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Co-produced with “Hidden Opportunities”
Introduction
Medical advancements have been coming at a rapid rate, many of which are credited for expanding the expected lifespan of adults all over the world. There was a time when reaching 50 years old was an impressive feat. Today, many adults live beyond the age of 80.
Yet in the market, we are seeing the opposite. Companies are seeing significantly shorter lifespans, they’re rising to prominence and crashing more rapidly than ever before. In fact, the average company lifetime has shrunk to ~10 years now, down from 60 years in the 1950s. This likely has had a big impact on how you are investing, and if it hasn’t, it should. Let’s look into why this is happening, and how to avoid losses due to this phenomenon, and make you a better investor.
Traveling Down History Lane
The history of the U.S. stock market can be traced back to 1792, under a buttonwood tree in today's Wall Street in New York City. Centuries have passed, and fortunes have been made and lost in this financial system. The idea of buying and selling securities hasn't changed much, however, there are many aspects of today's stock market that are vastly different from just 50-60 years ago.
The American public has a higher dependence on the financial markets today than ever before. Investors today can access, explore, and trade the markets in ways that were never possible previously. These changes, primarily driven by technology, are altering how we invest, meaning the concept of buying and holding forever may not necessarily be good for your retirement portfolio.
Your Retirement Finances Are Entirely In Your Hands
As of 1H 2021, total U.S. retirement assets stood at $37.2 trillion. Individual retirement account ('IRAs') assets totaled $13.2 trillion, Defined contribution ('D.C.') plan assets (including 401(k)) held $10.4 trillion. Pension-oriented plans like Government defined benefit (D.B.) plans (including federal, state, and local government plans) held $7.5 trillion, while Private-sector D.B. plans held $3.5 trillion in assets
- Source: ici.org
From a system where the private sector employer paid for the entire pension and absorbed all the risk, Corporate America has transformed into a system where the private sector employee takes on most of the cost and risk. More than 63% of retirement savings are in the hands of individual investors.
- Data Source: Willis Towers Watson
Today, most retirement plans involve employers giving you some cash and asking you to take care of your retirement. Only 13 companies in the Fortune 500 maintain a pension plan. With 401(k)s, your employer and plan provider curate a small investment selection. The funds are invested in mutual funds, index funds, and target-date funds. You are essentially placing your money in the financial markets.
The Government is strongly supportive of this transition. Defined contribution limits are on the rise from $30,000 in 1998 to $61,000 in 2021. With the bulk of the retirement savings of the entire nation sitting in the stock market through 401(k)s and IRAs, the U.S. government will do whatever it takes to keep the financial markets up.
The Information Age Changed How We Interact With The Market
Digital transformation has penetrated the industry of investment advice. Before the internet era, financial analysts used to publish weekly or monthly investment newsletters. Barron's is a 100-year-old company that, until 1996, was delivering market news, investment analysis, and top picks in print form.
Today, the internet brings to your fingertips information from across the world. Thousands of articles are being published every day with day-to-day commentary of the company's price action. There are YouTube channels where investors share their strategies and discuss their daily trades. There are Twitch channels where traders are live-streaming every move to a community of followers. Investment selections of famous figures are not a secret anymore.
In his book - One Up on Wall Street, Peter Lynch described a married couple, where the husband made the financial decisions, and the wife took care of the household. Mr. Lynch pointed to the apparent disconnect between the husband's investment decisions and the wife's shopping preferences.
"The husband with his nose in The Wall Street Journal looking for the next hot tip. He barely listens as his wife comes home from a shopping trip, gushing over a wonderful new women's apparel store called The Limited. Great clothes, great prices, and the place is full of customers, she says. The Husband, meanwhile, invests in an industry he doesn't understand, losing half his money.
The Limited expands to 400 stores across the country, and its stock price rises from a split-adjusted $0.50 to more than $52 in just eight years. After reading several favorable magazine articles, the husband tells the wife he has invested in that store she raved about several years ago. Predictably, she informs him that she doesn't shop there anymore, because the prices are too high and the same merchandise can be had elsewhere. As the stock price begins its descent to $16, the husband wonders why this investing game is so hard." - One Up on Wall Street by Peter Lynch (Source: Motley Fool)
In today's internet age, information is spreading immediately, bridging the former disconnect to investors who want to keep up. The possibility of gaining a better understanding of an industry from the experts is much more accessible, affordable, and current. With sites like teslarati.com, insideevs.com, we get details from Tesla's (TSLA) October sales in China to pre-IPO information on Rivian (RIVN). Due to the rapid flow of information, a lot of good news gets priced into companies' valuation, making them unappealing to traditional value investors.
Caution: There is a lot of information out there; not everything that’s available on the internet is factual or accurate.
With information widely available at your fingertips, let us now look at how the world of investing has its doors wide open to anyone regardless of age and net worth.
Investing Is More Accessible
As tech-driven disruption impacts industries across the globe, the financial markets were no exception. The average brokerage commission in the late 1980s was $45, and it could often climb into the hundreds or thousands depending on the size of the order. Brokers got away with murder in trading commissions, and for someone looking to invest $100 in the market, these steep rates were a massive barrier to entry.
In 2015, Robinhood (HOOD) disrupted the industry, making trading commission-free. With its colorful, easy-to-use mobile app, the platform became particularly appealing to the millennial and Generation Z population, who comprise 70% of its user base today. Seeing how Robinhood democratized investing for the masses, big brokerage firms went commission-free in late 2019. Since this change, we have seen a surge in average daily trades at major retail brokerage firms. The trading beast within the U.S. investor community was finally unleashed.
- Source: NASDAQ
Commission-free trading is undeniably a significant transformation in how investors interact with the Market. Not only has it removed the barrier to entry into the market, but it has also made it affordable to be impatient with your portfolio holdings.
Investors Are More Impatient
Wall Street looks for immediate catalysts and uses the term "dead money" when there are no exciting milestones in the near term. When there is no cost to buying and selling shares, investors are not incentivized to buy and hold forever. When investors are not forced to stay invested due to high brokerage fees, the idea to "sell now and buy later when prospects are better" becomes possible.
Legendary investor Warren Buffett has called platforms like Robinhood as tools promoting speculation and casino-like trading activity in the stock market. While it appears like Robinhood may have set off the buy-sell-repeat trend, this culture has been in development for decades. The chart below tells us that the average holding period of stocks dropped from ~8 years in the 1960s to less than five months in 2020.
- Source: reuters.com
There are over 6,000 companies listed on the NYSE and NASDAQ. Fast-flowing information and increased trading activity mean today's meme stocks may never come back into the limelight. The Oracle of Omaha is known for its "buy and hold forever" mantra. The following section will describe why that may not necessarily be a healthy investment strategy.
Your Average Company May Not Live Long
Even the most profitable and popular companies disappear without a word. For example - Toys"R"Us had 14% of the toy market and $7 billion in revenues before it was dissolved entirely in 2017. Similarly, Iceland's budget airline WOW Airlines was in rapid expansion mode and even introduced direct flights to India in 2018. The company had to cease operations the following year while thousands of its passengers were in the middle of their journeys.
The average lifespan of an S&P 500 company in the 1950s was 60 years. A good pick would reliably reward the investor for most of their adult life. In 2019, the average lifespan shrunk down to about ten years before buying, acquiring, or liquidating the company. So if companies, even profitable ones, are dying faster than before, how can we stay invested in them forever with our hard-earned money?
Buy and hold forever may not be the best strategy in this technology era. If an established business generating massive profits fails to adapt to changing times, tech-driven disruptors will quickly gain significant market share with higher margins. The established business will then have to spend much more to just catch up and maintain its moat. I am thinking about Intel (INTC) vs. AMD (AMD) here. The story could go either way. Either the established business could continue as a fighting leader like Walmart (WMT), or go out in fumes like KMart.
Predicting a company's prosperity 20 years into the future is very difficult. There are too many variables to account for, making the process one of wish and hope rather than predictability and stability. Businesses have to constantly look out for growing competition. When Amazon (AMZN) announced its entry into the pharmacy business, $10 billion was erased from the market caps of Walgreens (WBA) and CVS (CVS). Such drops could lead to an irrecoverable loss for buy-and-hold investors.
When we invest for dividends, we primarily care about the income, not so much the stock price. If our portfolio pick becomes unappealing from the income perspective, we replace it with the next income-producing opportunity. We don't hope and wait for the situation to improve. This way, we build wealth slowly but surely.
Traditional Fixed-Income Securities Have Negative Returns
Treasury and CD yields have consistently declined, now producing negative returns when adjusting for inflation. For decades, Treasury bonds and C.D.s were a retiree's best source of reliable income – but now is eating away your savings.
Every time the economy faces challenges, the Fed responds by lowering rates, and each time, the rates drop to historically low levels. Then when the economy is doing well, rates are never raised to former highs.
If you are planning for your retirement or are already retired, don't rely on these traditional fixed-income securities. At HDO, we recommend a diverse set of income securities comprising dividend-growth common stock, preferred shares, baby bonds, closed-end funds, and high-yielding ETFs. Our Income Method is designed on the premise that:
Dividend payers are comforting in downturns: As buyers of quality yield, we buy more when our favorite stocks experience a correction. This way, we strengthen our income stream and build capital gains in the process.
Dividend yields beat most Treasury maturities: Our model portfolio targets a yield between 9-10%. These are significantly higher than traditional fixed-income investments and allow investors to manage expenses and reinvest a portion depending on the portfolio size.
Dividends help you beat inflation: Above-average yields are a natural hedge against inflation as they ensure portfolio growth even when inflation is burning hot.
Well-run companies pay dividends consistently: Dividend-paying companies are profitable today and pay the dividends only after taking care of necessary expenses. It is easy to spot if a company is earning its dividends or if it’s cannibalizing its assets to sustain a payout.
Dividend payers produce cash today: With dividends, we get returns today and don't have to hope and pray that Mr. Market will award a higher valuation to our picks so we can buy low and sell higher. Contrary to popular belief that stocks only go up, your investments may stay range-bound or decline for months or years before they appreciate.
Has Technology Made Markets More Efficient?
One area where the market is still the same as the 60s is that human beings still pursue it. By design, human beings are emotional creatures. Our behavior is motivated and activated by our emotions. So the question - has technology made the markets more efficient?
The answer is no.
As human beings, we get greedy when the market soars, and we are afraid when the market tanks. Bad news or absence of excitement makes investors nervous, causing them to irrationally sell their shares (remember, zero commissions and fast-flowing information?). When bad news spreads fast, investors' emotions make the selling action worse. As a result, a lot of inefficiency gets introduced where the opportunity is misunderstood. Look at Verizon Wireless (VZ), for example. Backed by consistent higher margins vs. other telecom peers and future tailwinds from 5G expansion, the stock is down more than 10% YTD. Today Verizon's dividend yield is at historic high levels and presents a valuable opportunity.
As income investors, we pursue these inefficiencies and lock in high yields, and we rely on investor impatience to strengthen our income stream. Since our picks produce income today, we can afford to be patient. We get paid to wait for the stocks to appreciate. This is the essence of HDO's Income Method.
- Source: Getty
Conclusion
A regular stream of income from your investments is the key to long-term wealth building. During your early years, the income can be reinvested, so paychecks get larger and larger over time. You can later utilize these paychecks to sustain your retirement lifestyle.
The sheer volume of information around investment opportunities can be overwhelming, confusing, and downright scary for individual inventors. The question remains - How do I grow my savings, become financially independent, and sustain my retirement?
The key is to lock in immediate income now. Inflation is driving the value of money downward and having cash dividends provides ultimate flexibility today. You can add, open a new position, or sell as desired. Furthermore, each dividend is an infusion of cold hard cash into your portfolio that cannot be taken away. Future dips and crashes can erode unrealized gains into realized losses. Dividends are irrevocable once received. As income investors, each time we collect a dividend, we win!
This flexibility in investing, dividends, and how you manage your retirement savings lets us cheer “Long Live Income!” even though we’re not investing in your father’s market any longer.
If you want full access to our Model Portfolio and our current Top Picks, feel free to join us for a 2-week free trial at High Dividend Opportunities.
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