a month).
However, having such a fund is critical to allowing you to become the kind of long-term, buy, hold, and add on dip investor that history teaches us is likely to both beat the market and achieve your financial goals. Allow me to demostrate with a very painful example from my own life.
Early on in my investment writing career, I started out as an dividend writer for The Motley Fool, specializing in energy stocks such as high-yielding MLPs. This was back in March of 2014, around the time that oil prices peaked at $107 per barrel and the shale oil revolution was making MLPs some of the most popular dividend stocks around.
When the oil crash occured I was perfectly situated to take advantage of the 76% crash in crude prices, and I did. Every penny of spare income was funneled into my favorite high-yield MLPs.
For 18 months I watched my portfolio crash and kept on buying, being “greedy when others were fearful”. Then disaster struck.
In mid February of 2016 my now ex-wife, who was in charge of paying the mortgage, informed me that she had been defaulting for months, and we needed to pay $9,000 within a week or else the bank would forclose and sell our home. I was literally forced to liquidate my all energy stock portfolio on February 19th, very close to the bottom for oil prices ($26 per barrel). Worse yet? This coincided with most recent stock market correction, which bottomed out on Febrary 11th, 2016.
I still have Morningstar tracking that portfolio, which proceeded to triple in value AFTER I was forced to sell everything at a substantial loss. Had I had an emergency fund and not been forced to sell near the bottom, today I’d be enjoying annualized total returns of 75% compared to the market’s 8%. Ironically enough, in my divorce four months later I lost the house anyway, which shows the importance of being VERY careful about choosing a spouse; one that shares your financial values (live beneath your means and invest as much as you can).
However, the painful lesson that I learned from that is that no matter how right you may be, when it comes to controlling your emotions, and selecting your portfolio, if life throws you a curveball and you are forced to be a price insensitive seller, then you can still lose a small fortune.
That means the takeaway for you, dear reader, is simple.
- Make sure you have an emergency fund that can cover 6 months of expenes, because shit happens.
- Avoid dangerous leverage, such as using broker margin to leverage your portfolio at 2:1, even if you are only investing in the most unervalued shares.
The key to market crushing long-term returns is to enjoy the ride up, but most importantly of all, be able to avoid turning paper losses into permanent capital losses on the way down. This lesson is especially important for new investors, those who have started investing in the last eight years, when the market has been enjoying the second longest bull run in history.