This is the summary of Episode 37 of our Roaming Returns Podcast.
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Podcast Summary
This is the first of 3 different episodes that all tie into one another. This episode covers the reasons that people get analysis paralysis when they’re trying to invest and the system we use to avoid this.
One of those ways to is to mitigate risk, which we’ll talk about in Episode 38. While evaluating risk, you’ll be able to determine different criteria that allow you to screen investments. Episode 39 will cover screener inputs.
You need all 3 pieces to create a proper foundation for investing.
What Is Paralysis By Analysis
Have you ever been at the store and found yourself overwhelmed by the sheer number of choices? Even peanut butter has a bajillion options. Creamy vs chunky, tons of brands, natural… they even have jelly combos now. And then you might think, “is peanut butter the right choice or is almond butter healthier?”
This right here is the perfect example of analysis paralysis. This happens all the time and the realm of investing is no exception.
The longer you wait to invest, the harder it gets. More choices pop up and the anxiety compounds the closer you get to retirement time.
You know deep down you need to make a decision, but the fear of making the wrong one is crippling. You feel panic every minute you’re not actively invested because it means you aren’t taking care of your future needs.
FYI
If you struggle with the opposite of analysis paralysis, then you might want to look into extinct by instinct. Tim leans more that direction lol.
Anxiety Means You Need To Make A Decision
Carmela’s knowledge in the human behavior realm shows that anxiety is the body’s natural mechanism to get you to do something. Basically anxiety means you need to make a decision by either gathering more information or taking action.
It’s really that simple.
And it’s even easy if you decide to channel your efforts into creating a system. It takes some time to get one setup because a lot of thought needs to be put in but it will keep you out of that place of fear.
5 Reasons For Analysis Paralysis
There are many things that cause analysis paralysis. Understanding each one will help you figure out where your hang up is and how we can work around it in later steps.
#1 Desire For Perfection
We may desire perfection as a means to control our nerves, but it’s impractical when it comes to investing. You have very little control over stocks and market sentiment.
But you can control your system and how you react to the things that happen. You can create specific action plans based on different scenarios. (We covered this principle in our episode on Stoicism.)
Knowing you can control other things should give you more of the comfort that you’re ultimately seeking.
The best way to facilitate the need for perfection is to channel perfectionism into your investing system instead of holding an individual stock or the whole market to such high expectations.
Carmela uses the Pareto Principle to navigate how much effort she puts into a decision. You have to ask yourself how much of your effort is worth the potential outcome.
If your efforts might will go to waste, it’s better to put the efforts into things that matter more. This is why it’s better to put more effort into your overall system than an individual investment choice.
#2 Fear Of Making The Wrong Choice
With so many investing choices out there, people worry that they’re making the right choice. Will the stocks that you pick perform the way you expect? Expectations are a funny thing and cause many issues.
Everyone talks about how the markets provide ~10% yearly returns, but many people fail to understand that this is an AVERAGE. That means on any given year you could make a lot less or a lot more than that.
If you follow our investing strategy, we’re focused on dividend yield not value appreciation This makes the above point moot.
However, this one concept alone might be enough to get you over the fear of making the wrong choice. Investing in dividend stocks is one of the best ways to reduce losses during down markets.
The dividend earnings can zero out any losses and even put you in the green when everyone else is in the red.
Buying dividend stocks creates a safety net for your money. If you couple that with buying when a stock’s undervalued, the margin of safety gets even bigger.
Verizon (VZ) is a good example of an undervalued dividend paying stock right now.
Close-Ended Funds are a type of asset that makes it easy to determine value as that is always fluctuating. Bonds and Preferred Shares are two others. The other way is to compare a company’s P/E Ration to that of its peers.
Tip
The fear of making a wrong choice usually won’t go away unless we make a decision and take action. What our body is essentially trying to tell us is that we need information we currently don’t have.
If you can gain that information from research, then take action and obtain the needed info. But if you keep researching and still feel anxious, then the info you need lies in the cause and effect of making a trade action.
Mistakes teach us things. If you can’t bear any losses, open a paper trading account to get some of the data you need without the pain of monetary losses. When you do this, you’ll gain confidence to make real trades.
#3 Unclear Objectives
You can’t successfully invest if you don’t have clear objectives. So you need to start at the beginning with what your personal investing goals are.
A way to clarify this is to sit and really think about it. Another good way to start is to do a risk analysis. To do this, you need to be honest with yourself. Otherwise you won’t be investing in alignment with yourself.
Once you determine your bigger goals you have to find the types of investments that line up, and then sets goals for each investment. You should have some form of idea.
Many of our goals are about building an income with dividends. We also turn off our DRIP for certain investments when they reaches a certain P/E Ratio. Tim sells a company when they cut dividends 2 times.
Try to hypothetically imagine what can happen and create plans of action for different scenarios. This keeps you from being caught off guard and makes decisions easy when it’s time to take action.
Failing to do this major piece will cause you to get sucked into analysis paralysis or making emotional decisions when investor anxiety is running high and causing volatility.
Our YieldMax ETFs have a completely different strategy. Consider having different strategies based on the type of investments.
Then you have Black Swan Events like the fire in Lahaina or the lead in the cables with AT&T and Verizon, and MMM being sued over their ventilators. We buy the dips on good companies and get out of the risky ones.
How long are you going to stay in each investment? If you want to buy a house in 10 years, you have to know which investments you’re going to cut to get that money.
Selling doesn’t have to be time based. It can be event based like a bad earnings report or when a company cuts their dividend.
Having a strategy for different situations makes investing much more simple.
#4 Information Overload
Everybody knows that when you have access to endless info it’s hard to narrow things down. We often disqualify information that comes from untrusted sources. You really shouldn’t listen to other people anyway.
When you have your own criteria dialed in you don’t have to worry about info overload.
We both have personal systems to collect data and synthesize it for what’s important. Many things overlap which is where you can narrow things down.
If you look at information long enough you start getting a sense of the underlying pieces that you can use to create a system. Or maybe that’s just us. If it is, we hope we can help you by presenting our findings.
Tip
We provide a weekly top 10 stock list in our email subscription. Tim scrubs 1900+ stocks and narrows thing down to the best ones using his metrics.
If you struggle with overwhelming choices you might want to sign up to become and IIN-sider.
#5 Lack Of Confidence
All of the previous points kind of boil down to this one which we believe is the most important. Everything piles up the longer you wait and it’s hard to dig out when you lack confidence.
And it’s really bad when you lack confidence as an investor.
You need confidence to make decisions, but confidence doesn’t come without the success from taking action. Talk about a catch 22.
This is why you need to break your system down into smaller pieces and take action to get a bunch of small wins. This is how you build up confidence and create a snowball effect.
Again everything goes back to the need for a system and taking action.
Just be careful about what you’re focusing on. When you focus on running from the fear you have no direction and you’re constantly reminded of the fear.
If you instead focus on running towards your goals and getting wins you’ll find success and feel more positive about investing.
This one perspective shift can make a huge difference in your results.
How Do You Fix The Causes Of Analysis Paralysis
The way to fix anything is to understand the issue so you can come up with a plan to overcome of circumvent the problem.
We discussed the reasons for analysis paralysis above, so now it’s time to dig into the plan. You should go through each step using your own subjective criteria. This makes the system you design tailed to your needs.
Piece 1 – Determine Your Risk Tolerate & Mitigation Strategy
Investing carries risk just like life carries risks. You personal risk tolerance will determine what risk mitigation strategies you need to put in place in your plan.
This information is going to filter into the what you buy and why you buy it. It’s also going to determine how long you hold something and the conditions that will cause you to sell an investment.
We flush out some of those in the next point.
Personal preferences was a topic we covered in the investor profiles episode, and we’ll cover more specifics in next week’s episode.
Piece 2 – Know What You Own And Why You Own It
You can’t make a decision on something without defined criteria. And if you sub out this piece you’re taking the risk of other people’s needs and metrics not lining up with your own.
When you listen to 10 different investors, you may get 10 different views on the same stock. Right here is why more information can create further indecision. So how do you decide then?
You need to focus on what really matters to YOU, determine which metrics meet those needs and then do your own research.
Is it the yield? The P/E ratio? The PEG ratio? Revenue growth? Debt load? Profit margins? Payout ratios? Or maybe something else or combination of things.
Decide on only 3 to 5 pieces of vital information to focus on when researching an investment. The goal is to get you from a couple thousand stocks down to a hundred or so.
If the number is too big, you don’t have enough time to evaluate deeper before the metrics change. So sometimes you need to prioritize things to whiddle the list down smaller.
Peter Lynch said know what companies you woan d why you won them.
2 Reasons For Vital Metrics
First, it will save buttloads of time. You can research many potential investment ideas if you can just focus on 4 things. Second, it will help you compare investments to one another so much easier.
Piece 3 – Define What Makes An Investment A Buy
Once you’ve taken the time to go through the things above you’ll have a list of stocks to evaluate even further. This next piece has other specific criteria hold each stock to.
Then when enough of these metrics are favorable for a stock, it signals a buying opportunity. At that point, you take action and execute the buy. It’s simple and efficient.
Do you see how we got from an overwhelming amount down to a manageable number and to the action step? This is how you approach investment opportunities to avoid analysis paralysis.
Again, you want to come up with your own criteria, but I’ll give you ours as a reference point so you know what this might look like. These are the things that Tim considers to be a buy.
- P/E vastly lower than its peers
- Profit margin of at least 30%
- A history of multiple years of dividend increases
- At least 3 years of revenue growth
- At least 3 years of debt load reduction
- A yield of at least 4%
- A payout ratio of no more than 90%
Other Potential Considerations
Generally, we do not like to buy if the stock is around its 52 week high, because in our experience this leads to profit grabbing and price reduction.
Tim also don’t like to buy an investment within one week of its ex-dividend date, there is too much nonsense in price volatility. In fact, we find it better to buy 2 days after a stock goes ex-dividend.
December or the first 2 weeks of January are no-go’s because there’s too much volatility with tax harvesters.
And perhaps the most important. Don’t make decisions out of desperation as leads to losses and these losses are generally huge. Been there done that, hahaha.
Ending Discussions
ECC
This is the #1 stock that Tim gets asked about. It’s going ex-dividend next week. Generally trades at 8% over it’s Nav Price. It’s currently trading at 11% which makes it overvalued.
You can’t wait for it to go back to Nav Price because it will likely never do that. You’ll always be waiting.
This is what Tim considers before buying ECC. He makes sure it’s not close to its 52-week high. He doesn’t like to buy within a week of its ex-dividend date (usually waits until after).
The last piece is that it needs to be trading at its historical Nav Price which we discussed is 8%. When he does that, we never lose money investing in ECC.
This is one of the ones that really hard to find a P/E ratio for its peers, so you have to work with what you have.
Hercules Capital
Tim would not buy HTGC right now. It just smashed it’s earnings and it’s at its 52-week high which also happens to be its All-Time-High.
If you are invested, he suggests turning off the DRIP as it’s overpriced. You can put that money to better use in other undervalued assets. Or you can wait for it to dip back down and buy more shares then. Tim’s eye is on the $16.50 price point for his personal price to buy back in.
It’s not that we don’t think it can go higher, but based on probability, stocks don’t usually crack their ATH on the first attempt or even second. The economic climate of this year being a bull might negate that, but who knows.
It’s safer to not buy into a potentially overpriced stock and ride it down when sentiment changes. This is a risk mitigation tactic and a strategy that we use frequently. Ultimately the choice is yours.
There are always other stocks that are undervalued. MAIN, AGNC, EARN and PSEC are similar companies to Hercules Capital with great yields and good metrics. HGTC just happens to be the leader.
Risk Mitigation Preview For Next Week
Don’t take on extra risk. It trashes your confidence when you make bad decisions. The key is thinking through different scenarios before you even buy an investment.
True success comes from doing the prep work and dialing in a system that you follow for investing and possibly other areas in your life.
First you need to identify how much risk you’re willing to take. And then we’ll discuss ways to mitigate risks to meet your tolerance thresholds.
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