Cash Machine
If you own a well-diversified portfolio of fixed income (bonds, money market funds, etc.) and some dividend paying stocks, you own a ‘money machine’. If you happen to engage in covered call selling on top of your stock portfolio, you have a cash machine on steroids.
When it comes to their investment program, most people focus on one thing – the variable that matters least: short term stock price movements. But this is only one of four potential profit centers (cash generators), and the one that is intended to provide profits for the future you – you in 2027, 2035, 2048 and possibly beyond. Stocks are long duration assets.
So why are most investors fixated on the day-to-day movement of something that they are intending to cover needs in years or even decades hence? I am sure there are a lot of reasons, but none of them are good: a short attention span, fear, greed, the ease of doing so, addiction….
Consider this: instead of (or at least in addition to) looking at short-term stock price swings, pay some attention to the other key elements of your portfolio: dividends paid, interest earned, and options premium/cash generated. The irony is that these components likely make up the majority of your returns over time, yet people pay so little attention to them. Ideally some of your stock holdings pay dividends. If you feel the need to look at something investing related, examine dividend histories and upcoming payments. Have your holdings increased their dividends recently? SBUX just raised its dividend 7.5%, more than the current rate of inflation. SBUX has increased its dividend at an annual double-digit rate on average for years on end. That is meaningful, regardless of SBUX short-term price, as it reflects their growing earnings over time and confidence in future earnings.
While stock prices move up and down day to day, dividends typically get paid like clockwork every 90 days, and for those reinvesting said dividends, each payment is larger than the previous one. Now that is something to recognize.
For your fixed income, while you don’t see it per se, you are likely generating cash every day by way of accrued interest and/or the price of the bond slowly but surely heading toward par as it approaches maturity. Why not celebrate these daily victories if you feel compelled to look at your portfolio regularly (which I am not recommending, but I am trying to ween you off of just looking at short-term stock price movements).
If you sell calls, then each day, all things being equal, the option premium experiences time decay, meaning you make a bit of money day after day as that time premium heads towards zero upon the option’s expiration. Another small victory to acknowledge.
Seeing the Forest for The Trees
Here is a perspective shift: think of your investment portfolio as a forest of fruit trees. You need some of the fruit to eat each day (i.e. dividends or fixed income interest), and the rest you let fall to the ground to grow more fruit in the future (i.e. dividend/interest reinvestment). Your forest produces steady, growing amounts of fruit. But from time to time, storms pass, and the size of the trees diminishes – they get smaller. Not permanently, but temporarily – at least as it relates to the forest as a whole (any one tree can get smaller for a long period of time). Even when the forest ‘shrinks’, it is still producing the same amount of fruit. Your ‘money trees’ just keep cranking out cash day after day after day – no matter what the weather is and the height of the trees. Ironically, when there are storms and the trees shrink, they actually produce even more fruit in the near future (since you have reinvested dividends at lower prices, thus you own more shares for higher future income).
Bottom line, your portfolio is not just short-term stock prices, just like you are not your thoughts (of which you have around 60,000 a day). Your portfolio, if well-constructed, has other components that will provide consistent positive returns regardless of market conditions. This serves the purpose of taking care of short-term cash needs, if any, and also reducing dependence on just price appreciation for results. That said, over reasonable periods of time, the 4th profit center, namely, price, will also very likely work in your favor – if you don’t fixate on it day to day and take action at just the wrong time – aka selling when prices are temporarily down.