Client Note {Conclusion}

Here is the conclusion to our recent client note:

You have said before that dividends are ETF’s secret weapon.   What do you mean by that?  

 Dividends are the silent workers in a portfolio.  They don’t directly add to value each day like price movement and when they show up in a portfolio they generally arrive with little fanfare.  But over time their contributions add up.  Let’s illustrate this with an example using an actual ETF, although I will not name the security I’m discussing so as to not be seen as recommending a specific name.  {Feel free to call if you want to know the ETF. Also as a disclosure many clients own this security with us.} There is a dividend paying ETF that first came to the markets in 2003. It started trading at $50 and went below $26 in 2009.  It has appreciated along with the markets since then and now trades around $71. It has paid its dividend every quarter since inception, although the dividend did decline after the 2008-2009 bear market. If you had bought that security on it’s initial offering it has paid you nearly $25 in dividends and the dividend has increased 50% since its initial payment.  If you bought in 2009 or even in the next few years, your current dividend is about 3.45% but the yield based on your original investment is currently north of 6%.  This ETF’s dividend should increase over the years as the economy grows.   Growth like this may be boring to some but our opinion is that boring works in the long run.  Dividends like this can also provide some support in market declines. 

We should also mention how ETFs provide some stability in unstable markets.  I wrote about this last fall but will repeat again here.  There are enormous advantages to ETFs, especially during volatile times.  ETFs are not immune from market declines.  If their underlying index declines then they will also lose value by something that mirrors the decline in the underlying index.  They are also not a panacea for volatility.  The events of the most recent flash crash last fall shows that ETFs can be violently whipsawed around.  However, we can invest during such periods knowing we are buying a diversified portfolio of assets, backed by the value of the securities in an underlying index while removing single stock risk from the portfolio.  The history of equities tells us they can be wracked by fraud, can trade to zero due to a catastrophic loss or be rendered obsolete by unforeseen technological change.  It is an extremely low probability event that a plain vanilla ETF, especially one with a long trading history and based on a well-established index, will suffer such a catastrophic event causing it to lose all value.  We say this is a low probability event because 30 years of investing tells us there are no guarantees.  However, the inherent value of the underlying assets and the unique creation and redemption process of ETFs make this unlikely.  Frankly probability suggests the only events that would cause the inherent value of a majority of ETFs to trade to zero would be ones where we think most of us would have more things on our minds then the value of our investment portfolios.  Because the underlying assets supporting ETFs have value, we can use our systematic approach to creating portfolios and strategies from this asset class.

 Finally a note on market volatility.

Investors hate volatility.  Rather I should say investors hate volatility that leads to portfolio declines.  I receive few questions about markets on days where they go up 2%.  So I will repeat what I have often said in the past.  We know of no mechanism or system short of being 100% in cash that can completely protect a portfolio from volatile markets.  If Warren Buffett has not developed a way to protect his portfolio from market declines then we surely are not about to.  {Buffet’s Berkshire Hathaway by the way was down 11% in 2015.}  While there are ways to hedge a portfolio, these can be expensive and will often produce losses as a function of the hedge that the average investor is not willing to tolerate.  The best hedge in our opinion for a portfolio is cash.  The best action in our analysis is to have a disciplined investment plan and to readjust that plan as market forces dictate.

*Long ETFs related to the S&P 500 in client and personal accounts, although positions can change at any time.

I will be attending the Inside ETFs conference next week and posting may be sporadic from there.  I will resume a regular schedule the week of February 1st.  Of course we'll break in if events warrant.