As a youth softball coach for many years, I often spoke to my players about managing the highs and lows of the game. Softball, like baseball, is a very humbling sport in that as a hitter, if you fail seven out of ten times, you are considered successful. Consequently, a player must develop resilience so they can effectively process failure.
Mental discipline is also important when it comes to investing to help an investor ride out the volatility of the stock market without giving in to fear at the lows and greed at the highs. People who panic during a market downturn, often put themselves in a poor position to achieve competitive returns over the long haul by selling at depressed prices and failing to get back into the market before it has already recouped much of its losses. In times of economic uncertainty, it can be unnerving for an investor to see their net worth change dramatically based on market activity. That’s why, for near-term spending needs, we work to ensure our clients have money in more stable investments. It helps give the investor confidence that even though a market dip could result in a decline in portfolio value for a time period, they are positioned to meet their short-term financial requirements. In the long run, however, the stock market gives investors the best chance to generate growth that will outpace the rate of inflation. A clear mindset is equally beneficial when considering individual investments. As a coach, I spoke to my hitters about the importance of pitch selection (which pitches to swing at). I tried to help them understand what their strengths were as a hitter and instructed them to look for a pitch that allowed them to take advantage of it. Not every pitch, even if it’s a strike, gives the batter the same odds of success if she swings at it. If a pitch is in the low/outside part of the strike zone, for example, the chance of making solid contact would be lower than if the batter waited for a better pitch that is in her “wheelhouse” so to speak. The issue in softball (or baseball) is that a batter is limited to three strikes so when a hitter gets two strikes, they must expand their pitch selection to include any pitch that might be called a strike even if it is less appealing. As legendary investor Warren Buffett has pointed out in many interviews over the years, investors have no such limitation on the number of pitches and can afford to let pitch after pitch go by until they get one to their liking. Of course, implicit in this analogy is to have an idea of what type of pitch (investment) they are looking for in the first place. We know what a good pitch looks like to us at Wright Investment Partners. We are looking for dividend-paying companies that are highly profitable and have strong prospects for growth in both their cash flow and dividends over time. They should operate businesses with a competitive edge in their industry and not carry too much debt, which could cause distress during a business downturn. We look to buy stock in such companies at an attractive valuation. Importantly, we resist the temptation to chase investments that are outside of the zone. When we purchase shares of a company, it’s with the idea that we will be long-term owners in order to benefit from the compounding of future growth. Of course, sometimes circumstances change, and we sell a holding. In a positive scenario, perhaps we feel the shares have become significantly overvalued and we sell for a gain. However, in other instances, an investment may not work out as hoped due to a deterioration in business fundamentals. In these cases, we work to determine if there is a short-term blip that will be corrected or if there is a longer-term problem. In the latter case, we might have made a mistake in our evaluation of a company or there were unforeseen circumstances at play and we will cut our losses. In softball, when one of our players made an error, we taught them to learn from it and move on quickly. It’s important to be accountable, but if they pouted about it, they wouldn’t be ready for the next play and not in the right mindset to help the team. As investors, we reflect on our mistakes as a learning exercise, however, allowing them to consume our thoughts would be counterproductive as it might cause us to miss other opportunities to help our clients. To be sure, we by no means take mistakes lightly. We invest our own money right alongside our clients, so we feel the same pain when investment returns disappoint. Softball players don’t like to strike out or make an error and we hate losing money. But we know if we stick to swinging at pitches in our sweet spot, the odds of success will be in our favor over the long run. .
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If you’re like most people, you have toiled for a few different employers over the course of your career. The result can be that you own multiple retirement accounts when it’s time to call it quits for good. If that sounds like you, consolidating your retirement assets may be something to explore to help simplify your finances and potentially save you money. Retirement is something all of us look forward to but often it’s accompanied by some anxiety as we shift gears from accumulating assets to drawing them down. Why not streamline things so you can focus on the fun parts of retirement? You’ve earned it. There are many types of retirement plans, which include 401(k), 403(b), or 457(b) plans sponsored by employers as well as Individual Retirement Accounts (IRAs). There are versions of each that are differentiated by whether they are funded with pre-tax or after-tax dollars. Here are five reasons that consolidating your accounts may be the right move for you. Required Minimum Distributions (RMDs) The Internal Revenue Service (IRS) has established rules regarding RMDs from pre-tax retirement accounts once you reach the age of 72. Consolidating your accounts would make it much easier to calculate your RMD and reduce the risk of mistakes that could result in costly IRS penalties. Portfolio Management It is wise to periodically review and rebalance your portfolio to maintain proper diversification. With multiple retirement accounts, it takes more effort to calculate exposure to different types of assets such as stocks and bonds. Fees Depending on the type of plan you own and its individual characteristics, there can be investment fees, administrative fees, surrender fees, and fiduciary and consulting fees, among others. Plan costs vary so it is possible that folks with multiple accounts are being charged certain fees that would be reduced or eliminated if consolidated under a lower-cost plan. Investment Choices Retirement plans can have vast differences in the quality and quantity of investment choices available to participants. Leaving your money in plans with inferior choices can be an expensive mistake that compounds over time. Estate Administration Most of us don’t like to ponder our own mortality, however, it will be much easier for your beneficiaries to deal with a consolidated account instead of inheriting the burden of extra paperwork for several accounts. Each person’s situation is unique. There are some instances when consolidating accounts may not make sense and it’s better to keep separate accounts. There isn’t a cookie-cutter answer that suits everyone, so further analysis is needed to be sure it’s right for you. If you decide to research this topic on your own, make sure you are up to speed on IRS rules and other important details related to your various retirement accounts. There are many resources online that can help you. One place you can begin is the rollover chart located here on the IRS website that shows many different types of retirement accounts and which types can be combined. It’s a good start for the basics, but you should be prepared to research deeper to be sure to avoid triggering unwanted tax consequences or making other errors. For those who don’t feel like taking on the task alone, investment professionals can help. Wright Investment Partners offers a complimentary review of retirement accounts and any other investment portfolios you may have. Unlike many investment professionals, we do not charge commissions or sales fees, nor do we pressure investors to open an account with us. If it turns out that retirement account consolidation is right for you and you choose to invest with us, as an independent registered investment advisor (RIA) we can explore setting up an IRA for you with our custodian that you can roll other plans into. We offer our own in-house dividend growth stock portfolio as well as access to many high-quality, low fee mutual funds and exchange-traded funds (ETFs). Whatever you decide to do with your retirement assets, make sure you give them attention annually at a minimum. Your future self will thank you. The stock market is off to a choppy start in 2022 as worries mount about potential Federal Reserve action to tighten monetary policy in an effort to cool down inflation. While no one is interested in seeing the value of their portfolio decline, remaining calm is the best course of action for the long-term investor.
Composure during volatile market activity isn’t necessarily instinctual and, of course, we’ve all been a little spoiled by the recent past. The end of last year marked the eighth-best three-year period for the market in the last 94 years. The average annual return for the benchmark S&P 500 Index during that time was 26.1%. Amazing when you consider the Covid-related downturn in the market that occurred in the middle of that period. If history is any indication, the next three years may not be as profitable. In the three years following the seven best three-year periods for the S&P 500, the average annual returns ranged from 12.7% to -27%. The latter figure represents 1929 through 1931, reflecting the stock market crash of 1929 and the Great Depression. These figures may quell optimism, but it doesn’t mean it’s time to panic as there is no assurance that history will repeat. Predicting stock market returns is certainly not as easy as looking at past performance trends or current events as an indicator. The reality is no one knows how long the inflation issue will persist or what other unrelated, unknowable events may take place this year that could have an impact on the economy or market sentiment in either direction. Because the economy, world events, and investor behavior are so difficult to foresee, market strategists have proven to be poor at predicting market returns with any level of precision. It is mostly noise that the long-term investor would be wise to tune out. Daily market chatter and forecasts themselves are harmless enough except to the extent that investors may be compelled to act on them. Since no one has been able to reliably forecast market returns, the notion that investors should increase or decrease their equity (stock) exposure based on these experts’ market outlook is ill-advised at best. Instead of being concerned about what analysts say about the direction of the stock market, the main factors driving your investment decisions should include things like your personal financial position, the length of time you seek to grow your assets, and your risk tolerance. Studies have shown investor attempts to time the stock market is unwise. In other words, investors are bad at exiting the market just before it drops and subsequently re-entering before it recovers. The repercussions of mistiming the market often revolve around being on the sidelines when the market moves higher over time. Acting upon fear in the face of market volatility generally does not serve investors well. When it comes to the stock market, time is more important than timing. In the long run, equity investors are usually rewarded, and therefore participation in the stock market is best suited for those with spending needs that are further down the road. Money that you need to fund near-term expenditures should be in more stable assets and not be subject to the volatility of stocks. To illustrate these points, let’s look at the rolling returns of the U.S. stock market over various time periods. We use rolling returns because calendar-year performance is somewhat arbitrary and not more or less important to consider than any other period of the same length. So instead of just using January 1 as the starting point of a return calculation, rolling returns are calculated by also considering the period that begins in February, March, and so on. This method not only allows for more data points, but it’s also more realistic than assuming the only figures that matter are those of a calendar year. Based on rolling return calculations, U.S. stocks as measured by the S&P 500 Index have a negative return in 21% of one-year periods. However, the picture gets brighter when looking at longer time frames. When we consider rolling five-year periods, U.S. stocks are down about 7% of the time. For ten-year periods, that number falls to 3% and for twenty-year rolling periods that figure drops to zero. Within that framework, returns vary but it shows why stocks are most appropriate for long-term investing. With that in mind, our viewpoint at Wright Investment Partners is based on long-term thinking with respect to a client’s portfolio allocation to stocks as well as our analysis of the companies we invest in. The approach we take to stock selection is based on the assessment of individual companies rather than using a methodology dependent on broad economic assumptions. Our analysis includes a review of a company’s profitability, cash flow, credit risk, and growth prospects. We concentrate on companies that demonstrate a policy of increasing dividends annually and attempt to buy those stocks at prices that reflect a discount to our estimate of fair value. As 2022 churns forward, we will continue to monitor our holdings and other prospective investments as we always do. In the meantime, if it turns out the market hits a rough patch, we won’t be panicking or looking to the financial news networks for market predictions. Instead, we’ll spend our time looking to seize opportunities to improve our investment portfolio if they arise. As soaring inflation takes a bite out of consumer spending power, investors need a strategy to fight back. A portfolio of dividend growth stocks could be a good start.
After years of benign inflation, U.S. consumers have recently experienced sharply higher prices across several spending categories. Escalating prices have affected everything from food and building products to cars and housing. For the twelve months ending in October 2021, the U.S. Consumer Price Index (CPI) was up 6.2%, the highest level in thirty years. CPI measures what consumers pay for a standardized group of goods and services. While it is impossible to know how long this period of increasing inflation will last or the ultimate impact on the economy, if it continues long enough, it will likely lead to higher interest rates. Rising interest rates historically have hurt the stock and bond markets. Investors with a time horizon of twenty years or more are almost always better off ignoring such concerns by staying fully invested throughout the economic cycle. Investor attempts to time market exits and re-entries based on economic news is a path that’s littered with failure. But inflation can be more concerning for retirees or those near retirement age since their investment portfolio is likely to fund some of their spending in retirement. If the cost of living increases at a growing rate at a time when income levels are stable or maybe even declining, it makes it more challenging for retirees to maintain the lifestyle to which they are accustomed. One way to help mitigate this risk is to invest in companies with a history of growing their dividends, known as a dividend growth strategy. The strategy entails buying a portfolio of stocks with a track record of increasing their annual dividend payment. This rewards investors with income growth and helps offset the effects of inflation. To illustrate the potential for income growth, we can look at the Standard & Poor’s (S&P) High Yield Dividend Aristocrats, which is a group of stocks culled from the S&P Composite 1500 Index that has raised dividends annually for at least twenty years. They continued increasing their dividends even through the decade of the 2000s when the benchmark S&P 500 Index had a negative return for the ten-year period. More recently, the Dividend Aristocrats hiked dividends at a compounded annual growth rate (CAGR) of 9.1% for the seven years ended in 2020, according to S&P Dow Jones Indices LLC. This represents only one time period, of course, but a 9% annual income increase is nothing to scoff at. Even if the value of a dividend growth portfolio declines over a period of time due to market volatility, the growth in dividend income is yours to keep. A common question we are asked is how we can be sure these companies will continue their pattern of increasing dividend payments. We can never be completely certain, but there are characteristics we look for that tilt the odds in our favor. We start by determining the percentage of a company’s earnings and cash flow that is being used for dividend payments, called the payout ratio. A high payout ratio can signal the risk that a company may not be able to continue growing its dividend during a difficult period. We also analyze a company’s financial statements to make sure it isn’t carrying too much debt, which may divert its cash usage from dividend payments to debt service. In addition, we look for companies with businesses that are well-positioned competitively and have good prospects moving forward despite any short-term issues it may be facing. Companies that don’t operate with excessive debt and have sustainable competitive advantages often come out of economically challenging times even stronger in comparison with weaker rivals. Lastly, we look to add stocks to the portfolio at a discount to what we believe the underlying company is worth based on our analysis of its past financial performance as well as estimates regarding future growth. Over the long run, individual stock performance is usually correlated with the issuer’s profitability. Some investors assume companies that pay dividends do not offer desirable prospects for growth, however, many dividend-paying stocks offer the potential for capital growth as well as increasing dividends. Those are the ones we are interested in rather than stodgy companies that pay a dividend but offer little or no growth opportunities. Dividend growth stocks more than hold their own when compared with the overall stock market. According to a report by Ned Davis Research and Hartford Funds, dividend growers and initiators that are part of the S&P 500 Index generated an annualized return of 13.2% from 1973 through 2020 compared with 12.6% for the overall S&P 500. The outperformance was achieved with less price volatility than the index. To be sure, this study looked at one specific timeframe and the result may not repeat in future periods. Perhaps due to the prolonged bull market for stocks, there seems to be an underappreciation for the role dividends play in long-term investor returns. According to S&P, dividends have contributed about 32% of the total return of the benchmark S&P 500 Index since 1926. In a period of strong stock market returns like the last ten years, the percentage of dividend contribution would usually be lower. At other times, it can be much higher than 32%. In the 1970s, inflation was high, ranging between 5% and 10% for much of the decade. The compounded annual return of the S&P 500 Index during the 1970s was 5.8%. Dividend income during the decade accounted for 72% of the total return, according to Ned Davis Research. History aside, it is important to differentiate a dividend growth strategy from an investment approach that simply seeks stocks with the highest dividend yield, which is a company’s dividend per share divided by the share price of the stock. On the surface, it may seem like a compelling strategy to seek the highest yields possible, but it often comes with low growth prospects or other risks. For example, many such companies pay out an extremely large percentage of their earnings as a dividend, which leaves little cushion if there is a business downturn or other corporate expenses increase. Balance is important. Despite the compelling attributes of a dividend growth strategy, no investment strategy comes without risk. In an inflationary economic environment, nearly all businesses, including dividend growers, face pressure from rising costs that could crimp corporate profitability. Of course, companies will try to pass rising costs on to their customers but even if they are successful in doing that, they could experience timing differences that make quarterly financial results less predictable. We do not fancy ourselves to be economic forecasters, nor do we know how long this period of elevated inflation will last. Predicting the short-term direction of the economy or stock market is not a part of our investment approach. We are very comfortable with our dividend growth strategy even though it may not offer the excitement of chasing headline stocks or the latest investment trends. We believe the strategy offers an opportunity to generate competitive returns with an eye toward managing risk. It doesn’t hurt that it also gives investors ammunition to help cope with inflation. |
Matthew WrightFormer Wall Street mutual fund manager turned personal investment advisor. Archives
September 2022
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