Tag Archives: assets

Summary Introduction and series overview. The hardest lesson I have ever learned. The asset that always goes up in value when all other assets go down. Summary. Back to Part IV Introduction and Series Overview This series is meant to be an explanation of how I constructed my own portfolio. More importantly, it I hope to explain how I learned to invest over time, mostly through trial and error, learning from successes and failures. Each individual investor has different needs and a different level of risk tolerance. At 66, my tolerance is pretty low. The purpose of writing this series is to provide others with an example from which each one could, if they so choose, use as a guide to develop their own approach to investing. You may not choose to follow my methods but you may be able to understand how I developed mine and proceed from there. The first article in this series is worth the time to read based upon some of the many comments made by readers, as it provides what many would consider an overview of a unique approach to investing. Part II introduced readers to the questions that should be answered before determining assets to buy. I spent a good deal of that article explaining investing horizons, including an explanation of my own, to hopefully provoke readers to consider how they would answer those same questions. Once an individual or couple has determined the future needs for which they want to provide, he/she can quantify their goals. If the goals seem unreachable, then either the retirement age needs to be pushed further into the future or the goals need to become attainable. I then explained my approach to allocating between difference asset classes and summarized by listing my approximate percentage allocations as they currently stand in Parts III and III a. Part IV was an explanation of why I shy away from using ETFs and something akin to an anatomy of a flash crash. In this article I will explain one of the most difficult concepts for most investors to grasp. It certainly was for me. Why? Because we keep reading (or at least I do) that to do the opposite it is the best thing we can do. I will explain my education process as we go along in the article. The hardest lesson I have ever learned Growing up as a teenager in the 1960s I had to listen my Dad complain about inflation… a lot. Everything was getting more expensive and he owned his own business. Raising the prices he charged his customers was difficult for him but he had to do it because the cost of everything he used in his business, a small resort on the Canadian border waters of Minnesota, was rising. He kept telling me that the value of a dollar was going down. That lesson stuck with me. As I got a little older I went off to college after spending two glorious, all-expense paid year-long vacations in Southeast Asia, courtesy of my Uncle Sam. Yes sir, I got to spend time hiking trails and communing with nature with plenty of activities to keep my adrenaline flowing. What a rush! While in college I took a full load of classes and worked full time to pay my own way, helped once again by my good old Uncle who sent me 36 monthly checks to help with the cost of college. Every time I noticed that my savings had burgeoned to over two thousand dollars (I do not know why that number trigger an urge, but it did), I had to buy something. Otherwise, inflation would just eat away at that money as it became worth a little less each year. Thanks, Dad! Actually, I should not blame him because he did teach me how to save. He just stopped with that lesson and the one about inflation. The spending thing I came up with on my own. Then came my first professional job with a company car, liberal expense account, great pay, stock bonus and profit sharing. It was a nice start right out of college. This time I was so busy that my savings piled up faster than I could spend it. This was back in the late 1970s and interest rates were rising. At that point I knew nothing about stocks and very little about real estate. I had no interest in bonds, something that now I really wish I had understood well back then. By 1980 I had saved $25,000. That does not sound like much today, but in 1980 it seemed like a small fortune to me. If I had understood how bonds worked then I would have used all of it to buy 30-year U.S. Treasuries. I must admit right now that I did nothing very good with all that savings. I could explain but none of it would be very instructive nor beneficial to understand. To summarize, I did not have the same level of income but I did not adjust how I lived. While this is not the lesson of the article, it was a good one to learn early in life. Eventually, the money began to run low and I was forced to change some spending habits. Life would have been better had I had the foresight to make adjustments earlier. Live and learn. Looking back something that did not sink in at the time but has since become clear is that when interest rates are extremely high and housing values fall it is a great time to buy real estate. Interest rates will eventually drop providing an opportunity to refinance resulting in lower mortgage payments. Falling interest rates also tends to help boost real estate values at a higher rate than average. But that is not the lesson of the article either. The lesson that was so hard to learn was to unlearn what I learned from my Dad and from many other sources: holding cash without receiving any interest or income is a sure way for your savings to lose value because of inflation. I learned that not earning more than inflation on my money would cause me to permanently lose buying power. That is what I had learned all of my life. The hard part was to learn that what I had learned was wrong! Am I losing you? Stick with me a little longer and you will understand that what I am saying is true. It is not what any financial institution wants you to understand. Having money sitting in an account that may not keep up with inflation seems ridiculous, does it not? That is what we keep hearing. But that way of thinking just gets people to invest when they should be on the sidelines waiting for a better opportunity. Wall Street cannot make a profit on your money if you let it just sit there. They need transactions! The asset that always goes up in value when all other assets go down Cash is the one asset class that goes up in value when all other assets go down. Think about it for a few moments. If you have $10,000 in cash that you could invest in a the stock of a great company at $50 with a dividend of $1.25 now, would you do better than holding the cash until the share price went down to $40 two years later with a dividend of $1.40? The answer should be obvious. But rather than looking at a hypothetical situation I want to offer two real examples from my own portfolio. I decided back around the beginning of 1997 that I wanted to own shares of PepsiCo (NYSE: PEP ). My reason for liking PEP so much was that I was drinking several cans of the stuff every day at work. Most people drank coffee for the caffeine, I drank soda and my favorite was Pepsi. I know that is not a great reason, but I was just starting out. Besides, I knew I was not the only one who liked Pepsi products. After studying the stock I had some regret for not having bought it earlier and decided that I would only buy it if the price dropped back to $33 per share again. All of 1997 went by and the price did little other than rise. It was little different over most of 1998. I almost threw in the towel and bought the stock in March of 1998 at around $40. But at that price the dividend yield was under one percent. I decided to wait. Finally, sometime in late summer I learned about good-until-canceled buy orders. So, I placed an order to buy some shares at $33 per share, good-until-canceled and stopped worrying about it. In early October the shares traded down below $30 and I go my fill. I ended up buying the shares at $33. I could have done better, but I reminded myself that I was doing better than if I had bought at $40. It helped. I have since made another purchase of PEP and will go through that example in a minute. Now I want to show you how I did and the difference in results between my actual purchase and what would have happened had I pulled the trigger earlier at $40. To keep the math simple I will assume in both this and the next example that I had $10,000 to invest each time. If I had invested in PEP at $40 per share in March 1998, I would have gotten 250 shares. I would have collected a couple more dividend payments but the total of dividends I would have collected from then to now would be $5,814. My total gain would be $13,617. My original $10,000 investment would now be worth $29,431 and my dividend (as indicated) this year would be $680 for a 6.8 percent yield on my original investment. That all sounds pretty good. Here are the results of what the type of return I got by waiting for the price I wanted compared to the above example in table form. Date Price Shares Total Dividend Gain Original Value Current Value Comp Anl Rtn 2015 Dividend Yld 03/98 $40 250 $5,814 $13,617 $10,000 $29,431 11.4% $680 6.8% 10/98 $33 303 $6,967 $18,625 $10,000 $35,592 13.5% $814 8.1% The column for Compound Annual Return (Comp Anl Rtn) does not include reinvested dividends. The column labeled Yld represents the annual yield now earned on the original investment. Next I want to take a look at what I did later in life, after I had learned a little more about how the value of cash increases when other assets go down. But first, a little rant. I get tired of hearing that it does not matter if an investor buys shares in a company at the peak of a bull market or at the bottom of a bear market as long as they hold those shares long enough. The difference will become less over time, we are always told, and eventually become inconsequential. The problem with the examples they use to explain the difference is that they usually assume that the investor buys the same number of shares in both instances. Such examples do not consider the reality that an investor will be able to buy more shares at a lower price with the same amount of cash. Those additional shares result in more gain and a higher dividend yield and the difference increases over time. If I had followed the conventional wisdom that says it does not matter when you buy and invested $10,000 in PEP shares two months before the stock hit its high in 2007 I would have bought 142 shares at about $69.96, the average price on September 1, 2007. The stock traded as high as $77.41 in November 2007, so I am not taking the top of the market. I actually made a purchase on June 1, 2009, almost two years later. I missed all the dividend income that would have been collected for those two years, but I am glad I did. Check out the results in the chart below. Date Price Shares Total Dividends Total Gains Original Value Current Value Comp Anl Rtn 2015 Dividend Yld 9/1/2007 $69.96 142 $2,358 $3,480 $10,000 $15,772 5.9% $386 3.9% 6/1/2009 $52.82 189 $2,467 $7,872 $10,000 $20,339 9.3% $514 5.1% The results are obvious. Waiting for a better buying opportunity allowed me to buy more shares, collect more dividends, lock in a much higher yield and created a superior compound annual return. Again the returns do not include reinvested dividends or any income on the cash accumulated from collecting those dividends; doing so would only make the comparison more lopsided. Each time we go through another cycle I try to get better at identifying when an asset such as equities no longer offer me a bargain. At that point I stop buying and just begin to accumulate until the next time we experience a significant economic recession. I provided the two examples of my purchases of PEP shares for a reason. The first example, in 1998, represented a modest bear market swoon. The second example, 2007-2009, was a much more sever recessionary period. The point of the two examples was that it can be beneficial to wait whether the bear market is deep or relatively small. Summary The main point that I hope I have made clear is that when stocks, or any other asset, fall significantly in value the amount of that asset an investor can purchase with the same amount of cash increases. Stated differently, when the value of other assets falls, the value of cash increases. We need to stop thinking in terms of inflation eating away at the value of our cash and begin thinking in terms of how much more of an asset the same cash today will buy when the value of that asset drops. Cash has value, not only in terms of the everyday items that we buy. As an investment we need to think of cash as increasing or decreasing in value relative to other assets. This does not mean that we should only buy at the bottom after an asset class has crashed. What it does mean is that buying assets that are deeply undervalued will provide better returns than buying when those assets are fairly valued or above. After a crash like we experienced in 2008-09 real estate and equities remained deeply undervalued for several years. There were bargains everywhere I looked. I didn’t have enough cash to take advantage of all the opportunities. But I had more than most. And I benefited from my patience. Do not expect to be perfect. Just try to do better through each cycle. At our current point in time I believe that cash is king, but that does not mean I plan on selling any of my long-held holdings. I like my positions in most of my portfolio and I also like the dividends that help me accumulate more cash. In the next article of this series I plan to explain how I do trim some of my holdings systematically and why. After that I want to address the topic of tax efficiency in the following article. That is an area where some very simple planning can help a lot over a long holding period. I do not plan to cover the entire universe of tax planning because most of us do not need to understand it all. What I will cover are the simple things that we can all do if we just understand a little more about how to invest to avoid or defer taxes better. After that I would like to delve deeper into how to develop a plan for saving and investing, especially for those starting out, but also for those mid-stream of their accumulation and investing phase of life. One can always make adjustments and improve a little here and there. As always I welcome comments and questions and will do my best to provide details and answers. This is one of the best aspects of the SA community. We can learn from each other and share our perspectives so that other readers can benefit from the comprehensive knowledge and experience represented here.