You may be familiar with this picture. If not, do you see the old woman or the young woman? While this picture has been used in the past to demonstrate right brain and left brain thinking, I'm simply using it here to illustrate perspective.
Quite often, if not always, our perspective colors our view of things, such as whether you see the old woman or the young woman. I believe this is true in our investing as well. In fact, I believe our perspective is often what drives us to choose a certain style of investing, such as one which focuses on dividend growth or one that focuses on total return. But we should manage our perspective, much like taking our glasses off (or putting them on) in order to get a clearer picture of what we're attempting to view.
In a recent article titled How To Get The Most Out Of Dividend Growth Seeking Alpha contributor, Dale Roberts, attempted to make the case that dividend growth investors may be leaving money on the table by not focusing on total return. In the article he used the public portfolios of SA Contributors, Chowder and David Van Knapp, to illustrate his comparison with certain ETFs as a measure of total performance. He stated his article was a challenge to new investors thinking of using the DGI criteria, so my remarks are directed to the same audience.
My purpose is not to argue the point about leaving money on the table (in reality everyone leaves money on the table at some point) but to offer an opposing viewpoint to the following remarks where he said:
Of course all that matters in the accumulation phase is total return. In the end it will all be about how much money do you have to go shopping for dividends and income - when it comes time to spend the portfolio income and holdings.
Later on in the same article he added:
When all that matters is total return (how much you got) paying special attention to the dividend growth past history or portfolio income growth might be a distraction that leads to underperformance.
This was repeated in another article, where he made the comment that:
Of course in the accumulation phase all that matters is total return.
In my opinion there is much more that matters in the accumulation phase. Before I explain why I think these comments miss the mark, I'll clarify the perspective from which I view this.
First of all, my perspective is as a retiree, but one who is still in the accumulation phase of investing. In full disclosure, let me say I consider myself to be primarily a dividend growth investor. However, I also allocate a portion of my portfolio (up to 20%) to investments for which the purpose is capital appreciation, i.e. speculation, and which may or may not pay dividends. Part of that 20% allocation can be used for options as well. So while I manage the bulk of my portfolio with a goal to build income, I manage a portion of it to seek returns on capital, which means I ultimately want both income and capital appreciation.
Two things jumped out at me from the statements quoted above. First was the "all that matters" portion of the statement and second was that "in the end it all boils down to how much you have with which to obtain dividends and income." Here's why I think both of these are off-base.
One of the more basic problems with this statement is that it places all investors in the same bucket with the same goal at the end period, which is to have the most money to go shopping. But I like to say that investing is personal. While we should treat our investing like a business, inherently it is personal to each of us. We all have different goals, desires, and requirements for which the investments are intended to meet.
These are not the same for all investors and to lump all investors into the same group is painting with too broad a brush. Additionally, individual investors have different attributes, skills and abilities that both allow and prevent them from utilizing certain investment methods. For example, some investors are not comfortable using options or shorting stocks, whereas some use them frequently.
Furthermore, in the end it is not necessarily about how much money you have to go shopping. After all, a conservative investor who reaches retirement with $1,000,000 and who is unwilling to take much risk may construct a portfolio yielding 3% per year. They may invest in C Corporations like Coca Cola (NYSE:KO), Procter & Gamble (NYSE:PG), Johnson & Johnson (NYSE:JNJ), Walgreen (WAG), treasuries, municipals, and so forth. Another investor who retires with $500,000 but is willing to take on more risk builds a portfolio yielding 6%; investing in MLPs such as Kinder Morgan (NYSE:KMP), BDCs like Main Street Capital (NYSE:MAIN) or Prospect Capital (NASDAQ:PSEC), REITs like Annaly Capital (NYSE:NLY) or Omega Healthcare (NYSE:OHI), closed end funds like Eaton Vance Tax-Managed Diversified Equity Income Fund (NYSE:ETY), and even some small or mid cap companies. Mathematically both will throw off the exact same amount of cash and both are doable in today's investment arena.
Obviously most everyone initially would choose $1 million over $500K if given the choice, but the discriminating investor would ask "what do I have to do, what risks do I have to take, and what are the potential consequences in trying to achieve the higher number?" And the answer to those three things may change their response.
Another problem with the "accumulating and going shopping at the end" concept is that of waiting until one is ready to retire and then attempting to change investment methodologies. This completely disregards the learning curve that is inherent in choosing any investment methodology. Waiting until one is dependent upon the income from one's portfolio and then changing the style is potentially a train wreck waiting to happen. It's doable, but an investor should go slowly and tread carefully. Even if one has been investing for many years, changing the style from one seeking capital appreciation to one seeking reliable income requires transition time. The state of the market at that time can greatly affect the transition time required, not counting the individual investor's own skill set.
The "all that matters… is total return" portion of the statement implies that one should place their sole focus on total return. The reason I believe this is a mistake is that placing one's emphasis on total return drives one toward tendencies that lead to mistakes that are all too common in investing. I'm not saying don't invest for total return, I'm speaking of where the emphasis should be. Evaluating potential return as a consideration in analyzing a prospective investment is different than viewing total return as all that matters.
Focusing only on increasing returns will often lead to taking on more risk. If one is driven to increase returns by taking on more risk, the additional volatility that typically accompanies riskier investments can often be more than many can deal with emotionally. Emotional investing will most often lead to losses and it may lead to over-trading; this not only increases one's investment costs, but typically results in losses as well.
If an investor is solely focused on total return what typically happens to that investor when the market takes a dive? They feel the need to protect the amount they have so they sell at the lows, declare they'll never invest again, and then later decide to start buying back in just when the market is again at the highs. This has played out this way time and time again.
Don't misunderstand me, I am not against investing for total return. It is a valid method of investing, just as there are other ways to make money (and lose it) in the market. But the focus should be on following proven investment principles and not just seeking the highest return. Get the fundamental principles right and the returns will come. Understanding the potential for returns on a stock versus understanding the nature, quality, and intrinsic value of the underlying business or asset are two different things. One might say that higher returns are a by-product of getting a few individual things right and avoiding doing many individual things wrong.
So, if total return is NOT "all that matters" in the accumulation phase, what else matters? To me what matters is the accumulation of quality assets that will provide reliable income and/or returns over a long period of time. By long period of time I'm referring to 20 years or more. With that said, here are a few suggestions I believe should also matter to the investor in the accumulation phase.
- Patience: Learning to practice patience can be very important, especially in the accumulation phase. You're not in a sprint, it's a marathon. Decide you're in it for the long haul and every investment doesn't have to be a home run. And the awesome power of compounding comes from staying in the market and not by trading in and out. Patience is applicable to buying, holding, and selling.
- Don't Let The Market Dictate Your Decisions: The market is going to fluctuate. Portfolio swings are simply part of it. Once you realize your investment success doesn't depend on each and every tick of the market, you'll do much better as an investor. Resolve to use Mr. Market's mood swings to your advantage.
- Buy Only When At Appropriate Values: Value matters because over-paying will cost you in the long term. This goes hand in hand with both of the above points. All companies have an intrinsic worth. Learn how to determine when a company is being offered at a fair or under-valued price to their intrinsic worth or know where to get the information. Buy with a margin of safety.
- Stay In Your Circle of Competence: Know what you know how to do and work to get better at it, and know what you don't know. As someone once said, "half of being smart is knowing what you're dumb at". While one may want to work to continually enlarge their circle of competence, getting outside of it too soon can not only disrupt good habits but will in all likelihood cost you money.
- Focus on Fundamentals: By focusing on things such as earnings, return on equity, cash flow, profit margins, dividend history, business models, debt control, management practices, and so forth, one is more likely to invest in companies that will lead to more reliable income and returns. And that will matter greatly over the long term accumulation phase.
- Manage Your Risk: Risk matters. One should understand the risk involved in the investment being made. There are different ways to reduce and/or manage risk, such as diversification, limiting position size, holding non-correlated assets, etc. But much of managing risk is subjective. Know what you stand to lose in any given investment but also try to determine where the pitfalls are. The long term success of your investments lie more with managing your risk and controlling your losses than they do by the returns you get with your winners.
- Set Reasonable Goals: I earlier said investing is personal. Your goals should be as well. Thinking you need your portfolio to achieve a greater return simply because someone else is getting a higher return is a mistake. If your focus is income set goals for income. If it's return, set reasonable goals for a return you can achieve. Setting unreasonable goals can lead to taking on more risk, making mistakes, and losing money.
This is just a short list of seven things that, from my perspective, matter in both the accumulation phase and the distribution phase. There are a number of other things that matter as well. In his book "The Most Important Thing - Uncommon Sense for the Thoughtful Investor," Howard Marks lists twenty one different things that matter in investing. I highly recommend reading it.
As I stated in the beginning of this article, your perspective can have a huge impact on how you see the investment world. I personally see it primarily as a fertile field for collecting dividends and reinvesting them for accumulating even more dividends and more assets. Others may see it as a place to obtain returns on capital to grow their wealth. But whether your perspective and choices lead you toward dividends and income or towards investing solely for capital appreciation, or a combination of the two, focus on the things that matter most.
Disclosure: I am long ETY, JNJ, KO, OHI, PG, PSEC, WAG. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: I am not a professional investment advisor, just an individual handling his own account with his own money. You should do your own due diligence before investing your own funds.