The Patient Investor

Reflections on the Stock Market and My Career

As the Dow Jones Industrial Average reached 40,000 on May 16, 2024, I found myself reflecting on my career and what I’ve witnessed in the U.S. stock market over the last twenty plus years.

Note: The “Dow” or Dow Jones Industrial Average is an index comprised of 30 of the largest companies in the United States stock market (such as McDonalds, Apple, and 3M).

As one of the oldest market indices, the “Dow” is often used as a proxy for how the stock market is performing.

While we believe broad diversification is prudent for investors (and that’s a whole topic itself), I’ll be focusing on the U.S. stock market here.

I began my career at Piper Jaffray in early 2000. I had just finished an MBA from the University of St. Thomas and the investment world intrigued me. Over the last several years, the markets had gone through an explosive rally, driven by the promise of the internet. Technologies were seeing their stock prices skyrocket and it seemed like everybody was jumping on board. What an exciting time to start a career in the financial world!

In one of my prior blogs entitled “Would you have fired Warren Buffett?” I discussed how Buffett underperformed during this time with some investors questioning if he was too old fashioned. Some went so far as to fire him as their investment manager.

Unfortunately, my hiring coincided with the end of the party. In what’s become known as the “tech bubble,” stocks cratered and the tech-focused NASDAQ index fell 78%. That was my first lesson in the risk of failing to diversify and chasing past returns. When a certain investment or sector gets hot, I’ve seen that play repeat itself over the years in things like individual stocks, real estate, and cryptocurrency.

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The Patient Investor

Who Is the Media?

In the past, we’ve been known to take aim at the media. That’s because there may be consequences that are not beneficial to your personal wealth if you read, watch, or listen to too much news—or if you read too much into the news you’re reading.

It’s human nature to react to the onslaught of information with fits of fear, excitement, or confusion. These emotions, in turn, may lead to counterproductive, buy high/sell low investing.

Often, the media is partially to blame for this. They know what attracts our attention. They know this is rarely the evidence-based, sensible fare investors are better off digesting daily. Many members of the press choose to pander to our junk-news cravings and prioritize their own profits over a commitment to their craft. 

Let's return to our question: Who is "the media"? We’re happy to report that not every member of the financial press is cut from the same self-serving cloth. There are financial journalists who could get away with manipulating us, but they choose not to. By understanding the difference, you may find it easier to identify who within the financial press is worth following, and who you would be best advised to “unlike."

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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.

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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.

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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]

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