When I bailed out of AG Edwards-Wachovia-Wells Fargo-bankofthemonth and became a self-directed investor at Fidelity, I lost one thing of value in the process. Fidelity won't treat my mini-bonds like an equity and re-invest the monthly/quarterly interest payments for me without brokerage fees. That was one beni of the full service brokerage, but it wasn't worth the brokerage fees on new purchases. I am now forced to watch and wait until adequate interest payments have accumulated and then buy a big enough block of one or another of them to keep the positions growing and keep the cost of investing low. With the DRIP feature, I was blissfully relieved of the requirement of making a conscious decision to purchase an appreciating asset at the higher price in order to keep the position growing. How I miss that drippy thing...
fortunately, for common stocks and preferreds, as well as MLP units, the discount brokerage does DRIPs.
OK, well, it's late and I'm tired, so I'll revisit my new-found mouthpiece again tomorrow or another day...
Friday, February 19, 2010
Should I hold cash, or remain fully invested?
I know what Mr. Buffet said; be greedy when others are fearful and be fearful when others are greedy. That contrarian view requires a firm eye on valuation, and an ability to have ready cash when everyone else has leveraged themselves up to their eyeballs.
My approach to this is as follows: I ask myself whether I'm happy with the price of the earnings and dividends, or the interest earned on each issue when I purchase it. If I am, it doesn't matter whether the market is up or down, hot or cold. I can be fully invested and still feel that I haven't over-paid for the earnings/dividends/interest payments. That doesn't solve the issue of having dry powder when the shooting starts. One wants to pounce on great bargains when they present themselves. The best I can do here is to keep about 5% of my porfolio in an income fund; currently I like DNP. It doesn't fluctuate much in value, throws off about 6% and change every year and is easy to liquidate when I want to buy something that has a higher return on investment. It fulfills my biases on dividend payments, portfolio growth by DRIP, etc.
Perhaps I'm fooling myself, but currently cash IS trash, from a standpoint of interest earnings.
My approach to this is as follows: I ask myself whether I'm happy with the price of the earnings and dividends, or the interest earned on each issue when I purchase it. If I am, it doesn't matter whether the market is up or down, hot or cold. I can be fully invested and still feel that I haven't over-paid for the earnings/dividends/interest payments. That doesn't solve the issue of having dry powder when the shooting starts. One wants to pounce on great bargains when they present themselves. The best I can do here is to keep about 5% of my porfolio in an income fund; currently I like DNP. It doesn't fluctuate much in value, throws off about 6% and change every year and is easy to liquidate when I want to buy something that has a higher return on investment. It fulfills my biases on dividend payments, portfolio growth by DRIP, etc.
Perhaps I'm fooling myself, but currently cash IS trash, from a standpoint of interest earnings.
Managing risk, from the amateur perspective
At the beginning of my investing life, I was foolish. I accepted the truism that, having 3+ "market cycles" in me, I could ride out volatility and be rewarded for accepting more risk.
In retrospect, I should have followed a very conservative, capital preserving, modest but steady earning strategy until the foundation of my retirement corpus was built, then blend in some higher risk stuff when the price of a failure or two didn't hurt so bad.
I learned the first lesson on stocks like JDS Uniphase and Cisco in the tech boom. The rapid evaporation of 50% of my portfolio value taught me that I am, in fact, a risk adverse person.
A more difficult lesson was learned a number of years later when my investment in Washington Mutual rapidly declined to near zero. That company had a steady, slowly rising stock price, a nice steady dividend payment, moderate payout ratio, etc. Now then, how was I to know the the place was built on selling liar's loans? Well, fortunately I was fairly well diversified, but WaMu was still 5% of my portfolio and I had no clue what their real business model was. I thought they accepted deposits and wrote 30 year fixed FHA secured loans. Silly me....
I bought Bank of America, with it's nice fat 5% dividend, after it had grown to the biggest retail bank in the nation. I wasn't aware it was about to swallow Countrywide, Merrel Lynch, had put it's own foot into the mortage backed securities market and was about to swallow untold billions of dollars of credit default swap risks as it absorbed ML in a bid to become the biggest mega-bank on earth. The hubris of it all!.... and Ken Lewis took home his millions-upon-millions even as he went from genious to reckless, feckless fool in the eyes of the investing public. Silly me....
Interestingly enough, I was able to recoup alot of those losses by buying the preferred stocks of BofA and Countrywide at 50 cents on the dollar and watch them skyrocket as we emerged from the cold hard winter of 2009. They are still paying me in excess of 8% interest.
Then again, I have owned Duke Power for several years, which has paid a steady and rising dividend over the years, spun out a solid subsidiary and continues to perk along, not rising a lot in value, but allowing me to DRIP my way to a rising stream of dividends. Their business model isn't all that difficult to understand. They operate in the regulated utility space, along with some real-estate investments, some unregulated power production and have a rising portfolio of renewable energy in the form of wind and solar power installations. Come hell or high water, people will pay to keep the electricity on, until they are tosse out on the street.
I have purchased stocks in the energy field. However, rather than expose myself to the volatility associated with the price of oil and gas, I have found a more steady home with pipeline MLPs and MLPs who hedge the price of their production several years into the future, so as to make the cost of production and the expected earnings more predictable over time.
within the utility and energy space, I'm diversifying geographically and by multiple energy sources. This is a good space to look for international opportunities, like telecoms that pay nice dividends in countries where the penetration of communication systems is incomplete and still rapidly growing.
If the whole world goes into a blue funk, like it did recently, there is probably no completely safe haven, but I was fortunate to have made this transition in my philosophy before the biggest downdraft, and I am happy to report that I have emerged from the last year having completely recouped all my losses and come out nicely ahead of where I was in 2007-2008. It could have been a lot worse.
In retrospect, I should have followed a very conservative, capital preserving, modest but steady earning strategy until the foundation of my retirement corpus was built, then blend in some higher risk stuff when the price of a failure or two didn't hurt so bad.
I learned the first lesson on stocks like JDS Uniphase and Cisco in the tech boom. The rapid evaporation of 50% of my portfolio value taught me that I am, in fact, a risk adverse person.
A more difficult lesson was learned a number of years later when my investment in Washington Mutual rapidly declined to near zero. That company had a steady, slowly rising stock price, a nice steady dividend payment, moderate payout ratio, etc. Now then, how was I to know the the place was built on selling liar's loans? Well, fortunately I was fairly well diversified, but WaMu was still 5% of my portfolio and I had no clue what their real business model was. I thought they accepted deposits and wrote 30 year fixed FHA secured loans. Silly me....
I bought Bank of America, with it's nice fat 5% dividend, after it had grown to the biggest retail bank in the nation. I wasn't aware it was about to swallow Countrywide, Merrel Lynch, had put it's own foot into the mortage backed securities market and was about to swallow untold billions of dollars of credit default swap risks as it absorbed ML in a bid to become the biggest mega-bank on earth. The hubris of it all!.... and Ken Lewis took home his millions-upon-millions even as he went from genious to reckless, feckless fool in the eyes of the investing public. Silly me....
Interestingly enough, I was able to recoup alot of those losses by buying the preferred stocks of BofA and Countrywide at 50 cents on the dollar and watch them skyrocket as we emerged from the cold hard winter of 2009. They are still paying me in excess of 8% interest.
Then again, I have owned Duke Power for several years, which has paid a steady and rising dividend over the years, spun out a solid subsidiary and continues to perk along, not rising a lot in value, but allowing me to DRIP my way to a rising stream of dividends. Their business model isn't all that difficult to understand. They operate in the regulated utility space, along with some real-estate investments, some unregulated power production and have a rising portfolio of renewable energy in the form of wind and solar power installations. Come hell or high water, people will pay to keep the electricity on, until they are tosse out on the street.
I have purchased stocks in the energy field. However, rather than expose myself to the volatility associated with the price of oil and gas, I have found a more steady home with pipeline MLPs and MLPs who hedge the price of their production several years into the future, so as to make the cost of production and the expected earnings more predictable over time.
within the utility and energy space, I'm diversifying geographically and by multiple energy sources. This is a good space to look for international opportunities, like telecoms that pay nice dividends in countries where the penetration of communication systems is incomplete and still rapidly growing.
If the whole world goes into a blue funk, like it did recently, there is probably no completely safe haven, but I was fortunate to have made this transition in my philosophy before the biggest downdraft, and I am happy to report that I have emerged from the last year having completely recouped all my losses and come out nicely ahead of where I was in 2007-2008. It could have been a lot worse.
What constitutes adequate compensation to the owner?
Good question, self!. I've been working on this question for some time now. I own one equity in my 401k that represents a pure growth strategy; Medco. It spun out of Merck a few years back and landed, kerplunk, in my portfolio without requiring any work on my part at all. Since there weren't all that many shares and the brokerage fees at that time were a real disincentive to sell, I just let it sit there. Some time later, I took a look and realized that Medco was growing steadily and rapidly. I took my heart in my hand and bought a bunch more, and it continued to grow, and grow. Now that is rewarding! But, unless I keep buying, my position is fixed, and the total value of that investment is purely based on stock-price.
Well, to be honest, I also have some Berkshire B shares. Now that they were split and a part of every index fund on earth, they have actually appreciated a good deal in value, but like others, I put my faith in the wisdom of the Oracle to align my interests with his and grow the value of that company.
For all other mere mortals, I start with the primal question; what are you paying me this quarter/month/year? The question is, how much payment is enough?
It seems to make intuitive sense that if inflation is running 3%, and the purchasing power of a dollar is thus eroding by about the same percent, that equities in my portfolio should be capable of appreciating at a bare minimum of 3%, if there is an adequate dividend over and above that to reward me for owning them. The smaller the dividend, the more I want to see increase in value. On the other hand, I want to get paid NOW, or this year at least, so I myself can make the choice to invest more in the company or not, rather than allowing the CEO or the board to make that decision for me. Thus, I won't accept zero dividend except under very specific circumstances.
Also, I can understand compounding pretty easily, so I want to see the number of stocks I'm holding rising, and the quarterly/ monthly dividend payments increasing. This is my proof that my ownership in the company is securing a rising stream of payments (again, keep an eye on that payout ratio, or perhaps the company is losing the means to earn revenues)
If that position is only increasing a tiny bit at a time, or the dividend payments look static over 2-3 years, it makes me a bit nervous, so my personal floor on dividend payment is around 3% per year, sector by sector. I get a lot of comfort out of visible increases in the size of a position and visible increases in dividend payments, provided the valuation isn't plummeting or the payout ratio isn't rising.
Within any market cap range and any sector, one can find solid companies with a history of rising earnings and rising dividend payments. If the price of those payments is at a historic high, one can choose to wait, or average into a position over time, or look elsewhere. this is obviously a dividend investing strategy, but I don't stick to "dividend achievers" or "dividend aristocrats". I'm also looking in places other than the S&P 500, the Russell 2000 for investments that meet those criteria. I want diversification between fixed income and equities, between sectors, between US and international investments, in exchanges other than the NYSE and NASDAQ.
Well, to be honest, I also have some Berkshire B shares. Now that they were split and a part of every index fund on earth, they have actually appreciated a good deal in value, but like others, I put my faith in the wisdom of the Oracle to align my interests with his and grow the value of that company.
For all other mere mortals, I start with the primal question; what are you paying me this quarter/month/year? The question is, how much payment is enough?
It seems to make intuitive sense that if inflation is running 3%, and the purchasing power of a dollar is thus eroding by about the same percent, that equities in my portfolio should be capable of appreciating at a bare minimum of 3%, if there is an adequate dividend over and above that to reward me for owning them. The smaller the dividend, the more I want to see increase in value. On the other hand, I want to get paid NOW, or this year at least, so I myself can make the choice to invest more in the company or not, rather than allowing the CEO or the board to make that decision for me. Thus, I won't accept zero dividend except under very specific circumstances.
Also, I can understand compounding pretty easily, so I want to see the number of stocks I'm holding rising, and the quarterly/ monthly dividend payments increasing. This is my proof that my ownership in the company is securing a rising stream of payments (again, keep an eye on that payout ratio, or perhaps the company is losing the means to earn revenues)
If that position is only increasing a tiny bit at a time, or the dividend payments look static over 2-3 years, it makes me a bit nervous, so my personal floor on dividend payment is around 3% per year, sector by sector. I get a lot of comfort out of visible increases in the size of a position and visible increases in dividend payments, provided the valuation isn't plummeting or the payout ratio isn't rising.
Within any market cap range and any sector, one can find solid companies with a history of rising earnings and rising dividend payments. If the price of those payments is at a historic high, one can choose to wait, or average into a position over time, or look elsewhere. this is obviously a dividend investing strategy, but I don't stick to "dividend achievers" or "dividend aristocrats". I'm also looking in places other than the S&P 500, the Russell 2000 for investments that meet those criteria. I want diversification between fixed income and equities, between sectors, between US and international investments, in exchanges other than the NYSE and NASDAQ.
Taxes, Shmaxes
Well, how should I look at the issue of taxes, with respect to my retirement plan. When I started, I took the conventional wisdom: tax deferred investment, on the presumption that when the account is accessed for retirement earnings, I will be in a "lower tax bracket" and pay less than if I pay taxes now and invest after-tax money. Additonally, that "after-tax money" incurs taxes on earnings every year, further lowering my investment return. There may be a flaw in that logic. If I am wildly successful in investing, I may have more income in retirement than I do now, keeping me in a similar tax bracket (Fat Chance!). Also, given the spending habits of our state and federal government, taxes are almost certain to go up for all of us soon.
So, I am taking the one step that seems appropriate in my simple mind and funding a Roth 401k. I don't get to fund a Roth IRA, given my earnings, but the Roth 401k allows me to put a portion of my total qualified plan into a an after-tax, subsequent tax-free retirement vehicle, where earnings will never be taxed (unless of course, congress closes the door), in addition to the tax-deferred earnings in my traditional 401k and my life insurance policies. From this simplistic standpoint, I'm playing both sides of the taxation issue for retirement and I'm not worrying much about an after-tax brokerage account. I'm using all the after-tax money I have to pay a mortgage, school tuition for my son, keep food on the table, etc.
I don't know for sure whether I'll have a small or large stream of income in retirement. I don't know whether taxes will be generally higher, lower or similar to today. Not being a gambling man, I am doing my best to play both sides of the field. If I'm so lucky to have a large stream of income, I won't have to worry so much about paying higher taxes, right?
So, I am taking the one step that seems appropriate in my simple mind and funding a Roth 401k. I don't get to fund a Roth IRA, given my earnings, but the Roth 401k allows me to put a portion of my total qualified plan into a an after-tax, subsequent tax-free retirement vehicle, where earnings will never be taxed (unless of course, congress closes the door), in addition to the tax-deferred earnings in my traditional 401k and my life insurance policies. From this simplistic standpoint, I'm playing both sides of the taxation issue for retirement and I'm not worrying much about an after-tax brokerage account. I'm using all the after-tax money I have to pay a mortgage, school tuition for my son, keep food on the table, etc.
I don't know for sure whether I'll have a small or large stream of income in retirement. I don't know whether taxes will be generally higher, lower or similar to today. Not being a gambling man, I am doing my best to play both sides of the field. If I'm so lucky to have a large stream of income, I won't have to worry so much about paying higher taxes, right?
For a retirement stream of income, one needs a stream of income
Duh....
I've heard the conventional wisdom. Early in one's career, invest for rising valuation. Later, switch to instruments that protect principle and create a stream of payments, on which one lives after the monthly paycheck stops.
Being a simple minded person, unable to see through the jargon of the investment industry, I am coming to a different thought on how to determine if my retirement portfolio is moving to a place where it can support me.
Let's follow this simple line of logic. When I purchase a bond, or basically loan money to a company, the bond has a face value and a set interest rate. At the point the bond comes due, I receive the face value of that bond. I also have received the stream of interest payments for the life of the bond. Yes, I know that inflation erodes the purchasing power of that bond's face value, but then inflation erodes the value of everything, so lets forget the corrosive power of inflation for now. If I re-invest the interest payments into new bonds, I receive a rising stream of interest payments year after year after year. it's simply a form of compound interest payments.
Depending on the bond market, the face value of the bond will rise and fall. The dollar figure of the interest payment doesn't actually change, but the relative rate of return varies a bit, especially as I purchase new bonds at either a discount or premium to face value.
As with any investment, there is risk of default by the company issuing the bond, but there is some comfort in the face value of the bond, provided it is issued by a solid company and that the term of bond falls within my own investment lifetime. I can be pretty sure that I will eventually see my principal investment fully valued and returned to me.
If I purchase a preferred stock, the behavior of that stock is not too dissimilar to that of a bond, particularly if I purchase a trust preferred stock where payment of interest can be deferred, but not altered or eliminated by the company, short of default. Additionally, if the stock is convertible at a fixed ratio to common stock, at times one can take advantage of "mis-calculations" in the market and achieve an immediate increase in value of the holding by converting to common stock and then selling it at a premium to the value of the conversion ratio.
The preferred stock generally pays a healthy dividend, again allowing me to freely re-invest in that company and produce a rising stream of dividend payments, providing proof of the growing ability of my portfolio to support me in the future. It is up to me to purchase new blocks of the preferred stock at times when the discount to face value is in my favor, but the actual dividend payment will be constant dollars, linked to the face value and the stated dividend payment rate of that issue.
If I purchase the common stock in a company that pays steady and rising dividends, the market almost always produces fluctuations in the valuation of that company. We all know that the common stock dividend is the first thing to go when hard times hit. Look at the entire banking industry over the last few years. Dividends evaporated like ice-cubes in the sun. They did so because earnings dried up, not as a primary result of fluctuations in valuation of the companies. The stock prices plummeted for the same reason; earnings dried up. Those companies that maintained dividend payments in spite of declining earnings saw dramatic rise in dividend payment percentages. That's why you have to keep your eye on payout ratios.
Obviously, almost no one foresaw what a horrible situation all those banks put themselves (and our investment in them) into with their "off balance sheet" risky investments. Had anyone known, we would have put our money into businesses with more transparent methods of earning money, and measurable risks of loss of earnings.
Still, if one can trust the dividend payment history to a significant extent and one diversifies one's holdings across many companies, there is a degree of security in the stream of dividend payments. One can ride out variations in valuation, continuing to turn dividend payments into more investment in the company, producing a rising stream of dividends over time. The combination of dividend reinvestment and a modest increase in valuation over time can equal or exceed the increase in valuation in companies that do not pay dividends. The payment of dividends puts a cushion under reduction in valuations that periodically occur. Practically speaking, this reduces volatility in the valuation of the investment.
I'm looking for investments that will pay me a rising stream of income, whether it be interest or dividends. I need to pay attention to the price of those dividends. The price is reflected directly in the discount or premium to face value in bonds or preferred stock. It is reflected indirectly in the price/earnings ratio of a company, if that company maintains a steady payout ratio in it's dividend policy. However, if the dividend is steady and the payout ratio is steadily rising, look out for loss in the ability to raise dividends, and an upcoming loss in the valuation of the equity.
Not rocket science or quantitative investment theory, but a reasonable means to come to some comfort with one's choice in investments. One thing I know about this approach; when I approach my retirement, I won't be forced to completely and abruptly retool my investments to the "capital preservation" mode. I'll be pretty savvy in which investments do exactly what I need, having practiced it for the preceding 15-20 years.
I know I need to double the value of my retirement portfolio at least twice in order to have a stream of income that provides reasonable security at retirement. Fortunately, I can continue to add new money via my qualified plan,and I don't need to achieve that "10+ %" historical rate of return in the stock market. I need to minimize volatility, generate a continuing and rising stream of dividend/interest payment, re-invest and seek to have an account value that allows me to live on 3-4% "harvest" of dividends/interest when the time comes. Then, I'll never run out of money, the principal will continue to grow at some rate, and I'll have something to leave to my child when I'm dead and gone.
I've heard the conventional wisdom. Early in one's career, invest for rising valuation. Later, switch to instruments that protect principle and create a stream of payments, on which one lives after the monthly paycheck stops.
Being a simple minded person, unable to see through the jargon of the investment industry, I am coming to a different thought on how to determine if my retirement portfolio is moving to a place where it can support me.
Let's follow this simple line of logic. When I purchase a bond, or basically loan money to a company, the bond has a face value and a set interest rate. At the point the bond comes due, I receive the face value of that bond. I also have received the stream of interest payments for the life of the bond. Yes, I know that inflation erodes the purchasing power of that bond's face value, but then inflation erodes the value of everything, so lets forget the corrosive power of inflation for now. If I re-invest the interest payments into new bonds, I receive a rising stream of interest payments year after year after year. it's simply a form of compound interest payments.
Depending on the bond market, the face value of the bond will rise and fall. The dollar figure of the interest payment doesn't actually change, but the relative rate of return varies a bit, especially as I purchase new bonds at either a discount or premium to face value.
As with any investment, there is risk of default by the company issuing the bond, but there is some comfort in the face value of the bond, provided it is issued by a solid company and that the term of bond falls within my own investment lifetime. I can be pretty sure that I will eventually see my principal investment fully valued and returned to me.
If I purchase a preferred stock, the behavior of that stock is not too dissimilar to that of a bond, particularly if I purchase a trust preferred stock where payment of interest can be deferred, but not altered or eliminated by the company, short of default. Additionally, if the stock is convertible at a fixed ratio to common stock, at times one can take advantage of "mis-calculations" in the market and achieve an immediate increase in value of the holding by converting to common stock and then selling it at a premium to the value of the conversion ratio.
The preferred stock generally pays a healthy dividend, again allowing me to freely re-invest in that company and produce a rising stream of dividend payments, providing proof of the growing ability of my portfolio to support me in the future. It is up to me to purchase new blocks of the preferred stock at times when the discount to face value is in my favor, but the actual dividend payment will be constant dollars, linked to the face value and the stated dividend payment rate of that issue.
If I purchase the common stock in a company that pays steady and rising dividends, the market almost always produces fluctuations in the valuation of that company. We all know that the common stock dividend is the first thing to go when hard times hit. Look at the entire banking industry over the last few years. Dividends evaporated like ice-cubes in the sun. They did so because earnings dried up, not as a primary result of fluctuations in valuation of the companies. The stock prices plummeted for the same reason; earnings dried up. Those companies that maintained dividend payments in spite of declining earnings saw dramatic rise in dividend payment percentages. That's why you have to keep your eye on payout ratios.
Obviously, almost no one foresaw what a horrible situation all those banks put themselves (and our investment in them) into with their "off balance sheet" risky investments. Had anyone known, we would have put our money into businesses with more transparent methods of earning money, and measurable risks of loss of earnings.
Still, if one can trust the dividend payment history to a significant extent and one diversifies one's holdings across many companies, there is a degree of security in the stream of dividend payments. One can ride out variations in valuation, continuing to turn dividend payments into more investment in the company, producing a rising stream of dividends over time. The combination of dividend reinvestment and a modest increase in valuation over time can equal or exceed the increase in valuation in companies that do not pay dividends. The payment of dividends puts a cushion under reduction in valuations that periodically occur. Practically speaking, this reduces volatility in the valuation of the investment.
I'm looking for investments that will pay me a rising stream of income, whether it be interest or dividends. I need to pay attention to the price of those dividends. The price is reflected directly in the discount or premium to face value in bonds or preferred stock. It is reflected indirectly in the price/earnings ratio of a company, if that company maintains a steady payout ratio in it's dividend policy. However, if the dividend is steady and the payout ratio is steadily rising, look out for loss in the ability to raise dividends, and an upcoming loss in the valuation of the equity.
Not rocket science or quantitative investment theory, but a reasonable means to come to some comfort with one's choice in investments. One thing I know about this approach; when I approach my retirement, I won't be forced to completely and abruptly retool my investments to the "capital preservation" mode. I'll be pretty savvy in which investments do exactly what I need, having practiced it for the preceding 15-20 years.
I know I need to double the value of my retirement portfolio at least twice in order to have a stream of income that provides reasonable security at retirement. Fortunately, I can continue to add new money via my qualified plan,and I don't need to achieve that "10+ %" historical rate of return in the stock market. I need to minimize volatility, generate a continuing and rising stream of dividend/interest payment, re-invest and seek to have an account value that allows me to live on 3-4% "harvest" of dividends/interest when the time comes. Then, I'll never run out of money, the principal will continue to grow at some rate, and I'll have something to leave to my child when I'm dead and gone.
I'm an owner; I deserve to be paid
In my own business, I'm both an owner and an employee. I earn revenue by providing service; specifically I offer a variety of surgical services to persons in need of "fixing". I am also a small-business owner. I work to generate revenue. I pay the overhead in my business, then I pay my employees, and finally I pay myself. I must be careful to manage expenses, pay competitive wages but also keep a lid on wage inflation, in order to take home a paycheck. Being profitable is absolutely necessary, otherwise I'm working for the employees, the vendors, the owner of the building that houses my practice, but not to my own benefit.
It's no different with a big corporation, except that one depends on the senior management and the board of directors to look out for the interest of the owners, or the stockholders. It helps that senior management have interests aligned with the stockholders: i.e. they are vested in the companies stock, they have a long-term personal benefit to gain by rising earnings and stock valuation. It's also important that they pay attention to aligning compensation of the employees (including themselves) with profits to the shareholders, who own the business.
This is why I like companies that pay regular dividends, and rising dividends in particular. Some companies don't pay dividends, or pay very small dividends to their owners. They retain earnings to "re-invest" in the company's growth. Did you ever wonder why some companies can pay a generous dividend and still grow their revenues, earnings and valuations at the same time?
As an investor for retirement, I am not taking income out of my portfolio. In fact, I re-invest ALL earnings from my portfolio, in the interest of my future security. I make a free choice as an owner in a business to re-invest the dividends back into additional stock in that company, understanding that I have invested in the first place because I have some confidence in the ability of that company to earn profits, grow the business, and pay me a rising stream of increasing value in return for my capital investment in the business.
So I like companies who state, with the dividend payment, that they acknowledge my value to them as an investor and "pay me now". I return the favor by re-investing, so they get the same effect as if they had retained the earnings in favor of "growth", but in the dividend payment transaction, they are demonstrating their ability to be profitable, to grow over and above the dividend payment and they are stating their trust in me as an owner to continue to put resources into the company as opposed to sucking the juice out of it.
Many writers argue the merits of dividend-paying, versus dividend retaining companies. They argue the difference between "growth" and "value" kinds of investments. I simply want to see, in plain terms, that the company steadily generates revenue, has a rising stream of profits, and pays it's owners on a steady and preferably rising basis.
I choose to increase my position in those companies through dividend reinvestment and also purchasing new blocks of stock when the variations in the valuation of the stock are in my favor.
This isn't a quantitative approach to investment. It's an intuitive approach based on personal knowledge of the company, it's business and how it has historically treated it's stockholders.
If one follows the dividend payments as well as the payout ratio, one can spot a company that is not only steadily earning more from year to year, but also distributing a steady and rising portion of those earnings to the owners. That's a pretty simple indication that the business is being well managed. Not foolproof, perhaps, but a good place to start.
It's no different with a big corporation, except that one depends on the senior management and the board of directors to look out for the interest of the owners, or the stockholders. It helps that senior management have interests aligned with the stockholders: i.e. they are vested in the companies stock, they have a long-term personal benefit to gain by rising earnings and stock valuation. It's also important that they pay attention to aligning compensation of the employees (including themselves) with profits to the shareholders, who own the business.
This is why I like companies that pay regular dividends, and rising dividends in particular. Some companies don't pay dividends, or pay very small dividends to their owners. They retain earnings to "re-invest" in the company's growth. Did you ever wonder why some companies can pay a generous dividend and still grow their revenues, earnings and valuations at the same time?
As an investor for retirement, I am not taking income out of my portfolio. In fact, I re-invest ALL earnings from my portfolio, in the interest of my future security. I make a free choice as an owner in a business to re-invest the dividends back into additional stock in that company, understanding that I have invested in the first place because I have some confidence in the ability of that company to earn profits, grow the business, and pay me a rising stream of increasing value in return for my capital investment in the business.
So I like companies who state, with the dividend payment, that they acknowledge my value to them as an investor and "pay me now". I return the favor by re-investing, so they get the same effect as if they had retained the earnings in favor of "growth", but in the dividend payment transaction, they are demonstrating their ability to be profitable, to grow over and above the dividend payment and they are stating their trust in me as an owner to continue to put resources into the company as opposed to sucking the juice out of it.
Many writers argue the merits of dividend-paying, versus dividend retaining companies. They argue the difference between "growth" and "value" kinds of investments. I simply want to see, in plain terms, that the company steadily generates revenue, has a rising stream of profits, and pays it's owners on a steady and preferably rising basis.
I choose to increase my position in those companies through dividend reinvestment and also purchasing new blocks of stock when the variations in the valuation of the stock are in my favor.
This isn't a quantitative approach to investment. It's an intuitive approach based on personal knowledge of the company, it's business and how it has historically treated it's stockholders.
If one follows the dividend payments as well as the payout ratio, one can spot a company that is not only steadily earning more from year to year, but also distributing a steady and rising portion of those earnings to the owners. That's a pretty simple indication that the business is being well managed. Not foolproof, perhaps, but a good place to start.
Volatility matters
One thing my broker never explained to me: volatility matters. Average historic yields can be misleading to an individual who enters the market during a discrete year, and ultimately must "exit the market", or lock in the corpus of an investment account by converting to fixed income instruments at some point in order to secure principal and generate a stream of cash for distribution.
If the market (or a single equity, for that matter) declines 20% in one year, it takes a 25% gain the next to get back to even. If the decline is 25%, one needs 33% gain the next year to get back to even. That sequence means two years investment experience with ZERO appreciation. This observation leads to common sense rule number one: don't lose money. This concept stands behind the "margin of safety" of Benjamin Graham and Warren Buffet's rule number 1.
Try as I might, I have a hard time really understanding how one dissects a balance sheet and an annual report. I can follow the logic behind the various stock screening methods, but I'm not capable of the discipline to laboriously analyze equity after equity. So, some simpler logic must guide me in deciding how I will invest my retirement savings.
I know from experience that certain types of equities can fluctuate dramatically in value, particularly if the industry they work in is a "cyclic" industry, or if the company's earnings are variable from season to season and year to year. After all, the market is a very short-sighted, neurotic and over-reacting entity.
One principle that must guide me is choosing investments with very steady, hopefully rising earnings, year in and year out. Such an investments are unlikely to fluctuate dramatically in value from year to year. If the earnings trend is up, the valuation will generally also rise over time.
Each equity has a historical range in price/earnings ratios. It isn't prudent to purchase an equity at the north end of it's historic price/earnings range, unless there is some reason to believe that earnings will accelerate dramatically in the near term future. Otherwise, purchasing at a historically high price/earnings ratio may well be "over-paying" for those earnings.
So, without being too sophisticated in my company analysis, I am looking for companies, and industries that are "steady Eddy's" with respect to earnings and valuation. Where am I finding them? One sector is utilities. Another is in "certain" Master Limited Partnerships. A third is health-care entities. A fourth is certain REITs. One has to be careful to understand the underlying premise on which each business earns it's money and how it grows revenues and earnings over time. The best of these are those with a simple business model and easy-to- understand drivers of earnings.
If the market (or a single equity, for that matter) declines 20% in one year, it takes a 25% gain the next to get back to even. If the decline is 25%, one needs 33% gain the next year to get back to even. That sequence means two years investment experience with ZERO appreciation. This observation leads to common sense rule number one: don't lose money. This concept stands behind the "margin of safety" of Benjamin Graham and Warren Buffet's rule number 1.
Try as I might, I have a hard time really understanding how one dissects a balance sheet and an annual report. I can follow the logic behind the various stock screening methods, but I'm not capable of the discipline to laboriously analyze equity after equity. So, some simpler logic must guide me in deciding how I will invest my retirement savings.
I know from experience that certain types of equities can fluctuate dramatically in value, particularly if the industry they work in is a "cyclic" industry, or if the company's earnings are variable from season to season and year to year. After all, the market is a very short-sighted, neurotic and over-reacting entity.
One principle that must guide me is choosing investments with very steady, hopefully rising earnings, year in and year out. Such an investments are unlikely to fluctuate dramatically in value from year to year. If the earnings trend is up, the valuation will generally also rise over time.
Each equity has a historical range in price/earnings ratios. It isn't prudent to purchase an equity at the north end of it's historic price/earnings range, unless there is some reason to believe that earnings will accelerate dramatically in the near term future. Otherwise, purchasing at a historically high price/earnings ratio may well be "over-paying" for those earnings.
So, without being too sophisticated in my company analysis, I am looking for companies, and industries that are "steady Eddy's" with respect to earnings and valuation. Where am I finding them? One sector is utilities. Another is in "certain" Master Limited Partnerships. A third is health-care entities. A fourth is certain REITs. One has to be careful to understand the underlying premise on which each business earns it's money and how it grows revenues and earnings over time. The best of these are those with a simple business model and easy-to- understand drivers of earnings.
Making sense of the concept of saving for retirement
I entitled my blog; "common sense for the amateur retirement investor".
I am, in fact, an amateur retirement investor. I have no training or credentials in this area. I am, however, a hard-working health care professional. It took a reasonable amount of intellectual horsepower to get to where I am professionally, so the subject of investing for retirement should not be too far beyond my grasp. Being a subject-matter expert on a particular slice of the health care field, I accept the concept that there are experts who can guide a person in making wise decisions about subjects in which that individual lacks personal knowledge or expertise.
Trouble is, I have looked fairly diligently for those experts and have failed to find one who can deliver even a modest return on investment for my retirement savings. Apparently I am not alone.
In the last year of my surgical training, I participated in a university system retirement plan and socked away 1 years worth of deferred compensation; a grand total of $1500, matched 1:1 by the institution. The manager was TIAA/CREF. I chose the "stock fund", a very broad based equity fund with very low expense ratio, with it's 40+ years of history. I finished my training and moved on into my career and allowed that fund to "naturally" mature. 15 years later, that fund has barely doubled in value. The rate of return is roughly half what common wisdom quotes as the expected rate of return for the stock market over many decades of slightly over 10% per year.
My wife has diligently invested in her company retirement plan, as well as a supplemental retirement savings account over the last 20 years. The investment earnings contributions of these plans, managed by "institutional investors" is a small fraction of her personal contributions, even over 20 years. She is invested in a "diversified" group of mutual funds.
After starting my surgical career in a group practice, I began participating in our corporation qualified plan. Each year for the last 15 years I have contributed the maximum allowable amount to our qualified plan, which allows the employee to self-direct the investment. I went to a reputable full service brokerage account, chose a senior broker and explained my desire to build a broad-based investment portfolio over the next 30 years. He directed me into the purchase of equities and I soon learned the consequence of "momentum investing" during the tech bubble.
Having learned a painful lesson about valuation and about my own tolerance for risk, I insisted on a new approach. In 2002, he proposed that we build a "S&P 500 mutual fund" of equities across the sectors, only without those pesky mutual fund management fees. I dutifully contributed my deferred income and we chose large-cap stocks in each sector, safe in the knowledge that I would track the historic rise in valuation of the largest and most successful companies in the world. Little did I know that the S&P 500 would appreciate exactly ZERO in the decade I was building my portfolio. In fact, over that decade, brokerage fees added up to $12, 000, far more than I actually earned in the process of investing.
Also during that time, I purchased life insurance. My insurance broker steered me first to variable life insurance, then whole life policies, explaining about the cash value appreciation, the tax deferred earnings, the ability to borrow against my own policies, etc. etc. I scrimped and squeezed my budget to fund another stream of savings for the future, trusting in the wisdom of these august, highly rated companies to prudently and conservatively invest my premium payments. Sadly, the actual investment performance never even roughly approximated the models projected by the insurance broker at the time of purchase. 10 years later, the cash value of those policies is no more than 80% of the cost of purchasing them, even accounting for the actual cost of insurance within them.
So, the experts haven't done much for me or my wifeor anyone I know, for that matter.
My growing awareness of the sub-standard performance of my retirement assets, the increasing frustration with lack of transparency on the part of my advisors and growing alarm as my earning years tick by, I began to read, and read, and read some more. I read every source I could find on investing. I subscribed to newsletters, websites, associations for independent investors. I consumed information in magazines, books, and television shows. I read the biographies and autobiographies of great investors. I tried to educate myself from every angle I could find about prudent means to secure a stream of income in retirement.
In the throes of a stock-market down-draft, I dismissed my broker, transferred my badly diminished funds to a discount broker and struck out on my own, seeking to develop a portfolio that will reliably pay me a rising stream of income that will someday be enough to support my wife and I when we no longer can work for a living. I suspended premium payments on my life insurance policies, leaving them to fund themselves out of the existing cash value, refusing to throw good money after bad.
This blog is a letter to myself, attempting to explain what I am learning and how this is driving me to make decisions on managing my portfolio. If you happen upon my blog, maybe you'll gain an insight, or maybe you can lend me one, that will help us both on our way.
I am, in fact, an amateur retirement investor. I have no training or credentials in this area. I am, however, a hard-working health care professional. It took a reasonable amount of intellectual horsepower to get to where I am professionally, so the subject of investing for retirement should not be too far beyond my grasp. Being a subject-matter expert on a particular slice of the health care field, I accept the concept that there are experts who can guide a person in making wise decisions about subjects in which that individual lacks personal knowledge or expertise.
Trouble is, I have looked fairly diligently for those experts and have failed to find one who can deliver even a modest return on investment for my retirement savings. Apparently I am not alone.
In the last year of my surgical training, I participated in a university system retirement plan and socked away 1 years worth of deferred compensation; a grand total of $1500, matched 1:1 by the institution. The manager was TIAA/CREF. I chose the "stock fund", a very broad based equity fund with very low expense ratio, with it's 40+ years of history. I finished my training and moved on into my career and allowed that fund to "naturally" mature. 15 years later, that fund has barely doubled in value. The rate of return is roughly half what common wisdom quotes as the expected rate of return for the stock market over many decades of slightly over 10% per year.
My wife has diligently invested in her company retirement plan, as well as a supplemental retirement savings account over the last 20 years. The investment earnings contributions of these plans, managed by "institutional investors" is a small fraction of her personal contributions, even over 20 years. She is invested in a "diversified" group of mutual funds.
After starting my surgical career in a group practice, I began participating in our corporation qualified plan. Each year for the last 15 years I have contributed the maximum allowable amount to our qualified plan, which allows the employee to self-direct the investment. I went to a reputable full service brokerage account, chose a senior broker and explained my desire to build a broad-based investment portfolio over the next 30 years. He directed me into the purchase of equities and I soon learned the consequence of "momentum investing" during the tech bubble.
Having learned a painful lesson about valuation and about my own tolerance for risk, I insisted on a new approach. In 2002, he proposed that we build a "S&P 500 mutual fund" of equities across the sectors, only without those pesky mutual fund management fees. I dutifully contributed my deferred income and we chose large-cap stocks in each sector, safe in the knowledge that I would track the historic rise in valuation of the largest and most successful companies in the world. Little did I know that the S&P 500 would appreciate exactly ZERO in the decade I was building my portfolio. In fact, over that decade, brokerage fees added up to $12, 000, far more than I actually earned in the process of investing.
Also during that time, I purchased life insurance. My insurance broker steered me first to variable life insurance, then whole life policies, explaining about the cash value appreciation, the tax deferred earnings, the ability to borrow against my own policies, etc. etc. I scrimped and squeezed my budget to fund another stream of savings for the future, trusting in the wisdom of these august, highly rated companies to prudently and conservatively invest my premium payments. Sadly, the actual investment performance never even roughly approximated the models projected by the insurance broker at the time of purchase. 10 years later, the cash value of those policies is no more than 80% of the cost of purchasing them, even accounting for the actual cost of insurance within them.
So, the experts haven't done much for me or my wifeor anyone I know, for that matter.
My growing awareness of the sub-standard performance of my retirement assets, the increasing frustration with lack of transparency on the part of my advisors and growing alarm as my earning years tick by, I began to read, and read, and read some more. I read every source I could find on investing. I subscribed to newsletters, websites, associations for independent investors. I consumed information in magazines, books, and television shows. I read the biographies and autobiographies of great investors. I tried to educate myself from every angle I could find about prudent means to secure a stream of income in retirement.
In the throes of a stock-market down-draft, I dismissed my broker, transferred my badly diminished funds to a discount broker and struck out on my own, seeking to develop a portfolio that will reliably pay me a rising stream of income that will someday be enough to support my wife and I when we no longer can work for a living. I suspended premium payments on my life insurance policies, leaving them to fund themselves out of the existing cash value, refusing to throw good money after bad.
This blog is a letter to myself, attempting to explain what I am learning and how this is driving me to make decisions on managing my portfolio. If you happen upon my blog, maybe you'll gain an insight, or maybe you can lend me one, that will help us both on our way.
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