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Dividend Reinvestment & Compound Interest

Their combined power must be recognized & appreciated.

Why reroute dividends back into your investments? Isn’t taking the income the preferred outcome when a dividend is produced?

Retirees and pre-retirees are eager for dividend income in this era of historically low interest rates. Even so, the choice to buy more shares has merit for the long run.

Reinvestment & compounding may have profoundly positive effects. As a hypothetical example, let’s say you own 100 shares of a stock with a $10 share price. For the sake of mathematical convenience, let’s say that this stock maintains that share price while providing you with a 3% annual dividend. That 3% payment breaks down to a 0.75% quarterly dividend ($7.50 per quarter going to you). You choose to reinvest these payouts, buying more shares each quarter. So after one quarter, you own 100.75 shares of that stock (valued at $1,007.50), and a year later, you own 103.034 shares (valued at $1,030.34). Your annual yield effectively improved from 3% to 3.34%.1

That’s after one year. The big picture, even with such a simple example, is easily grasped here. While past performance is no indicator of future results, some recent stock market history illuminates the power of dividend reinvestment and compounding further.

Bears reference the “lost decade” of the 2000s, but dividend trends from that era certainly put stock market investing in a more positive light. Even with the 2000-02 bear market and 2008 downturn, S&P 500 firms increased their dividends by an average of 5.46% in a 10-year stretch that witnessed both those market setbacks. In the same ten-year period, DJIA companies boosted their dividends by an average of 7.07% per year, while NASDAQ firms bumped up theirs by an annual average of 45.38%! If an investor put $100,000 into a hypothetical investment that performed similarly to the DJIA on January 1, 2000, simple price appreciation would have taken its value north to more than $105,000 by January 1, 2012. Yet across the same 12 market years, that hypothetical $100,000 invested with dividends would have grown to approximately $141,000 by the start of 2012.2

Over 80% of S&P 500 firms pay dividends. In September 2013, 83% of stocks in the index were issuing dividend payments – the most in 15 years – with dividends from 99 firms at 3% or better. Some firms paid them out even as they lost money.3,4

Think about DRIPs. About 1,000 publicly traded firms offer dividend reinvestment plans (DRIPs), and you can get into them for the price of a single share. DRIPs let you buy partial shares using your reinvested dividends – often without a fee. (You can also open a DRIP using a broker, but commissions and transfer charges may apply.) This is really another form of dollar cost averaging – slow and steady investment with the potential for a considerable long-term benefit. Multiple DRIPs mean multiple 1099s and some shareholders lose track of DRIPs over time, but they offer you a nice way to broaden your portfolio.5

Do you work for a big company that offers a DRIP? While you expose your portfolio to too much risk by assigning too much of it to one company’s stock, the reinvestment and compounding potential of a no-fee DRIP certainly warrants your attention.

Here is another hypothetical example. Say you go to work for the Rewarding Corporation and you invest an initial $1,000 in its employee DRIP, buying 100 shares at that price. You make $100 monthly contributions to the drip for the next 20 years while the shares appreciate 5% annually over that period and the dividend yield averages 2.3%. (We’ll factor in unchanging capital gains tax rates of 15% as well.) Twenty years later, your investment grows to $52,790.80. If your consistent monthly contribution to the DRIP is $250 rather than $100, you end up with $126,221.11 under the same conditions.6

Keep investing consistently, with compounding & reinvestment in mind. It may make a huge financial difference for you over time – a difference that might even let you retire earlier instead of later.

Warmest Regards,

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Citations.

1 – beta.fool.com/cacody/2012/09/02/compound-interest-the-8th-wonder-of-the-world/10945/ [9/2/13]

2 – tinyurl.com/pftknyj [3/26/13]

3 – factset.com/dividend [9/16/13]

4 – 247wallst.com/special-report/2013/10/02/the-highest-yielding-dividends-that-are-safe-to-hold/ [10/2/13]

5 – consumerreports.org/cro/money/personal-investing/drip-your-way-to-growth/overview/index.htm [10/11]

6 – hughchou.org/calc/drip.php [10/17/13]

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Cash Flow Management

An underappreciated fundamental in financial planning.

You’ve probably heard the saying that “cash is king,” and whether you own a business or not, it is a truth that applies. Most discussions of business and personal “financial planning” involve tomorrow’s goals, but those goals may not be realized without attention to cash flow today.

Management of available cash flow is a key in any kind of financial planning. Ignore it, and you may inadvertently sabotage your efforts to grow your company or build personal wealth.

Cash flow statements are important for any small business. They can reveal so much to the owner(s) and/or CFO, because as they track inflows and outflows, they bring non-cash items and expenditures to light. They denote your sources and uses of cash, per month and per year. Income statements and P&L statements may provide inadequate clues about that, even though they help you forecast cash flow trends. 

Cash flow statements can tell you what P&L statements won’t. Are you profitable, but cash-poor? If your company is growing by leaps and bounds, that can happen. Are you personally taking too much cash out of the business and unintentionally letting your growth company morph into a lifestyle company? Are your receivables getting out of hand? Is inventory growth a concern? If you’ve arranged a loan, how much is your principal payment each month and to what degree is that eating up cash in your business? How much money are you spending on capital equipment?

A good CFS tracks your operating, investing and financing activities. Hopefully, the sum of these activities results in a positive number at the bottom of the CFS. If not, the business may need to change to survive.

In what ways can a small business improve cash flow management? There are some fairly simple ways to do it, and your CFS can typically identify the factors that may be sapping your cash flow. You may find that your suppliers or vendors are too costly; maybe you can negotiate (or even barter) with them. Like many companies, you may find your cash flow surges during some quarters or seasons of the year and wanes during others. What steps could you take to improve it outside of the peak season or quarter?

What kind of recurring, predictable sales can your business generate? You might want to work on the art of continuity sales – turning your customers into something like subscribers to your services. Perhaps price points need adjusting. As for lingering receivables, swiftly preparing and delivering invoices tends to speed up cash collection. Another way to get clients to pay faster: offer a slight discount if they pay up, say, within a week (and/or a slight penalty to those that don’t). Think about asking for some cash up front, before you go to work for a client or customer (if you don’t do this already).

While the Small Business Association states that only about 10% of entrepreneurs draw entirely on their credit cards for startup capital, there is still a temptation for an owner of a new venture to go out and get a high-limit business credit card. It might be better to shop for one with cash back possibilities or business rewards in mind. If your business isn’t set up to receive credit card payments, consider it – the potential for added cash flow could render the processing fees utterly trivial.1

How can a household better its cash flow? One quick way to do it is to lessen or reduce your fixed expenses, specifically loan and rent payments. Another step is to impose a ceiling on your variable expenses (ranging from food to entertainment), and you may also save some money in separating some or all those expenses from credit card use. Refinancing – if you can do it – and downsizing can certainly help. There are many, many free cash flow statement tools online where you can track family inflows and outflows. (Your outflows may include bugaboos like long-term service contracts and installment payment plans.) Selling things you don’t want can make you money in the short term; converting a hobby into an income source or business venture could help in the long term. 

Better cash flow boosts your potential to reach your financial goals. A positive cash flow can contribute to investment, compounding, savings – all the good things that tend to happen when you pay yourself first.

Warm Regards,

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Citations.

1 – smallbusinesscomputing.com/tipsforsmallbusiness/5-tips-for-a-smoother-small-business-cash-flow.html [11/19/12]

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7 PRINCIPLES OF LONG-TERM INVESTING

Increasing your wealth over time is about more than making the right stock picks or always buying low and selling high. Too often, we see intelligent investors shoot themselves in the feet by making fundamental errors in their investing strategy.

Through years of experience, we have observed the effects of fear, greed, lack of discipline, groupthink, and many other pitfalls that investors experience. Accordingly, we have compiled this list of seven principles of long-term investing. These are by no means exhaustive, nor will they guarantee investment success, but we hope that you will find them useful in helping you make investment decisions.

1. FOCUS ON THE TOTAL REAL RETURN OF YOUR INVESTMENTS

To maximize investment growth over time, it’s critical to factor in the effects of fees, taxes and inflation on your returns. Many posted investment returns explicitly exclude the effects of fees, which come right off the top of each year’s gains, so it’s important to dig a little deeper and find out how much that performance is costing you each year.

Taxes can also take a serious bite out of your investment gains each year and it’s important to structure your investments to account for taxes on capital gains, dividends, and income. While we don’t believe that taxes should be the primary driver of an investment strategy, incorporating tax efficiency into your overall plan will help you keep more of what you earn. If taxes are a problem for you, structuring your investments so that taxable investments can grow in a tax-deferred account may be an option.

Inflation, the erosion of your purchasing power over time from increases in the cost of goods, is another insidious force that can eat away at investment growth each year. For example, a candy bar that cost 25 cents in 1975 would cost over a dollar today, due to the effects of rising prices. That same candy bar would cost approximately $1.30 in 2020 if we assume an annual inflation of 4 percent per year. Consumer prices have risen each year in the United States. In the century since the U.S. Department of Labor was founded and began tracking consumer prices, the average annual inflation has been 3.22 percent each year, which means that what cost one dollar in 1913 costs $23.51 today.

To put these numbers in the context of investments, an assumed inflation rate of 4 percent will reduce the value of a $100,000 portfolio invested today to approximately $67,500 in just ten years; this means that your investments would have to grow to $148,000 during that time period – a 48 percent gain – simply to keep pace with inflation. And this number doesn’t include the effects of taxes and fees on investment performance.

In an effort to reduce risk, many people over-invest in fixed-income securities, which are highly exposed to inflation risk since they do not have the same potential for capital appreciation as equities. We recommend that our clients’ portfolios contain enough exposure to equities for their ability to fight inflation through growth. Historically, common stocks have offered the best performance over time. For the period 1928 to 2011, the S&P 500 returned an average annual performance of 9.2 percent, while 10-Year Treasury bonds returned just 5.1 percent, investment-grade corporate bonds returned 6.0 percent, and inflation during the same period was 3.2 percent.  It can be psychologically difficult to weather the volatility of equity markets, but investors who fail to adequately plan for the effects of inflation risk running out of money later in life.

An investment strategy that fails to account for the effects of fees, taxes and inflation on overall return will severely handicap your ability to increase your wealth over time. After some research, you may find that in some cases, an investment with a lower return may actually have a higher total return once you account for taxes, fees, and inflation.

2. DON’T CHASE THE CROWD

No one knows with any certainty which direction markets will go in the future. However, a good axiom to remember is that it is usually wise to avoid following the herd. By the time your friends, family, neighbors and newspaper columnists are all investing in a particular sector or security, it’s often too late to benefit because hype has already inflated the price. Whenever investment dollars charge in, prices soar and savvy investors usually move on. By the time the mass of average investors have caught on to a new fad, prices are often too high and investments are overvalued, making them a poor choice for investors who are seeking value.

We don’t necessarily advise becoming contrarian investors, i.e. those who believe that crowds are always wrong and look for opportunities to invest against the prevailing trend. Instead, we strongly encourage an investment strategy that is based on objective research using the best information available, calculated choices, a realistic assessment of risk, and a determination to avoid emotional decision-making.

The herd mentality is a well-documented pitfall among investors and it can have striking consequences for investment performance. Investment clubs, which were popular during the 1990s, were studied as part of a study in 2000 about the dangers of groupthink. These clubs, made up of amateur investors, often favored certain sectors and investment types such as small-cap domestic stocks to the exclusion of all other types. Researchers at the University of California found that portfolio returns of investment clubs lagged the S&P 500 index   by 3.7 percent per year, meaning that members did worse as part of the group than the market overall during the same period.

3. REMAIN FLEXIBLE AND DIVERSIFIED*

In today’s volatile markets a successful long-term investment strategy can often benefit from flexibility and proper diversification. Diversification is one of the pillars of modern investment theory and can be a powerful tool to reduce certain types of risk in your portfolio. Be sure that your overall portfolio contains a variety of quality investment types, including stocks, bonds, international securities, and a few alternative investments if your risk profile and investment goals support them.

No matter how careful or prudent you are, you cannot predict or control future market movements. Much of the market volatility of the last few years has been driven by economic events that are outside any investor’s control. Global economic events, natural disasters, and government activities can all cause large-scale market movements. While we can’t diversify away all forms of risk, a flexible strategy can help you find investment opportunities in many market conditions.

On the level of individual companies, any number of unforeseen factors can affect a stock’s price: Natural disasters, supply line disruptions, unexpected technological advances by a competitor, or the loss of a major partner can all cost a company millions of dollars in losses and affect its value to your portfolio. Since it’s impossible to predict these events, it’s important to implement an investment strategy that diversifies by industry, by risk level, by country, by investment type, and other factors. While diversification can’t always protect your assets in times of widespread market declines, by spreading investment risk among a wide variety of securities, we hope that what affects one part of a portfolio doesn’t bring down the value of the whole.

It’s important to remember that there is no single kind of investment that is always best. There is a time to purchase corporate bonds, Treasuries, blue chip stocks, small-cap stocks, internationals and so on. And there are times when it’s best to keep enough cash on hand to take advantage of investment opportunities that present themselves.

4. BUY VALUE, NOT MARKET TRENDS OR THE ECONOMIC OUTLOOK

Wise investors focus on value when evaluating investment options. Too many investors focus on buying market trends and economic outlook, not realizing that trends can be deceiving and markets often perform very differently from the economy. Individual stocks can easily surprise you – rising in a down market, and falling during a rally – making it important for long-term investors to focus on buying quality investments with good fundamentals.

While economic trends can exert a powerful effect on market movements, the stock market and the economy do not move with perfect correlation and there are many occasions in which markets rally in spite of poor economic fundamentals or declining corporate earnings. This is not to say that economic outlook is unimportant. Over the long term, market movements often foreshadow economic trends as investors attempt to “price in” how they expect the economy to affect stock prices. A smart investor keeps an eye on the economy and factors economic outlook into investment decisions, but ultimately seeks out high-quality individual investments.

5. TAKE THE RIGHT AMOUNT OF RISK

Experience and research has taught us that investors do best when they take on the right amount of risk for their individual goals and tolerance. Too many investors focus strictly on generating returns while ignoring the importance of managing risk properly. Although there are many different types of risk, when discussing portfolios, we generally are referring to systematic risk: risk that affects markets as a whole, such as recessions and wars; or unsystematic risk: risk that is specific to individual stocks and securities that can be addressed through diversification.

Too much risk can leave your nest egg vulnerable to market swings with too little time to recover before you must start withdrawing money and locking in the losses. Too little risk in your portfolio will reduce your potential for capital appreciation and allow inflation to eat away at the long-term value of your investments.

The challenge is in ascertaining how much risk is right for you and your portfolio. Determining risk tolerance and the appropriate amount of risk for your investment goals is one of the most important things we help our clients with.

Obviously, no one wants to see their portfolio lose money at any point, but it’s important to understand that, generally, one must take on more risk in order to achieve higher long-term returns. It’s vital to be honest about your ability to withstand short-term swings in value and take investment losses in the pursuit of returns.

Another essential question that you must answer is how much risk you need to take on in order to meet your investment goals. Modern portfolio theory hypothesizes that there is an asset allocation strategy that will generate the highest return for every risk level. The right risk allocation for a portfolio will depend on a number of factors, including your expectations for return, investment objectives, time horizon, and appetite for risk.

Many popular asset allocation tools focus on age – or time until retirement – as the primary driver of an allocation strategy. While this can be useful, we believe that age is only one factor in determining a proper asset allocation strategy; other factors include liquidity needs, net worth, and investing priorities. On the face of it, the logic of decreasing allocation to equities and increasing fixed income holdings as one gets older seems reasonable. As investors approach retirement, their ability to wait out portfolio swings or earn their way out of losses diminishes. However, many age-based allocations fail to adequately account for longer lifespans and the effects of inflation, putting investors at risk of running out of money later in life.

Ultimately, holding the wrong amount of risk means that you may not realize the investment gains that you expect or that you may experience wider swings in portfolio value than you can stomach. If you are unsure about the current level of risk in your portfolio or have questions about risk management, it may be worth talking to us. We can help you understand your options.

6. LEARN FROM YOUR MISTAKES

The words “this time is different” are among the most costly words in the history of investing. One of the key differences between successful long-term investors and those who are not, is that successful people learn from their own mistakes and commit to never making the same mistakes twice. Even when a mistake results in a large loss, take a step back to review the actions that led to the loss. Don’t compound the errors by taking bigger risks in an effort to recover your money. Determine where you went astray and take steps to ensure that you avoid the same mistake in the future.

Many common investing mistakes can be attributed to emotional decision-making. Whenever you make financial or investment decisions, you will confront the challenges of overcoming fear and greed. Fear can cause you to run for the exits when markets decline or your portfolio takes losses. Greed can encourage you to chase fads and take on too much risk in the pursuit of a big score. However, by recognizing your emotional triggers and engaging your rational mind, you can overcome your impulses and cultivate discipline.

Working with a financial professional can help avoid emotional decision-making and many other pitfalls commonly encountered by amateur investors. It’s our job to remain focused on the long-term strategy and act as a voice of reason when emotions run high. In today’s world of high-tech investing, major financial decisions are only a click away and investors pay a high price for short-term thinking. Professional financial representatives can be invaluable for their ability to answer questions, provide reassurance, and keep financial strategies on track despite volatile conditions.

7. AGGRESSIVELY MONITOR YOUR INVESTMENTS, OR PAY SOMEONE SKILLED TO DO IT

When markets are rising and amateur investors are doing very well, it’s easy to forget that protecting your assets during declining markets requires skill, discipline and constant attention. Investors need to expect and be prepared to react to fast-moving markets. No market rally is permanent and no decline lasts forever, meaning that there are no investments that you can buy and forget about. The pace of change of today’s markets is too great for investors to be complacent. For example, the 30 companies that make up the Dow Jones Industrials, which are some of the largest publicly traded companies in the U.S., have changed numerous times since the Dow’s inception in 1896. These companies were removed as they declined, were acquired, went private, or simply went bankrupt.

Investing with long-term assets is not child’s play since most investors can ill-afford to lose their nest egg. Today’s markets are no place for dabblers without the time, patience, discipline, and diligence needed to do a proper job. If you aren’t completely sure that you have what it takes to manage your investments well, it may be time to find a professional financial representative with the skills and experience to do it for you.

CONCLUSIONS

Achieving long-term investing success is challenging and requires discipline, time, and skill. While it’s not possible to predict future returns or market movements, it is possible to develop strategies that mitigate risk and place us in the best position to achieve reasonable returns. No strategy is perfect, but our experience has shown that when used with prudence, these guiding principles can help investors achieve financial success over the long term. We hope you’ve found these rules useful and that they will help you in your financial journey.

Footnotes, disclosures and sources:

* Diversification does not guarantee profit nor is it guaranteed to protect investments from losses.

Neither the named representative nor the named Broker dealer gives tax or legal advice.

Opinions, estimates, forecasts and statements of financial market trends that are based on current market conditions constitute our judgment and are subject to change without notice.

This material is for information purposes only and is not intended as an offer or solicitation with respect to the purchase or sale of any security.

Investing in small- and mid-size companies may involve greater risk in price volatility and potential reward than investing in larger, more established companies.

 International investing presents certain risks not associated with investing solely in the United States. These include currency fluctuations, political risks, accounting procedure differences and the lesser degree of public information required to be provided by non-U.S. companies.

Investing involves risk including the potential loss of principal. No investment strategy can guarantee a profit or protect against loss in periods of declining values.

Opinions expressed are not intended as investment advice or to predict future performance.

Past performance does not guarantee future results.

Consult your financial professional before making any investment decision.

Opinions expressed are subject to change without notice and are not intended as investment advice or to predict future performance.

All information is believed to be from reliable sources; however, we make no representation as to its completeness or accuracy. Please consult your financial advisor for further information.

These are the views of Platinum Advisor Marketing Strategies, LLC, and not necessarily those of the named representative or named Broker dealer, and should not be construed as investment advice.

[1] Bureau of Labor Statistics. Inflation Calculator. Source: http://www.bls.gov/data/inflation_calculator.htm  

[1] Annual Returns on Stock, T.Bonds and T.Bills: 1928 – Current. Aswath Damodaran. Source: http://people.stern.nyu.edu/adamodar/New_Home_Page/datafile/histretSP.html#_msoanchor_1 , Long Term Returns. Historical Long Term Investment Grade Corporate Bond Returns. Source: http://www.longtermreturns.com/2012/01/historical-long-term-investment-grade.html , Multipl.com. US Inflation Rate by Year. Source: http://www.multpl.com/inflation/table

[1] The Standard & Poor’s 500 (S&P 500) is an unmanaged group of securities considered to be representative of the stock market in general. You cannot invest directly in an index.

[1] Barber B. and Odean T. “Too Many Cooks Spoil the Profits: Investment Club Performance.” 2000. AIMR. Source: http://faculty.haas.berkeley.edu/odean/papers%20current%20versions/faj%20jf00%20barber%20and%20odean.pdf

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The Annual Financial Check-Up

Don’t ignore it. Here’s why.

Here’s the scenario … you get a card in the mail, one of those little reminders that tells you it’s time for your annual financial checkup. Your reaction: I’ll take care of that later. Here’s why you should look forward to it.

Why do I need an annual review? Because things change, and during the course of the last 12 months, you may have … changed jobs, made major purchases, welcomed a new child, retired, bought or sold a residence, decided upon new goals. These developments can change your financial objectives. Also, it is just sensible to measure your financial progress. If you are not making progress in accumulating assets, or if you are assuming too much risk as a result of your current portfolio or financial decisions, it’s time for change.

The annual review is a “deep breath” where you can get away from daily distractions and think clearly about financial planning.

Just imagine. Imagine letting your investments go for five or ten years, assuming that they’re doing okay while you wonder what the quarterly statements mean. Imagine being a few years from retirement only to find you have less than a year’s salary in savings. Imagine passing away and leaving unresolved money issues for your loved ones, or subjecting them to a contentious probate process.

These scenarios are all too real; people run to financial advisors for help with them every day. If they had only reviewed what was happening with their lives financially, they could have planned to avoid these issues in advance. Putting things off can be dangerous.

This is an ideal time to take a look under the hood – financially speaking. During your annual review, you can estimate your net worth, and also possibly learn about any tax changes that might affect your investments, business or estate. It’s also a good time to make voluntary IRA contributions, and get college funding and financial aid applications underway.

Financial planning is not an event you do once in your lifetime and forget about. Financial planning should be an ongoing priority.

“Don’t put off until tomorrow what you can do today.” ~ Benjamin Franklin

Happy planning,

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