Market editor Dave Kansas describes a new emerging trend in long term investments. He is encouraging the market watchers to put their money toward dividend-returning stocks instead of the traditional mutual funds and government bonds. Now, I don't have any of my own money in any of those three investments (though I think my parents have a mutual fund and a few savings bonds) and I don't pretend to have a full understanding on any of them, but this new idea seems completely contradictory to everything the world has told us so far. We have been told frequently that mutual funds and savings bonds are the "safer" way to go if you are to put your money in a long term investment. Now Mr. Kansas appears with advice telling us to put all our long-term investments into the volatile stock market. I'm just a bit skeptical...
The only moderately convincing point I found in his argument was the fact that inflation adds reward to dividends, while strangling returns from interest in bonds and mutual funds. But what I find shady is the fact that he never describes the sheer risk you could place yourself in by following his dividend-milking program. He suggests setting stakes in five companies that return generous dividends and allowing these returns to pour in. It seems like such an easy plan, and the fact that it supposedly returns more than bonds or mutual funds makes the plan seem all the more attractive.
But what about the risk, Mr. Kansas? Nearly all the dividend stocks he suggests in his article are some of the biggest news-makers in America: McDonald's, Microsoft, Exxon Mobile, Coca-Cola, and more. I for one would be incredibly reluctant to put my money in any of the aforementioned companies (maybe Coca-Cola because I like an adequate supply of high fructose corn syrup in my digestive tract, but that's beside the point). All it takes is one issue leading to bad publicity, and any of the companies could come close to tanking. BP? Enron? No one could have foreseen Wall Street's darlings under such heavy media fire, and the stock market could barely withstand the hits either. In that respect, could anyone be so prepared as to put their investments in a pure dividend plan? I consider that a gamble beyond reasonability. To me, following the plan for dividend returns is akin to putting your money right in the hands of controversial media figures, and in a long-term investment, you're bound to run into trouble sooner or later.
I agree that it is a bad idea to invest a lot of money in dividend returning stocks. It is true that the return is great but at the same time there is a really high risk. For example, Microsoft's stock price in April 2010 was at 31.39 per share. Now it is down to 24.35$. If someone had bought the stock at 31.39$ and needed the money right now they would have lost 7.04$ per share.
ReplyDeleteIt is a nice idea to invest in these types of stocks only if you are willing to lose the money you are investing.
Firstly, congratulations to Warren for taking the lead and posting an article! Before we continue to discuss this topic, I feel some very important clarifications must be made:
ReplyDeleteAs we will touch on in a future seminar, there are many different types of mutual funds. A mutual fund just means that a bunch of people's money is grouped together and then invested. The mutual fund manager takes a fee based on a percent of funds under management. There may be some mutual funds that invest exclusively in treasuries, which would be considered risk-free for all practical purposes, but the majority of, and most popular, mutual funds invest almost entirely in stocks. More conservative mutual funds have as their top holdings these high quality dividend yielding stocks that you mention. The only thing that makes mutual funds less risky (in general) than directly investing in these dividend bearing stocks is that the mutual fund also holds hundreds of other stocks. This means that you don't get hit as hard if certain stocks go down, but it also means that you severely sacrifice your potential return if they go up.
As we covered in the first seminar, a dividend is an optional disbursement of profits that a company can make to its shareholders. If a stock has a 6% yield (dividend), as does AT&T mentioned in the article you linked, that means several things, if you buy $1K of their stock today:
1) The share price can go down 6% ($60) over the course of a year and you will still break even because of the $60 dividend.
2) This article was written with a long term perspective in mind, the stock market moves up and down but historically (we will address historical data in a future seminar) it goes up over the long run (20 year period). Even if that $1K investment is turned into $750 because of a lower share price, unless the company cuts its dividend, you will still be making the same $60 in annual dividends. Basically, if you invest in high quality dividend paying stocks, they will pay you to wait for their share price to go up.
3)You get to choose when to sell, whether to reinvest or bank the dividend payments, and you don't pay fees to someone else for managing your money (as with a mutual funds).
With all this in mind, investing in a diversified portfolio of high quality dividend yielding stocks is widely regarded as one of the most conservative, risk/return advantaged, strategies one can employ in terms of investing.
This is absolutely not to say that you can just buy five of these stocks and forget about them for the rest of your life. Just as you need to be doing for the EMC, you always need to be monitoring your investments to make sure they still meet your individual investment criteria. You also need to take into account macroeconomic factors, as we will be covering in the next seminar.
Lastly, to address the concerns of risk, I would slightly alter Lakshmimaniteja's concluding sentence to read: "It is a nice idea to invest in ANYTHING other than U.S. government issued treasuries or instruments that are FDIC insured, only if you are willing to lose the money you are investing."
I have to completely agree with Warren and Lakshmimaniteja's arguement. Just investing in stocks that return a divident isn't the safetest, or smartest, thing to do. Yes you will get a higher return, but how high will that return be when you lose all your money?
ReplyDeleteI myself am looking forward to investing in stocks when the right time comes, and i wouldnt want to lose all my money. I sure anybody wouldnt want to lose all their hard earned cash, and it seems that if you put all your money on just divident returns without any research, or actually thinking about your investment, you might just as well flush your money down the toilet.
A mutual fond is definitly safer, even though you get less returns. I don't know about you, but i rather get a slow, steady and safe return and make a safe investment, then rather see all my money vanish before my eyes.
Florin, when investing in a company, keep in mind that all of your capital does not need to be invested all at once. If you have $100,000 that you are willing to commit to a given company, you can formulate some kind of buying strategy. For example, you can invest $50,000 at first, then wait for the stock to drop x% (because you cannot time the market with 100% certainty) and invest the remaining $50,000.
ReplyDeleteWith $100,000 being invested all at once, you might buy 1,000 shares @ $100, so your 'basis' would be $100/share. With a buying strategy, you might buy 500 shares @ $100 for $50,000 and actually hope that the stock declines to $80 (due to volatility and non-company related events) so you can buy 625 more shares totaling $50,000 - your basis would then become $90/share, not $100. If the stock price has not gone down and you only invested $50,000, not the full $100,000, just think of that as a good thing and do not rashly buy into strength.
Know that the smartest stock pickers can never time the market. As a matter of fact, these stock pickers do hope for their stock positions to decline (knowing the fundamentals of the company are still sound), only so they can buy more shares at a cheaper price.