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The Clash – Coin Flipping Part Deux
June 24, 2016
The last time the British Pound traded at this level vis-à-vis the dollar, a great song was released entitled “Should I Stay or Should I Go?”. With the Brexit vote behind us, I wanted to follow up on the concepts raised in the June Coastwise Dividend Newsletter.
As noted, despite the fact that over long period of time heads will rule to the tune of about 8% (as in the approximate average annual gains for stocks over many decades), there will be times when the coin flips are predominantly tails (in our analogy tails were losses, heads gains). So the question is – since investing for many is an emotions-driven activity despite best efforts to act rationally – how do you survive these losing streaks without doing yourself financial harm by prematurely exiting (Prexiting?) what is otherwise a very winning game? Here are some ideas:
First and foremost, recognize that losing streaks (aka bear markets) do end. The average bear market lasts a little over a year. Even if you are retired in your mid-60’s, that seemingly painfully long year of recovery represents less than 10% of your expected investment time horizon. For younger folks not needing the cash anytime soon, these short term declines are not only blips on the radar, they are actually great opportunities to invest more capital at lower prices via retirement account contributions, reinvestment of dividends, etc. Even the mother of all bear markets – the once in a generation Great Recession of 2008/2009 - is at worst a distant painful memory, or at best was a once in a lifetime opportunity to buy some of the best investments in the world at dirt cheap prices.
Don’t take any of this personally. The average 20 something in Liverpool has no idea what’s in your IRA, the stock market doesn’t know what you own or don’t own; no one is intentionally doing anything against you. Have some perspective: there are over 7 billion people on earth, countries have been forming, splitting, being conquered, etc. for millennia: it has nothing to do with you, and if you really think about it, it’s quite amazing how much order there is given the number of creatures that inhabit our relatively small planet.
In owning income producing securities (e.g. dividend paying stocks), recognize that you actually have a ‘side bet’ which all but assures you of about 50% of your 8% advantage. To make the point clear, dividends represent upwards of half of all stock returns over time. So while you are waiting for the coin flipper’s unlucky tails streak to end, you are getting heads after heads after heads as your high quality blue chip companies pay you income like clockwork every 90 days.
S&P 500 dividends (the aggregate dividends paid by companies within the S&P 500) have marched steadily upwards over the decades. Sure, there has been a year here or there when they took a brief step backwards (e.g. 2009) but dividends paid have never dropped to zero, so this ‘side bet’ is a pretty sure thing. When the Clash song was released the S&P 500 was paying out around $16.91 per share, today that amount is about $44.26.
When it comes to dividend reinvestment, the power of compounding is, as Einstein noted, the most powerful force in the world. That is a pretty amazing statement coming from a scientist who discovered the theory of relativity and certainly appreciated Newton’s revelation of gravity. But if you look at the numbers you can see what Einstein was raving about: owning a company yielding 5% which grows its dividend 8% a year on average will generate income nearly 5 times today’s income in just 10 years. So if you own a 5% yielding stock that pays $1,000 of dividends today and reinvest those dividends growing at 8% per year, that same stock will produce nearly $5,000 of income for you 10 years hence. Your effective yield (the amount of income in year 10 divided by your original investment amount) will likely well exceed 20%. Do you really want to sell your apple tree that is generating 1,000 pieces of fruit per year today and will very likely produce many times that when you need fruit most a few short years from now? Just because someone 6,000 miles away voted for something they really didn’t understand?
On a more qualitative but equally important level, examine your life: how has whatever the latest world ‘disaster’ (Brexit, etc.) truly affected your day to day existence other than psychologically as you read dire headlines? Has it changed your health? (If the answer is yes that means you are stressed: breath). Does it stop you from talking to your kids? Your spouse? Your friends? Does it prevent you from working out? Or reading your favorite book? Does it really keep you from doing anything today that is good for you and makes you happy? If you are really honest with yourself the answer to all of these is invariably “no.” So rather than having the latest in an endless string of bad headlines ruin your day, refocus your attention on what really matters and what you really control: your health, your relationships, your day to day activities, etc.
Where the market goes day to day, week to week from here is unknown. As we have learned from decades of macro-economic events, outcomes can take time to unfold and be very different than the initial hysteria suggests. S&P downgraded the U.K.’s sovereign debt rating to AA from AAA this week. When S&P took similar action – for the first time in history – to US debt, investors thought it was the beginning of the end. That was in August, 2011. The S&P 500 is up around 80% since then with the US economy showing ever increasing strength along with its currency. I’m not suggesting the same will happen with the UK, I am simply noting that the ‘obvious’ outcome is not always the case, which is why it is important during times of crisis to get back to the basics: owning high quality, income producing securities that can withstand any and all market and economic conditions over time since they will surely face them. In the meantime, as the Brits say, keep calm and carry on.
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