Thursday, 14 February 2013

Ignore Price Fluctuation - Focus on Yield

I’d like to again welcome back John Hulton.  John claims to not be a financial guru, stockbroker or financial journalist, but just an average bloke who has managed to find a way through the minefields of personal finance and develop a system that works for him and, which could be helpful for other people.  He has already retired from full time work which puts him at the end game of what this Site is about – Save Hard, Invest Wisely, Retire Early.  So while John is not a financial expert his approach has given him what many of us are chasing.  I hope you again enjoy his thoughts.

The FTSE 100 got off to a flying start in 2013, the best January rise since 1989!  The markets rose above 6,300, a price last seen prior to the start of the sovereign debt crisis in 2008.

How long this surge will continue nobody can know.  Is it a temporary spike or is it a sign that the economies around the world are starting to see signs of real recovery?  There will be much speculation in the media and on the discussion boards.

At one time, earlier in my investing career, I would probably have been thinking about selling some of the shares which had risen strongly.  I would be trying to second-guess the market - there is no justification for this rise - all the problems of systemic debt in the major industrialised countries have not suddenly disappeared - the markets will soon fall back towards 5,000 and I will keep my powder dry and pick up a few bargains later in the year.

I say ‘at one time’ but I’m sure there’s still a bit of me that thinks the same way now.  However, the emotional factors which underlie that process are basically twofold - fear and greed.  Fear the markets may suddenly swing down as quickly as they have risen and I will lose all the double digit gains on my portfolio - and the greed of selling high and buying low during the next downturn.  These two bedfellows are always present but need to be understood and neutralised if you wish to invest for the long term.

After many years as a private investor, I am gradually learning to regard these market swings and share price fluctuations with an attitude of mildly detached interest.  I really don’t get over-excited when markets rise and equally, I don’t become wracked with fear when markets are falling.  As an income investor, it will probably suit me when markets are in decline as it will throw up many more opportunities for a decent yield.

On a day to day basis, most investors will probably be following share prices because this is where all the action is.  Profits are made on the markets by buying at a low price and selling at a high price, right?  Wrong!  Over the longer term, up to 90% of the total return on your portfolio will be derived from dividends - growth of dividends and especially the reinvesting of dividends.

Of course, if you invest in stocks and shares, you should be looking at the longer term.  Academic analysis of long-term returns consistently point to the fact that investing in dividend-paying equities and reinvesting the income can be the most rewarding strategy thanks to the magic of compounding.  Dimson, Marsh and Staunton showed that £1 invested in the stockmarket in 1900 would have returned £2.10 after inflation in 2010.  However, with income reinvested, the total return on that £1 would have been £317.  So, on the one hand your investment doubles, on the other it increases by a factor of 317 times thanks to the compounding of dividends.

Capita Registrars have recently published their end of year dividend monitor for 2012.  This showed a record £80.4bn delivered by UK companies, an increase of over 16% on the previous year.  Around 90% of total dividends are paid out by FTSE 100 companies - indeed, the top 5 account for over 1/3rd - Vodafone, Shell Oil, HSBC, BP and GlaxoSmithKline.

Whilst prices and markets have been rising and falling over the past year, (and the previous year and the year before that…) dividends have been quietly churned out on a regular basis with hardly a mention in the financial media.  For me and many other income investors, dividends not share price action is where the smart money is invested.

Sure, for the day trader or hedge fund speculator, there is money to be made from short term positions on the markets but for the average punter, it will be a losing strategy over the long term for most.  Dividends are the key, in my opinion, to generating inflation-beating long term returns for the vast majority of small investors.

So, is now a good time to invest? Nobody can know where the markets will be next week, next month or next year - although there are no shortage of pundits who will tell you otherwise.  Now is as good a time as any for anyone starting out on the investing road.

In any event, it’s almost a law of nature that share prices fall the day after purchase (and rise the day after a sale!).  The main thing will be to spend a little time on researching the company fundamentals - free cash flow, dividend cover, dividend pay-out ratio etc - before the purchasing decision.  After all, you will be investing in the company for many years to come and as the time passes and dividends are reinvested, the original purchase price will not be an issue.

As ever, my advice would be the usual… slow & steady steps… drip feed your money into your chosen investments on a regular monthly or quarterly basis.  Invest in well researched income-yielding equities - shares or investment trusts, and ignore short term fluctuations in share prices and markets. Reinvest dividends to turbo-charge your portfolio returns over the long term.

The 2012 Barclays Capital Equity Gilt Study showed that £100 invested in equities at the end of 1899 would now be worth just £160 in real terms.  But with reinvestment of dividend income the portfolio would have grown to a huge £22,239.  In the case of an investment made in 1945, the real capital value would have risen to £227, whereas with gross income reinvested it would be worth £4,027.

Finally, it seems we are living in an age of instant gratification - I want it all and I want it now! With investing, it’s never going to happen - cultivate the art of doing nothing - it will pay dividends in the long run! Jesse Livermore, who wrote over 70 years ago “After spending many years in Wall Street and after making and losing millions of dollars I want to tell you this: It never was my thinking that made the big money for me. It always was my sitting. Got that? My sitting tight!”

If you're new to Retirement Investing Today and you found this post informative then you also might like John’s thoughts on Investing for Income via High Yield Shares or Investing for Income via Investment Trusts.  John has also written two excellent easy to understand Ebooks, Slow & Steady Steps from Debt to Wealth and D-I-Y Pensions, which I personally found very informative.

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