I'm a big fan of the returns the big Ivy League endowment funds have been able to produce over the years. Yale has been able to produce a compound return of almost 16% over a 20 year period. Harvard produced a compound return of just over 14% over the same time frame. So it is with interest that I study the asset allocation of these funds each year.
However, as a small investor, I've always felt that I was unable to replicate the asset allocation of these endowment funds. They have been reducing these exposure to listed equity investments in recent years thereby making more difficult for an investor like myself to approximate what their investment portfolio contains.
But just recently, I read an article on the Kiplinger website (The Ivy Endowment-Fund Portfolio) where a simple portfolio is put forward which aims to copy the diversification and risk management techniques employed by the ivy league schools. The best part is that because the portfolio is composed of 10 exchange traded funds, the average investor like myself is able to buy these ETF's directly on the stock market.
The diversification achieved and low cost of using ETF's in an investment portfolio have been discussed at length many times the world over so I wont go into the arguments again here. Suffice to say that I'll be taking a closer look at the asset allocation recommended in the article to see whether it's worth incorporating some of the investment ideas into my own portfolio.
The stock market is plummeting. I can't believe the turnaround in investor sentiment in the last year or so. The Dow was over 14,000 just 18 months ago and now it looks like it might go down below 7,000 again. I know the economic outlook is not as rosy as it used to be but has the underlying value of the companies which make up the Dow really halved?
You could well argue that the stock market was overvalued 18 months ago and that it's really just approaching fair value now. I can't claim to be an expert on valuation of equities markets so this may well be the case - but even if it is the case, it still food for thought.
A patient investor who's willing to hold onto some cash when markets are racing out of control, will eventually be rewarded with better value. And that's where we are now. Stocks are on sale - they're 50% off.
Now I wont pretend that I'm not worried about the financial crisis. I have no idea how bad it will get or how long it will last. But I suspect that in 5 or 10 years time stock market investors (particularly value investors) will look back at this period as one of the best buying opportunities of a generation.
Having said that, I think investors should tread warily. I would stick to companies in sound financial shape - low debt and strong cash flows. And be prepared to see the market price of your investment continue to fall. But take comfort in the fact that it's almost impossible to pick the bottom and that you're still buying a quality business for half of what it sold for less than 2 years ago.
I should point out that I'm an private investor managing only my own money. I'm in no way qualified to give financial advice. You definitely should not take any of what you read on this blog as personal financial advice. See a professional. I could be spectacularly wrong - maybe the world really is coming to and end.
A little while back, in my post about building wealth, I mentioned that I thought it was important to re-invest any income derived from your investment portfolio. It is an example of the compounding effect at work. Today I'd like to share my thoughts on dividend reinvestment plans (sometimes referred to as DRIPs). Dividend re-investment is touted by many a being a great strategy for growing your investments over the long term.
What Is A Dividend Reinvestment Plan?
When a company declares and pays a dividend, investors would normally receive that amount in cash. Under a DRIP, an investor can opt to forgo the cash payment and instead receive the equivalent amount in company stock.
As an example, if you own 100 shares in a given company and that company declares a dividend of $1 per share, you would be entitled to a cash payment of $100. But if that company offered a dividend re-investment plan and you decided to participate in the plan then you could take the $100 in shares. If the company's stock was trading at $50, you would receive 2 shares under the DRIP.
Advantages Of Dividend Reinvestment
Participation in these schemes allows an investor to acquire more stock an a company without paying brokerage fees. This means it can be a low cost way of increasing your ownership of an investment. Even though only a small quantity of stock is accumulated each year, this can add up over a number of years.
To make it more attractive, some companies offer stock in their DRIP's at a discount to the current market price (around a 5% discount or so). This can make the plan an even more cost effective way to add to your holdings.
Disadvantages Of Dividend Reinvestment
The main issue I have with these plans is that you may not necessarily be investing your funds in an investment which represents the best value at any given time. I like the idea of re-investing the income from my stock market investments. It creates a compounding effect whereby the amount reinvested increases the income the following year and so on. But I like to choose where I invest my hard earned cash. I prefer to take all of the income received over a given period then plow it back into the opportunity which represents the best value at that time, or perhaps even invest in a new idea.
Another thing to consider is the additional paperwork required. You will need to track each purchase for tax purposes. As your portfolio starts to grow and the number of holding increases, you will need to track the issue of shares twice or sometimes 4 times per year for each holding.
When you put your money into a savings account at the bank, it is on the understanding that you will earn some interest on that deposit. It's your reward for letting bank use your money for a while. Alternatively, you could say it's the cost a bank incurs when borrowing your money. Dividends are a little bit like interest but with a number of subtle yet important differences.
A dividend is a payment a company makes to its owners (stock holders) out of any profits it makes in a given period. Dividends are normally paid either quarterly or half-yearly.
While the interest you receive on your deposit in a savings account is typically agreed up front (ie. the interest rate is advertised), the amount a company pays out in dividends is a little more fluid. The payout may fluctuate from year to year. If the company is successful, the the amount will normally go up each year. However, when profits falls, so does the dividend - and if things get really bad, there may be no payment at all.
Another thing to consider about dividends is the chance of capital appreciation (or capital loss). In order to receive a dividend, you must first buy stock in a given company. You may consider this to be the equivalent of making a deposit in a bank savings account. However, when it comes time to take your money back out again, there can be a big difference between a bank and a shareholding.
With a bank account, you would expect to receive back the same amount of money as you deposited, plus your interest (not withstanding the present economic climate). But with a stock market investment, you need to sell your shares to get your money back. And for this, you will be at the mercy of the markets. Stock prices may have gone up - but as we have seen over the past year, they can also go down.
Now it's is not all down and gloom with dividends. History tells us that provided you invest in good quality stocks for the long term, then your dividends, along with some capital growth, will exceed the interest you could get in the bank. Just be aware that a much longer time horizon is needed. Most investment professionals recommend 5 years or more.
Dividends are payments a company makes to its shareholders out of corporate profits. It is the income you receive for investing in the stock market.
Typically the returns derived from equity based investments like stocks take the form of capital growth (through a rising stock price) and income through dividends.
It's important to note that not all companies pay dividends. Newer companies and those experiencing high growth may decide to re-invest all of their profits back into the business. This may be a better outcome in the long term as it will grow the value of the business. But income investors want the cash now (or at least on a regular basis) rather than at some point in the future.
A convenient way of expressing this income component of return on your stock market investment is as a dividend yield. It's calculated by dividing the amount of the dividend by the price of the share. So a stock trading at $20 which pays a dividend of $1 would have yield of 5% (1 divided by 20).
But don't worry too much about the maths. These yield figures are available in the business section of most newspapers and on all of the finance and investing web sites (like Yahoo Finance and others). Using this figure, you can then compare the returns on offer for various stocks and get a rough idea of the relative values involved.
You can also compare the dividend yield to the interest rates available on the various bank savings accounts and other income investments. Just be aware the buying stock is not the same as putting money in the bank. The risks involved are much greater - you're not comparing apples with apples.
One of the key features of a personal finance plan is the section aimed at building wealth. And investing in the stock market can be a great way to accumulate wealth over the long term. And there are plenty of options to help you get started. You don't need to go out and buy a heap of shares straight away. In this post I'll examine some of the ways you can go about investing in the stock market.
Get A Good Adviser:
First off, find yourself a good adviser. The adviser could be a financial planner or a stock broker or even your accountant. This person must be trusted and must know you current financial situation well and understand what you future financial goals are. Finding the right person is especially important when you're just starting out. A financial planner could be useful if you're looking generally at investments as part of your overall financial plan. A stock broker is more useful when you're looking at making specific stock market investments.
Mutual Funds:
But you don't need to jump straight in. Rather than holding stock of individual companies, you may like to invest via a mutual fund. The managers of these products pool investors' funds together and buy a range of different stocks. One advantage of this approach is that you can achieve a level of diversification even if you don't have much to invest. In fact an investment in one mutual fund may gain you exposure to the stock of 60 to 80 companies or even more.
One thing to be aware of however, is that even though you're spreading the risk across different businesses and industry sectors by using a mutual fund, you are taking on specific risk associated with that mutual fund. Make sure you do your research before choosing a fund and get professional advice if need be. Another way of mitigating the specific risk is to consider buying more than one fund. It's all about eggs and baskets.
Investment Clubs:
This is something I've not yet tried but I'm quite interested in. An investment club is a group of stock market investors (or any sort of investors I guess) who pool their resources - both financial resources and brain power. The idea is that each member of the group contributes funds to the club and the members meet on a regular basis to make investment decisions.
To my way of thinking this has a couple of advantages. By putting your money together with others, you'll collectively have more buying power. This means you can diversify your investments more broadly. Instead of being able to buy stock in one company every one or two months by yourself, you may be able to make two or three purchases each month as part of a club (or even more depending on the number of members).
The other advantage is that you'll be making joint decisions. This means there will be more ideas on what stock you could buy and more people to filter out the poor ideas. Collectively you should be able put together a good stock portfolio over time.
The main disadvantage I can see is that because it's a group thing, you'll need to make sure it's a group of like minded people. Do they all share your investment philosophy? Are they long term investors or short term traders? Will their preference be value stocks or growth investing? And the more people involved, the harder it will be to gain a consensus.
Invest Regularly:
Whatever method (or methods) you choose, my preference is to invest regularly. It's like a regular savings plan. And by spreading your investment activities out over time you can avoid putting all of your money into the market at the very top. Detractors of this approach would argue that you will also avoid buying at the bottom of the cycle as well - thereby not buying as cheaply as you may have. There is some merit in this argument, however, timing the market is notoriously difficult so I'll leave the decision to you.
|
