Does your portfolio have a strong foundation?
Every building needs a foundation, a base for its upper reaches, something that keeps it from sinking.
Your stock portfolio needs a foundation, too. For most investors, that foundation is large caps -- stocks of the giant, global companies that make up the Dow Jones Industrial Average
If you're investing for the long term, like most of us, you need some large-cap stocks, plain and simple. I'll explain below -- and give you some good ideas to get started.
Stocks for the rest of your life
In the new issue of the Fool's Rule Your Retirement newsletter, available at 4 p.m. ET today, Foolish retirement guru Robert Brokamp makes the case for having large caps as the cornerstone of your portfolio -- before and after retirement. As Robert sees it, the established revenue streams, big brands, easy access to capital, and global reach of the best large-cap companies are important advantages that help offset the knock many investors have on large caps: They don't grow as much or as quickly as the best smaller stocks.
It's true that large-cap stocks are, generally speaking, less volatile than stocks of smaller companies. That means they don't go up as dramatically during bull markets -- but it also means that they don't come crashing down as hard. That's because a lot of big, relatively conservative investors like mutual funds and pension funds own large caps, and those investors tend not to make big moves when the markets shift. And with many of these stocks, their steady dividend payments make them appealing investments no matter what the market's doing.
That relative stability during Mr. Market's rough patches is a valuable thing to have, as many have realized in recent years -- and it's a good thing to hang on to even when you're in retirement, as Robert often points out.
But let's be really clear about this: Owning large caps doesn't mean you're giving up growth. One of my favorite examples of this right now is McDonald's
Wrong. In fact, if you count reinvested dividends (and you should), McDonald's stock has roughly quadrupled over the last decade -- a period when the S&P 500 was up just 31% -- and it's poised for even more qrowth. Why? Because it's expanding into developing markets: It turns out that its stores aren't quite everywhere yet after all.
Finding the right large caps is the key
You could do much worse than buying McDonald's stock today -- though I'd argue that it's a little expensive at the moment -- but it's a great example that shows that buying large caps doesn't mean you're giving up growth.
One of the keys to that growth -- with McDonald's and in general -- is dividends. Sure, a 3% or 4% dividend might not sound like all that much, but consider this: A 3% dividend that grows steadily at a 6% rate over time, reinvested to buy additional shares of the stock, can give you 8% average annual returns or more over the long term even if the stock price doesn't go up at all, thanks to the power of compound growth. That can carry your portfolio nicely through an extended bear market. And after you retire, you can take those dividends as extra income.
Buying stocks with a long history of raising their dividends every year is one way to ensure that your portfolio has a solid foundation. Stocks like the following:
, with its spectacular global brands; (NYSE: KO)
- Well-run energy colossus ExxonMobil
, which has seen great earnings growth over the past decade; (NYSE: XOM)
Procter & Gamble
, the ultimate consumer stock -- and one that has more than doubled over the last 10 years; and (NYSE: PG)
Relentless innovator 3M
. (NYSE: MMM)
All of these stocks are "dividend aristocrats," meaning that they're S&P 500 member companies that have an unbroken streak of annual dividend increases going back at least 25 years (as does McDonald's, by the way) -- a testament to traditions of solid management and profitability, exactly what you'd want in a portfolio cornerstone.
If you'd like more ideas along these lines, check out the new issue of Rule Your Retirement, where two of the Fool's top analysts share their four favorite large-cap picks for new money now -- and Foolish mutual fund expert Amanda Kish names her best large-cap fund choices to give your 401(k) a great foundation, too.
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