PODCAST 168
SAFE DIVIDEND INVESTING
16 May 2024
Greetings to listeners all around the world. Welcome to Safe Dividend Investing’s Podcast # 168, on May 16th of 2024.
My name is Ian Duncan MacDonald. In today’s podcast, I will be answering one interesting investment question.
The objective of my books, my website and my podcasts are to show all those seeking financial independence how to become informed, confident, successful, self-directed investors.
QUESTION #1
WHY DO INVESTMENT ADVISORS CHOOSE TO SELL YOU MUTUAL FUNDS INSTEAD OF INDIVIDUAL STOCKS?
Suppose you are forty years of age, just entering the prime of your life. Your hard work and experience have given you job security with the expectation of further promotions.
Your life feels “perfect”. You have a job you enjoy that pays a competitive salary. Your wife is happy and supportive. Your two kids are healthy. The three-bedroom house is comfortable with a tolerable mortgage. The loans on your two cars are not onerous. Every year you have been able to take the family away on a two-week vacation. At the end of each month there is a little money left over to add to your emergency fund of ten thousand dollars that you keep in your bank saving account.
You believe Investing in stocks is something that concerns only wealthy. You certainly do not consider yourself wealthy. You see yourself as middle class.
Now imagine that suddenly you are the recipient of five million dollars in cash. It could have been an inheritance, a lottery win, or even an unexpected legal settlement. Initially it does not seem real.
Immediately you are flooded with life altering choices. What do you do with this $5,000,000 that has been deposited in your bank account? You can’t just ignore it. You feel the pressure of this lump sum pressing down on your shoulders. You must do something.
Immediately paying off your mortgage and car loans is an easy decision. Now what? You have just got rid of what was the major drag on your income. It frees up cash. This is ironic because your salary is now inconsequential compared to your sudden wealth. Your focus on job security and getting ahead in the corporate rat race also now seem to be irrelevant in view of your seven-digit bank balance.
Competing thoughts race through your head. Do you quit your job? If you quit working what will your goals now be? How would you now spend your days? Could five million dollars last for the rest life even if you lived to be one hundred?
You soon reach a logical conclusion that you need help in handling the millions of dollars. You seek out a financial advisor by asking friends for a referral. Even though, you have no idea how your friends evaluate financial advisors nor whether they have significant investments.
The advisor you eventually contact is eager to meet with you. You travel to his office, and he explains that the smartest thing for you to do is to immediately invest all the money in several mutual funds. There it will be safely diversified and start growing.
He explains that investing quickly is important because while five million dollars may seem like a great deal of money right now, it really isn’t and every day it is shrinking because of inflation. He tells you that the average annual inflation rate has averaged 3.5% over the last one hundred years and it is already eroding the value of your wealth.
He points out that if you were to live for the next fifty years to the age of 90, if you did not invest the $5,000,000 money, its purchasing power and your living expenses would have shrink it to zero.
At this point he presents you with his financial institutions sixty-three-page investor contract to sign. This contract is deliberately long and difficult to read. It is full of legalese and investment industry jargon.
The financial institution really does not want you to read it. They want you to just blindly sign it. The investment advisor hands you a pen and uses silence to pressure you into signing it.
This is a salesman who is ten times more manipulative than the salesman you bought your last car from. To maintain his high six figure income he needs to control your five million dollars.
If you sign it you have given that financial institution the right to legally take as much of your money as they can. Since you have not spent hours reading the contact, you are not aware of clauses in it giving them the right to receive payment in the form of rebates and credits against fees in return for routing your investments certain market centers, plus the right to keep any interest on any cash balances in your account that they invest for themselves. They will also benefit from a spread on foreign currency transactions that might involve your money.
When you ask the investment advisor how much you will be charged for his services. He is trained to say, “So little that you will not even notice it”. You do not realize that you have agreed to pay them 2%to 3% each year of your millions of dollars for the rest of your life. Perhaps 2% or 3% may seem inconsequential but this will be draining $100,000 to $150,000 from your investment account each year.
When you combine inflation, and these management fees you need to be realizing a safe return of at least 6% just to break even. Many investment advisors and mutual funds think you are doing well if your investment portfolio generates a 5% return. If your portfolio should lose money in a market crash, they will still be taking that full percentage each year. In the document you signed you accepted that there is no guarantee of your profiting from your investment.
Suppose before you sign the investment contract that you float the idea of retiring at forty and living off the $5,000,000 invested in your mutual funds. To do this, you are told you would have to sell off a portion of your mutual fund each year. You are not stupid you can see that this would quickly erode what you have invested.
If you point out this potential erosion to the fund manager, his response would be to say that this fund has had a steady growth in its value for ten years plus you would receive any dividends paid by the companies in the fund.
He does not reveal that creating a perception that a fund has been growing steadily for ten years is not difficult. You would not know if during these last ten years the mutual fund was even offered for sale. Perhaps it was one of fifty experimental mutual funds being tested with minimal money invested to find that one fund that would allow them to now market it as a fund with steady growth over the previous ten years. No mention is made of the other 49 discarded trial portfolios.
Nor can they guarantee that a mutual fund will repeat the previous year’s increases. Many studies report that it is unlikely for fund increases to be repeated from one year to the next.
As for the realization of income from dividends. In a fund containing shares from perhaps hundreds, even thousands, of companies. A large percentage of these companies pay no dividends and those that do pay dividends will almost always be paying dividends of less than 2%.
Most mutual funds pay dividends once a year. The total dividend amount is divided by the total value of all the shares in the fund would reduce them yield percent for the total fund to probably less than 1%. Thus a million dollars in a mutual fund would have trouble realizing $10,000 in dividend income. Compare that to a million dollars invested in a single stock like Enbridge whose dividend yield of 7.5% would provide a dividend income of $75,000.
This raises an interesting question. Would investing equally in the shares of twenty financially strong high dividend payers like Enbridge provide the strength of diversity and a profitable annual income far exceeding inflation and any mutual fund?
The number of stocks in a mutual fund does diversify your investment but not in a healthy way. There are not hundreds or thousands of stocks worth investing in.
If mutual funds are not a solution what is the solution? The solution is to be very concerned about investment expenses and the very careful selection of a limited number of stocks for your portfolio.
An investment advisor’s job is not to make your investment expenses as small as possible. They also do not see their job as one of selecting individual stocks for your portfolio. It takes a bit of effort, time and risk on an advisor’s part to select individual stocks for a client’s portfolio. If they should have the analytical ability to do it, they do not have the time nor are they willing to make the effort to select individual financially strong companies paying high dividends for your portfolio.
The typical advisor services about 220 client households. It would not be unusual for a financial advisor to lose 20% of their clientele to competition, death and financial losses. To replace 44 lost accounts could involve thousands of phone calls and hundreds of physical meetings in a year. This leaves little time for meeting with their clientele or doing stock research.
What also discourages financial advisors from recommending carefully chosen stocks for portfolio is that the financial institution they work for are very aware of the legal risk of recommending individual stocks. There is always the possibility that large rich financial institutions can be sued for their investment advisor’s individual stock choices. It is far safer and far more profitable for the advisor and the company he to take their cut of your wealth from selling mutual funds. This appears to be why 78.3% of what advisors sell are funds and only 6.3% are individual stocks.
Funds can be easily defended in court by showing that hundreds of thousands of investors chose to invest in the mutual fund. The fund managers would point out to the strength of the well-known market leaders in their funds, like Tesla and Microsoft with trillions of dollars in market capitalization. The hundreds of mediocre companies that make up most of the fund would be ignored. That a Tesla or a Microsoft represented less than 2% of a fund’s shares would be ignored as would the reality that the hundreds of other stocks would each represented a fraction of 1% of the fund’s portfolio.
When the stock market goes through a crash every few years, and mutual funds loses half their value, the investor will be told that this is just the nature of the stock market. This will not stop the advisor from continuing to subtract their 2% to 3% of your mutual fund portfolio. Most investors are blind to the erosion because it is done slowly.
What is the best way to invest a five-million-dollar windfall?
Keeping the money in cash provides safety and liquidity. However, it does not provide an investment return in capital or in dividend income.
Stocks are liquid and provide returns, but they can suffer a loss when share prices drop.
Bonds offer returns and safety, but they are not liquid because they must be held to maturity
The solution is to carefully choose 20 financially strong stocks paying high dividends who have had ever increasing share prices and increasing dividend payouts for years. This is totally contrary to the speculation investing that most investors pursue.
Speculators buy stocks at one price expecting to soon sell them at a higher price to make a profit. Unfortunately, speculating outweighs the reward because no one can accurately predict future share prices. Studies show 80% of speculators lose money in any 10-year period due to investor psychology, emotional biases, and a lack of capital.
What is far more predictable are dividend payouts. Dividends are almost always paid out of profits. A company that has steadily increased its dividend payouts for the last twenty years is a company that knows how to operate a company profitably. It also shows its management has a habit of paying out ever increasing dividends. Even during the inevitable market crashes, when you see almost all share prices declining, you will see many financially strong high dividend payers continuing to pay out their steady dividends.
The executives of companies make those revenue and expense decisions that create the profits. Dividends are paid from profits. Those executives know they do not control their company’s share price which fluctuate on the whims of the speculators’ negative and positive price bids in that auction vehicle called a stock market. At best, they can only try to influence speculators.
It is not difficult to realize a reliable 7% return on your investment in financially strong companies paying dividends between 5% and 10%. Such strong companies do exist. They are spread among the thousands of companies traded on stock exchanges. There are hundreds of these strong, high dividend companies and they can be easily found. You just need to be shown how easy it is to find them.
The first step to financial independence is to open a self-directed investment account with a financial institution. It will give you total control over what you choose to invest in. No one will be taking 2% to 3% of your wealth every year for the rest of your life and giving you little in return. On a five-million-dollar portfolio over that lifetime you will save several million dollars advisor deductions.
The capital value of such a portfolio will grow, not overnight, but steadily over time. One of my listeners referred to it as being like a snowball rolling down a snowy hill getting bigger and bigger. It is not unusual, in those years, outside of market crash years, to see the share prices of these strong dividend stocks growing by 12% plus generating that annual 7%dividend income. If you choose to invest your dividend income back into the stocks in your portfolio instead of living off it, you could expect to double the value of your portfolio in five years.
Unlike speculators, you will become immune to market losses and emergencies that force speculators to the liquidate their portfolios to weather unexpected economic changes and threats.
How do you easily find twenty safe high dividend companies? The quickest way is to go to one of my investment guides such as “New York Stock Exchange’s 106 Best High Dividend Stocks” or to the “Canadian High Dividend Investing-215 Stocks Scored and Analyzed”. A page for each stock listed in these books shows you its financial strengths and weaknesses. The twenty-three-year history of their share prices and dividend payouts identifies those stocks with ever rising share prices and dividend payouts.
Most financial services that offer self-directed investment accounts also provide additional research tools that allow you to find other stocks to consider and compare. The free scoring program supplied with my books then allows you to calculate the financial strength and desirability of new stocks.
While you may never be the recipient of a multi-million-dollar gift, this does not mean that you cannot start to manage your money as if you were already a millionaire. Successful investing is very much a matter of common sense, patience, and discipline. You are never too old or too young to manage your money well.
Achieving financial independence requires you taking the first step of educating yourself about safe investing. All my books are available and reviewed at amazon.com. You can also visit my website, informus.ca.