The Patient Investor

Should You Depend on Dividend Stocks? Part 2: Dividend Stocks vs. Total Return Investing

In Part 1 of Should You Depend On Dividend Stocks? we described why dividend investing—or, buying up stocks known for attractive dividends—may not be an ideal strategy for generating a dependable income stream out of your investment portfolio.

In this blog, we’ll look at why we typically prefer a total return investment strategy over more concentrated dividend stock portfolios in many circumstances, including retirees who are drawing income out of their portfolios. Here are two questions for homing in on a more comprehensive way to build and spend your lifetime wealth:

1. Investing: As you invest and accumulate wealth over time, how can you pursue a potentially higher total return over time, given the level of market risk you can tolerate?

2. Divesting: As you take income out of your portfolio, how can you maintain its risk-managed structure, while generating tax-efficient withdrawals over time?

Where dividend investing can fall short on these pivotal counts, total return investing is structured to directly address them, head on.

How Does Total Return Investing Work?

Bottom line, there are essentially three ways any given investment can reward investors:

1. Interest/Dividends: A security can pay out more or less interest or dividends.

2. Capital Appreciation: A security can offer higher or lower capital gains or losses (based on how much you pay per share versus how much your shares are worth when you sell them).

3. Cost Control: As you buy and sell your holdings, you can incur more or fewer taxes and other costs that eat into your returns.

Instead of seeking to isolate and maximize dividends as a single solution, total-return investing seeks to make best use of all three of these potential money-making tools as they apply to you, your investment opportunities, and your personal financial goals.

Continue reading

The Patient Investor

Should You Depend on Dividend Stocks?

There’s a popular perception that “dividend stocks,” stocks known for paying out consistent dividends, can deliver decent returns, while also creating a dependable income stream for spending in retirement or elsewhere. But is loading up on dividend stocks really such a good idea? Building a concentrated position in dividend stocks may be appealing at first glance, but a closer look reveals cracks in the foundation. First, let’s look at how dividend stocks deliver their returns. Next, let’s see why we prefer the total return approach of a more globally diversified investment portfolio, even when you’re spending down your investments in retirement.

More Dividends Equals Less Capital

One of the greatest misperceptions about stock dividends is that they represent “free” or “extra” money, beyond the capital value of the shares you hold. This free-dividend fallacy leads many investors to think of stocks as their “cake,” and dividends as an extra layer of frosting. However, this view is not true.

As University of Chicago’s Samuel Hartzmark explains:

“[I]f you have a stock that is worth $10 and it pays a dollar worth of dividend, the price goes to $9, and you’ve got a dollar worth of dividend. So, unlike the bond where, if it paid a certain coupon payment, you end up with more money, when you receive a dividend, you have the exact same amount of money, just labeled slightly differently.”

Think of it like this—dividends are a bite out of your cake. You might not notice a specific dividend-driven price drop, since market pricing mechanisms are always instantaneously adjusting share prices based on myriad factors. But it’s there. Post-dividend, your stock—your slice of a company—is worth a tiny bit less.

Continue reading

The Patient Investor

Considering Private Debt in Diversified Portfolios

Let’s set the stage by discussing how we think about portfolio construction and why we often look beyond traditional stocks and bonds in an attempt to build more robust client portfolios. Most of our clients' primary objective is to improve their odds of meeting their financial goals, such as retirement. We believe broad diversification helps portfolios because the more asset classes and strategies that provide positive returns over time and diversify one another, the more predictable the portfolio’s range of returns. Furthermore, the more independently each asset class moves related to one another, the closer the correlation is to zero, and the more positive its diversification benefits. The end result of a broadly diversified portfolio is that it should experience a smoother ride over the long run.  Carl Richards of Behavior Gap does a nice job of simplifying this concept through the image.

The Allodium Investment Committee analyzes our recommended asset classes, strategies and portfolios eachyear. One newer asset class we’ve been evaluating is known as private debt. Without going into the specifics of any specific fund, let’s cover the basics of this asset class and why it is garnering attention.

What is Private Debt?

Private debt (also known as private credit) is comprised of direct loans made to U.S. middle-market companies bynonbank lenders. Borrowers typically have annual profits in the $10-100 million range and are similar in size to small and mid-cap companies in publicly traded equity markets.[1] The word “private” refers to the fact that these loans are not publicly tradeable and are meant to be held to maturity.  As a result, lenders are rewarded by an illiquidity premium that results in higher yields than most traditional bonds.

Direct loans have been a rapidly growing area of the investment universe in recent years, and direct lending increased 250% from its $400 billion size in 2019.  Larry Swedroe, Director of Research for The BAM Alliance, explained in a recent blog, “The enactment of the Dodd-Frank Act in 2010 made it increasingly expensive for small banks to operate, cutting off their supply of loans to small and mid-sized companies. As a result, private debt funds stepped in to fill the gap.” [2]

Continue reading

The Patient Investor

What Does a Strong Dollar Mean for the U.S. Economy?

In late September 2022, the U.S. dollar hit a 20-year high in an index that measures its value against six major currencies: the euro, the Japanese yen, the British pound, the Canadian dollar, the Swedish krona, and the Swiss franc. At the same time, a broader inflation-adjusted index that captures a basket of 26 foreign currencies reached its highest level since 1985. Both indexes eased slightly but remained near their highs in October.[1–2] Intuitively, it might seem that a strong dollar is good for the U.S. economy, but the effects are mixed in the context of other domestic and global pressures.

World Standard

The U.S. dollar is the world's reserve currency. About 40% of global financial transactions are executed in
dollars, with or without U.S. involvement.[3] As such, foreign governments, global financial institutions, and multinational companies all hold dollars, providing a level of demand regardless of other forces.

Demand for the dollar tends to increase during difficult times as investors seek stability and security. Despite
high inflation and recession predictions, the U.S. economy remains the strongest in the world.[4] Other countries are battling inflation, too, and the strong dollar is making their battles more difficult. The United States recovered more quickly from the pandemic recession, putting it in a better position to weather inflationary pressures.

The Federal Reserve's aggressive policy to combat inflation by raising interest rates has driven demand for the dollar even higher because of the appealing rates on dollar-denominated assets such as U.S. Treasury securities.

Continue reading

The Patient Investor

Evidence-Based Investing

How do you invest your money over the long-term? If you’ve read much of our work, you’ve probably noticed we embrace evidence-based investing. But what does that mean?

What is Evidence-Based Investing?

Evidence-based investors build and manage their portfolio based on what is expected to enhance future returns and/or dampen related risk exposures, according to the most robust evidence available. This also means sticking with your long-view, evidence-based strategy once it’s in place, despite the market’s uncertainties and your own self-doubts you’ll encounter along the way.

Evidence-Based Investing, Applied

Do you hope …

  1. Investors can come out ahead by finding mispriced stocks, bonds, and other trading opportunities; and/or by dodging in and out of rising and falling markets?

Or do you accept …

  1. The market’s rapid-fire trading creates relatively efficient pricing that is too random to consistently predict?

There is an overwhelming body of evidence suggesting investors should skip the first approach and act on the second assumption. This has been the case since at least 1952, when Harry Markowitz published Portfolio Selection in The Journal of Finance. In their book, “In Pursuit of the Perfect Portfolio,” professors Andrew Lo and Stephen Foerster describe:

“While it’s commonplace now to think of creating a diversified portfolio rather than investing in a collection of securities that each on their own look promising, that wasn’t always the case. It was Harry Markowitz who provided a theory and a process to the notion of diversification. He helped to create the industry of portfolio management.”

Markowitz’s work became known as Modern Portfolio Theory (MPT). Academics and practitioners have been building on it ever since. His initial work and others’ subsequent findings strongly support ignoring all the near-term noise and taking a long-view approach.

Continue reading