Long Term Investments

Some interesting notes from Blackrock regarding dividends and the S&P 500.

-409 S&P 500 companies were paying dividends as of 04.30.2013.  

-More than 60% of these companies had a yield higher than the 10 year treasury.

-S&P 500 dividends increases have historically outpaced the rate of inflation by 1%-1.5%.

So let's think about this.  If you did nothing but buy an ETF based on the S&P 500 today you would be buying an instrument that pays you a dividend yield greater than the 10 year treasury with a growth component over time.  If you never sell that ETF you will never pay tax on its appreciation.  Let's make an assumption and say that from today's levels, price appreciation of the S&P 500 is just 3% over the next twenty-five years- a rate well below its historical average.  Your money from appreciation will approximately double.  $100,000 will be slightly larger than $200,000.   If on the day that money doubles and assuming our current tax code is in place then, you pass away {or "step off" as a friend of mine says}.   If your estate is under five million you will have never paid a dime of capital gains taxes on this investment, although you will have paid taxes over the years on the dividends.    Remember also that we are using in this example a rate of return below the historical 5-6% return that stocks have increased. 

What are your options today?   What are the options most of us have?  In the main here's what I see.

Well for one thing there's real estate.  My gut feel has been that excess cash from investors has been going into this since the 2008 crash, especially those who might be interested in a second home and have the ability to purchase such an asset.  Vacation markets have had great bargains over the past five years.   Somebody with excess cash in a taxable account might have been tempted to buy that retirement or second home, reasoning that even if they never made a dime on the place it was something they could use or at least wouldn't go away.  Like the stock market though these places have also rebounded in price today.

There's also annuities.  Don't get me started on these.  Someday I'll do a series on how big a rip-off I think these are.

Then there's bonds.  It is hard for me to understand why anybody would put anything other than nominal amounts of money in bonds or CDs today with yields being so paltry.  At best if bond prices never move higher from here you will lose money and purchasing power from the corrosive effects of income taxes and inflation.  If yields start to move higher you will lose principal value until maturity.  Billions of dollars however still are flowing into bond funds.

So equities via ETFs today can give you income that's competitive with bonds and an appreciation kicker.  What's the trade off?  Well stock markets have and will continue to experience declines.  Even if the secular bear market is over and we're going into a better economic place there will be periods of market volatility.  We're seeing an example of this today.  Japan is down before our open about 7%.  US stocks are poised to lose between 1-2% at our open.  Stocks have historically seen price declines of 5-20% even in good times.  That's just the natural volatility of things.  However.......

Volatility is not necessarily risk.  It is the price you pay for being in a completely liquid investment such as stocks or ETFs.  ETFs are subject to volatility risk and market declines like every other instrument.  They are in general not subject to single stock risk-the risk that an event such as a bad earnings report or an unexpected event such as an accident or a product failure will immediately and perhaps permanently impair your principal.  The reason that I say in general is because it is possible in some ETFs for certain components {think Apple in the QQQs} to become such a large part of the index that it's price decline will hurt the ETF's performance.  But I know of no single stock event, even an individual stock going to zero that will completely wipe out the principal value of any ETF that I research.  That cannot be said for common stocks.  There may be something out there in the future lying in the weeds that can do this trick to some sort of ETF in the future, but I think that's unlikely given the way most of these are currently configured.  Also ETFs went through their own trial by fire in 2008-09 and for the most part held in there in regards to busting out and going away.  Even levered ETFs {disclosure here, I use some of these in certain strategies we employ for clients} for the most part survived and are thriving today.

In my view volatility is not risk if you have time.  Over time if the US and world economies continue to grow, the natural order of things should bail out prices.  You may have had to wait over five years  during the previous bear market but the markets are now at new highs.  That means even if you picked the worst time ever to buy say a general US stock market ETF, which in my mind is is September, 2008, if you held on during that time you've been made whole and then some.   Note though that the same cannot be said of individual stocks or certain sector ETFs.  Owners of individual bank stocks for example and financial ETFs have for the most part not recovered these highs, either have all foreign markets.  Perhaps the next time we see an event of that magnitude things will be different but so far that has not been the case.

Volatility is risk if you don't have time.  Here at Lumen Capital, we in general take a six to eighteen month view of markets.   If your time period is short, say if you need cash for a certain event like college tuition  before the fall, you probably shouldn't have that part of your investment money invested in stocks right now.  The risk of a volatility event in that period is too great.  Here I'm not talking about market seasonality.  This applies to anytime you see a need in the short term.  There's in general usually not enough time to recover.  

Longer term investors, especially those with an inordinate amount of money stashed in cash or bonds need to rethink their asset allocation.  Come talk to us and let us show you how we do it!

*Long ETFs related to the S&P 500 and the Nasdaq 100 QQQ's in client and personal accounts.  Long Apple individually in certain client accounts and in certain ETFs.

Link:  Blackrock.com: Digging into Dividends.

Next Monday is Memorial Day.  There will be no posts either then or Tuesday as I will be traveling that day.  As usual, we'll break in if events warrant.