Improving Investor Behavior – Focus on the Right Number
With the year coming to an end, 2018 has been a tumultuous one for investors. For the first time in 46 years, there has not been a clear winner in any asset class: from stocks to bonds, emerging markets to precious metals. As of this writing, none are on track to generate a better than five percent return according to a recent article from Bloomberg.
With all the attention focused on performance and prices, little appreciation goes to what we believe is a most desirable outcome for investors: income. Why do most people invest? Income. Whether you need that income today or tomorrow, most people invest with the belief that doing so will provide, maintain or improve their income.
The problem is that some people tie their income directly to the performance of the market. After all, this is a common approach to investing. Step one, buy a bunch of your desired asset class (stocks, bonds, gold, real estate). Step two, hope their value improves over time. Step three, sell the asset when the price has improved using the proceeds for income.
But this is akin to a farmer selling off acres of his land. As the area shrinks, so does his ability to grow crops. It becomes a downward spiral, eventually leading to asset depletion. This is what we refer to as a Growth for Income strategy, whereby growth is necessary for continued income. Years like 2018 make this strategy hazardous. No growth means it’s time for the farmer to sell some land, which makes generating income next year even more difficult.
The other risk is that of inflation. At a mere three percent inflation rate, the prices of food, fuel, and just plain living doubles every 24 years. That might seem like a long time, but that’s the age range of 60 to age 84. With better access to healthcare, science, innovation, and taking better care of yourself during the retirement chapter of your life, reaching age 84 is more likely. If your income has not doubled from 60 to 84, your standard of living is lower, and for many retirees, this is a problem. Often people do not realize this until it is too late.
So what can be done to protect income, and grow it at a rate that outpaces inflation?
There are many ways to approach this challenge, and you should ask your financial advisor if there’s one that may be a good fit for you. From my perspective, dividends are a solid way to grow income since companies distribute a portion of their profits from the business to investors, usually in the form of cold hard cash. Though not always, these companies are typically successful and established. Their dividend is a point of pride and offers them a vehicle to reward investors for owning their shares.
As a result, some companies maintain a long track record of paying a consistent dividend and even grow that dividend over time. Companies like Colgate, 3M, Coca-Cola, and Clorox all have a long track record of paying and adding to their dividends. Better yet, as a result of the tax law changes enacted late last year, some companies chose to increase their dividend more than five percent, beating most asset classes this year. As in our farmer example, dividends paid are like income from the sale of the crops. The land is only a vehicle for generating revenue. We call this a Growth of Income strategy.
We believe Growth of income is a better strategy rather than Growth for income.
In times of extreme volatility and uncertainty, it’s easy to get thrown off your plan. But as we’ve seen time and again, abandoning a well-constructed plan in favor of an emotional reaction almost always leads to a poor outcome. This is why we encourage investors to keep an eye on their income, not their portfolio value. My guess is your real estate agent doesn’t call you every 15 minutes with an update on the value of your home. This would make even the best investors a little cranky, although this is precisely what investors do with the stock market. Using a cell phone and app, the value of your portfolio is only a glance away.
So as you wrap up 2018, I’d encourage you to look past the value of your portfolio. Try flipping to page two or three in your statement and find the income line. Did your income improve in 2018? Did it stay the same? Did it go down? Hopefully, your income is rising, and at a rate higher than inflation. Over a long period, this will lead to more choices, more opportunities, and greater freedom.