A Decade of LossSubmitted by TROY M. SMITH on November 19th, 2018
The stock market as measured by the Dow Jones Industrial Average or Standard & Poor's 500 index still has yet to break even over the last ten years. The Standard and Poor's &P 500 Total Return Index (Price plus Dividend Income) is down 2.2% for the ten year period ending August 31, 2009. Although past performance is not indicative of future results, clearly it is time to evaluate asset allocation.
Is now the time to diversify? While it obviously was ten years ago, now is still a good time to diversify. Growth investment are nice, but Income investments are also important. Many investors focus only on Growth of Capital during their accumulation years and then consider Income oriented investments only at retirement. The transition from Investment Accumulation to Cash Flow Generation is the cause of much stress and uncertainty. There is an important in concept that should be recognized, most investors are investing for income, whether it be for a short-term strategy or long-term purposes. The difference is when the income is spent. For a long-term strategy any earnings in your portfolio (dividends and interest) can be reinvested. For a short-term strategy current income is the goal, and diversifying into income investments may be of benefit to you. Having current income from an investment can increase the likelihood you will have more income when it is needed it to cover expenses, not considering principal and other risks (see disclaimer below).
What type of Income investments are there? Income investments break into two main categories: Debt and Equity. Income from Equities is a sharing of the cash flow of a business and the Income from Debt investments is the interest portion of a note payment received, such as a mortgage. In seeking safety of principal, investors looking for Income can invest in U.S. Government debt. Investments safe from principal decline carry another risk, the risk of purchasing power or inflation risk.
In searching for Income investments, investors have to consider decisions similar to a swimmer who is faced with only two pools to choose from: one containing a shark and the other containing a piranha. The shark can be likened to the risk of principal loss, it can happen in large bites and cause death. The piranha can be likened to inflation risk, it happens is small nibbles and death takes longer. Swimming in either pool can ultimately result in death. A balanced portfolio could be allocated to strive to manage the risk of capital loss and inflation. In other words, a balanced portfolio could seek moderate growth equity investments and higher yielding debt investments. Income investments, like all investments, have risks such as interest rate risk, default risk, liquidity risk and other risks (see disclaimer below).
If your portfolio is lacking Income investments, contact your Certified Financial Planner™ professional to review your objectives and risk tolerance and educate you about investment types available and to make recommendations. In many cases, investors have simply ignored income oriented investments. The new tax laws make some Income investments, like stocks, more attractive, because the income from them is taxed at a “qualified” dividend tax rate of 15% rather than ordinary tax rates.
One type of Equity Income investment that has received increased attention lately is Real Estate Investment Trusts (REITS). REITs differ in many ways from the infamous tax-shelter limited partnership popular in the late 1980s. REITS have been around since President Dwight D. Eisenhower signed the legislation creating them in 1960. REITS can be traded like stocks or unlisted public or private companies. Investors who ignore asset categories like REITS may be lacking a significant area of diversification. According to Bank of America Equity Research, “...REITS have out performed the S&P 500 in each of the last 1, 3, 5, 10, 20, & 30 years...” Bank of America Equity Research, January 10, 2003. REITS can be as volatile as other stocks and the chance for loss is similar. Furthermore, non-traded REITs have start-up costs and are highly illiquid.
Another type of Equity Income investment is equipment leasing, oil and gas is another example. Some investors prefer paper and forest investments, royalty trusts and other income focused equities for Income. There is much more to consider in the world of investments other than simply stocks and bonds. Equity Income investments can provide variable Cash Flow, even during times of principal decline, thus reducing risk and potentially increasing return.
Troy Smith is a Certified Financial Planner™ professional and Investment Adviser offering Financial Planning and Investment Advice to clients in Raleigh, Durham, Chapel Hill, Cary, and throughout the North Carolina area. His web address is www.asktroy.com.
DISCLAIMER: This article is intended to serve as a basis for further discussion with your professional advisers. Competent legal and tax advisers should be a part of every sound financial plan. This information is not intended as legal or accounting advice and should not be relied upon in the preparation tax returns or when making any business or personal financial decisions. You should always seek the counsel of your advisers to understand how this information applies to your particular facts and circumstances. Indexes are hypothetical portfolios of specified securities, the performance of which is used as a benchmark in judging the relative performance of securities. Indices are unmanaged portfolios and do not guarantee future performance. It is not possible to invest in an index. Past performance is not indicative of future results. All investing involves market risk and possible loss of principal. Asset allocation and diversification do not necessarily assure a profit or guarantee against loss. The features, benefits, risks and expenses of every investment need to be considered. Mutual fund investing carries risks. Investment returns and principal values fluctuate and shares, when redeemed, may be worth more or less than original cost. The Standard & Poor's (S&P) 500 Index measures stock market return performance. The Dow Jones Industrial Average is computed by summing the prices of the stocks of 30 companies and then dividing that total by a value that has been adjusted over the years to account for the effects of stock splits on the prices of the 30 companies. The NASDAQ Composite Index measures the performance of all issues listed in the NASDAQ Stock Market, except for rights, warrants, units and convertible debentures. Indices are unmanaged and not available for direct investment. Government Bonds are guaranteed by the U.S. Government and, if held to maturity, they offer a fixed rate of return and fixed principal value. Certain types of Real Estate Investment Trusts (REITs) are highly illiquid. Non-traded REITs have significantly reduced liquidity. Some REITs can be pressured to sell assets in response to stock market movements. Non-traded REITs have net worth and income level requirements. REITs also contain interest rate risk as well as other risks.