Notes starting November 23, 2006
Updated: December 4, 2006.
Don’t be defensive
I posted this at the Income & Dividend Investing discussion board at Morningstar.
Morningstar Web Site
Don’t be defensive about your investment allocations. Set them to suit your needs and your personality. Just be sure to emphasize dividends.
My research favors low stock allocations at this time. What if I am wrong? Consider this article:
What If There Is A Bubble?
“What about today? With today’s interest rates? What will happen if you have to wait 20 years before buying stocks?”
“The answer: You will be sitting pretty.”
Even if you have to wait 20 years, by focusing on dividends:
“The most likely outcome is an income stream that starts at 4.0% (plus inflation) that jumps to 4.45% of the original balance (plus inflation) in year 20.”
What if you are never able to buy suitable stocks?
The absolute worst case is that you would withdraw 4.00% (plus inflation) for 35 years (using TIPS at a 2.0% real interest rate) before running out of principal.
Benjamin Graham recommended setting stock and bond allocations from 25% to 75%. Doing so minimizes regret.
Others favor even higher stock allocations.
The most important thing is to focus on dividends. Dividends almost always grow enough to match inflation. Dividend amounts are usually stable because they come out of earnings. They are isolated from most of the effects of downward price fluctuations. Even then, dividends help. Dividends reduce downward price fluctuations substantially.
Here is one of my favorite articles: “Three Powerful Advantages of Dividend Strategies.”
“Here are three powerful advantages of dividend-based strategies.”
“1) Dividends continue indefinitely.”
“2) Dividends isolate you from price fluctuations.”
“3) Dividend-based strategies have a gentle failure mechanism.”
Three Powerful Advantages of Dividend Strategies
Notes Index
I have added a complete Notes Index section. It has all of the titles. This will make it much easier to locate articles.
Notes Index
One Time Bets
I was offered a bet recently.
It was the kind of thing that would be a real money maker if I could duplicate its essential features again and again. I cannot. It was only a one-time opportunity.
One Time Bets
Plots of P/E10, P/D5 and P/D10
I have placed plots of P/E10, P/D5 and P/D10 into my Yahoo Briefcase. They are in my “Graphs vs E and D Yields” folder.
Some people have difficulty thinking in terms of P/E10 (or, more precisely, the percentage earnings yield 100E10/P) when it comes to Safe Withdrawal Rates. It is easier to think in terms of the dividend yields that allow withdrawals to continue over long periods of time. P/E10 was better in earlier years because of dividend cuts. These days, dividend cuts are rare. These days, P/D10 is often better.
I have included plots of the equivalent yields 100E10/P, 100D5/P and 100D10/P. I have included Professor Shiller’s plots of Prices and Earnings and P/E10 and the Interest Rate.
Just remember that these are not the averages of single-year P/Es and P/Ds. P/E10 uses the current price and the average of the most recent trailing ten years of earnings. P/D10 uses the current price and the average of the most recent ten years of dividend amounts.
UPDATE
I have added another set of plots to the “Graphs vs E and D Yields” folder. I call them "HWSR Yields vs Year." I have plotted several combinations of 100E10/P, 100D5/P, 100D10/P, HSWR20T2, HSWR50T2 and HSWR80T2 versus Year for 1921-1980. Portfolios HSWRxxT2 consist of an "xx" allocation of stocks along with TIPS at a 2% (real) interest rate. The most telling plot has 100E10/P, 100D5/P, 100D10/P and HSWR80T2 versus Year. It shows the tight relationship between the earnings yield and dividend yield with the 30-Year Historical Surviving Withdrawal Rate of a portfolio with a high stock allocation (80%).
To a first approximation, the 30-Year Historical Surviving Withdrawal Rate equals the dividend yield plus a small amount because the balance is allowed to fall to zero at Year 30.
Yahoo Briefcase
Edited: E10 or D10?
E10 or D10?
Share Repurchases
I don’t like share repurchases. This is why.
From Professor Robert Shiller’s “Irrational Exuberance” Second Edition 2005, chapter 3 footnotes, pages 239 and 240:
“8. Managers holding incentive options also have an unusual incentive to substitute share repurchases for a portion of the dividend payout, since the direct effect of such a substitution is to increase the value of the managers’ options..”
“Share repurchases may also have become more popular because firms with higher earnings do not wish to commit themselves to higher dividends (which investors would then expect to see continued)..”
“Historical data confirm that dividend payouts tend to be reduced after executive incentive option plans are adopted..”
Today’s Stock Market Outlook
These quotes put today’s stock market in perspective.
From Professor Robert Shiller’s “Irrational Exuberance” Second Edition 2005, chapter 6, page 125:
“Despite the suggestion inherent in the phrase speculative bubble that there may be a dramatic burst--a stock market crash--speculative bubbles and their associated new era thinking do not end definitively with a sudden, final crash..”
“People today remember the stock market crash of 1929 as occurring in one or two days. In fact, after that crash, the market recovered almost all of its lost ground by early 1930. The significance of the 1929 is not the one-day drops in October, but the fact that that year marked the beginning of the end: the beginning of the three-year period that reversed much of the stock market gains of the 1920s. The same is true of other stock market drops..”
From Professor Robert Shiller’s “Irrational Exuberance” Second Edition 2005, chapter 12, page 207:
“The high valuations that the stock market attained at its peak in 2000, and the relatively high valuations that it still shows today, came about for no good reasons..”
“The high stock market levels did not, as so many imagine, represent the consensus judgment of experts who have carefully weighed the long-term evidence. The markets have been high because of the combined effect of indifferent thinking by millions of people, very few of whom have felt the need to perform careful research on the long-term investment value, and who are motivated substantially by their own emotions, random attentions, and perceptions of conventional wisdom..”
By historical standards, using P/E10, P/D10 and Tobin’s q, today’s stocks are seriously overpriced.
Must Read Article
Here is a "must read" article. It is outstanding. Rob Bennett wrote it.
20 Investing Insights from the First 54 Months
Dividend Growth to the Rescue
Here is an alternative calculation of the worst case outcome of a 50% stocks-50% TIPS portfolio.
(Nominal) dividend growth rates of 5.0% to 5.5% are sufficient to support younger retirees.
Dividend Growth to the Rescue
Slowly Rising Earnings
Today’s market is expensive. P/E10=27.6.
There are lots of ways for earnings to return to historical levels. What if prices remained stagnant while earnings continued to grow?
Would it happen? Could it happen? What would be the consequences?
Slowly Rising Earnings
Edited: Slowly Rising Earnings
Guessing the Future
Prices are high. P/E10=27.6. There are many ways for valuations to return to normal. Yet, discerning the best course of action is remarkably straightforward.
Guessing the Future
Sideways Market Sound Bite
If stock prices remain steady and if valuations return to reasonable levels through earnings growth, the best stock allocation for dividend investors will be a toss up.
Dividend investors who own TIPS as well as stocks will do well if prices drop faster. They will be able to replace their TIPS with stocks at more attractive yields.
Sideways Market Sound Bite
Edited: Sideways Market Sound Bite
Earlier Notes
Visit Notes Starting July 10, 2006 for links to all earlier notes:
Notes through August 21, 2005
Notes through November 29, 2005
Notes through January 13, 2006
Notes Starting from January 14, 2006
Notes through April 18, 2006
Notes through June 12, 2006
Notes starting June 13, 2006
Notes Starting July 10, 2006
Notes Starting July 10, 2006 covered the following topics:
It is about time..., Time and the Gordon Model, It is about time...continued, It is about time...more, The Copie Index, It is about time...number six, Compact Variable Terminal Value Rate Calculators, Orders of Magnitude, Using Stock Return Predictions, Eye Opening Calculations with Compact CVTVR L, New Standards for Financial Reporting, A Tip about my Yahoo Briefcase, Rational Pessimism and Tobin’s q, Super Variable Terminal Value Rate SVTVR Calculators, What does “3% + inflation” mean?, Tobin q Survey, Turning Points, A Helpful Theorem, Year 15 Calculator A, Designing a 45-Year Retirement, Retirement Trainer.
Notes Starting July 10, 2006
Notes starting August 25, 2006 covered the following topics:
Retirement Trainer, P/E10 Predictions, Bulls, Bears and P/E10 Predictions, P/E10 Predictions Revisited, Great Article, Playing with the Toy, More Fun with the Toy, Why Dividends Are Better, Improving the Retirement Trainer, Great Fun with the Improved Retirement Trainer, Accumulation and the Retirement Trainer, Dividends versus Capital Appreciation, E10 or D10?, Type 2A Bull Bear Retirement Trainer, Simplified Retirement Trainer A, More PE10 Predictions.
Notes starting August 25, 2006
Notes starting September 16, 2006 covered the following topics:
My Retirement Trainers Work!, Demonstration a1 to a8, Retirement Planning Insights, Retirement Trainers and Accumulation, Learning the RIGHT Lessons, The Wrong Lessons, Denial Is Expensive, My Yahoo Briefcase, Dollar Cost Averaging at Year 15, The Next Recession, Interesting Web Site, Market Timing--What Works and What Doesn't, I Saw My Doctor Today, Capitalization Weighted Stock-Bond Allocations, Explosive Earnings Growth, More about Earnings Growth, Why Is Today's Investing Advice So Poor?, Another Note about Earnings Growth.
Notes starting September 16, 2006
Notes starting October 21, 2006 covered the following topics:
Earnings Growth Adjustments, Capitalization Weighting of What?, More about Earnings Growth Adjustments, Mindless Comparisons to Index Funds, New Standards for Financial Reporting, System Engineering, Today’s Skill, P/E10 Updates, Short Term Price Fluctuations, Simplified Retirement Trainer with Dividends A, Late Letters, Basic Estimates and Refinements.
Notes starting October 21, 2006