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Critique of Low Yield/Short Hold Methods

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By jackcrow
July 26, 2006

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(This is intimately attached to the HDogs thread on his fathers utility company but morphed into a thought line that I though deserved its own thread for clarity of discussion)

A huge mistake that many who began investing on their own during the late 90's make is buying into the concept that stock price appreciation is superior to dividends. Thousands of companies bought into this fad, new and old alike. The dividend yields of both the S&P500 and DJI30 have yet to completely recover from this fad. Millions of investors have bought into the idea that retained earnings can/should outperform dividend payouts. The concept is short sighted, as such it requires higher churn in one's portfolio to try to capture a higher return. The fundamental problem is that even if one manages to capture a higher growth rate on principal the likely hood of getting a significant cash payout is less, which is ultimately what most of us are going to need upon retirement.

The higher turnover methods are going to require the holder to continue to seek higher returns because they will need to tap into principal or accept a significantly lower yield when they convert to "safer" vehicles. They may or may not have grown their principal to a larger nest egg but they are more than likely going to have to accept a 4%-7% yield. While the LTBH dividend lover can receive a much higher yield as such they actually need less money piled up in the principal.

The old adage in investing is "Cash is King". For fundamental focused investors we love companies that throw off consistent cash. The odd thing is we rarely manage our own business of investing to do the same thing. It's odd that we would recognize that good businesses throw off cash and not manage our own business to do the same thing.

This is one of the huge problems attached to most retirement calculators available on the web. Most of them have bought into the idea that we need to be more aggressive in risk taking in the beginning and then accept the much smaller yield of conservative approaches later. So we take significant risks early and often in order to build up large principal so that we can live off the much smaller yields of safer investments. Does anyone else see the flaws in this approach? Why must we take on significant risk when we could very well have greater yields equaling the same cash payout with less risk? Especially when we know how long it takes to recover lost principal and what lost principal does to our final returns.

Now I'll ask these simple questions:

Who is better prepared to assess risk the seasoned investor or the beginning investor?

Who is better at mitigating their risks the seasoned investor or the beginning investor?

Does anyone else see the fundamental flaw of asking the younger/newer investors to take on the greatest risks? In what other venue in society do we ask the least prepared to take on the greatest risks? I certainly hope I'm a more astute investor 10 years from now.

<I posted this on the Bond board several weeks ago>
The risk involved in swimming across a river is not solely dependent on the current behavior of the river. A strong swimmer has a better chance of safely getting to the other side. The strong swimmer is more likely to not only get to the other side safely but quicker and more efficiently so they are better prepared to do something else after the swim. A weak swimmer is more dependent on the river behavior. If its mid-August and no rains have fallen for a couple of weeks the lazy river affords reasonable passage to the weak swimmer. Spring run-off creates conditions that make the river impassable. The worst place to be is the intermediate swimmer, without experience they may think they can swim the spring river and end up dashed against the rocks; meanwhile the strong, experienced swimmer never bothered to do much more then look out their window because they knew there was no way they could cross that river today

Why do we ask the weak swimmer to swim during dangerous times and then insist the strong and experience swimmer sit on the shore and watch or maybe wade a bit but only on safe beaches?

It seems to me that smarter approach would to be to start out in the lower risk end. Beginning investors ought to think about buying bonds and stalwart dividend yielding companies. As their skills improve, as their assets under management grow they can size their positions properly and begin to take on more risks in individual positions without dramatically increasing risk to the overall portfolio, toward the end they can scale back their risks(now defined by them not some academic or Wall St. guru) and enjoy their retirement.

Why do we ignore the power of a high yield manifested tomorrow for a lower yield grubbed for today?

All thoughtful critiques welcome.

Jack


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