FYI | May 06 2015
By Peter Switzer, Switzer Super Report
It’s good to hope for the best but you sometimes need to expect the worst and develop a contingency plan for those rainy market days.
Most of you know that I hold a position that stocks have probably two good years ahead before I start to worry about a big sell off. It could be earlier than I think, and I will be on the lookout for any early signs but it also could be later.
We’re locked into very unusual economic and stock market cycles created by the GFC crash and the policy response by central banks, as well as governments around the world.
We were trying to beat a Great Depression and right now the big watch for me, for you, is to monitor how the QE programs from the US, to Japan, to Europe, translate into economic improvement. If it happens as hoped, then the bull market could drag on for three or four more years! If Europe, for example, fails to turn green shoots into credible young trees of hope, then the current market optimism could end abruptly.
The stress test
My key question to you is: Could your portfolio of shares stand say a two or three year period where your capital depletes substantially? Three years would be a really rough time and I think a two-year test would be good enough, but I’d rather see you do a tougher stress test so you’re ready for the worst-case scenario.
When people ask me about my portfolio, I tell them I like dividend-paying stocks. It might sound odd but stock market crashes do present opportunities because you can buy great companies at low prices.
Unfortunately, my colleagues in the media have a strange view on stocks. They seem to think it’s like going to the races, where you pick winners and you losers but hopefully, over time, you end up in the black.
Like a lot of investors, who really more resemble speculators, they like the idea of a cheap stock that might, say double, in price from 20 cents to 40 cents. However, I’d prefer a stock like CBA that goes from, say, $30 to $90 in the space of seven years paying great dividends along the way, all enhanced by franking credits!
Many of you know I love the following chart as it proves my point about having a great quality set of stocks that do as well as the S&P/ASX 200 index. And furthermore, if you reinvest your dividends, it ends up like this:
I like the fact that $10,000 in a good portfolio with dividends reinvested ends up as $453,165 just after the GFC ends, despite all those crashes and corrections. By the end of January this year, it has turned into $722,110.
Imagine if I created a chart that took out the 2008 and a bit of 2009, 2000 and 2001, 1993, 1987 and 1988, etc., we’d end up close to a straight line from $10,000 to $722,110!
The action plan
Your challenge is to create a dividend or income flow that remains pretty damn good even with a huge market sell-off. You need to create a cash buffer for the bad times, built in the good times.
So, if you had a $1 million in stocks and you want $70,000 a year to live on, then when you make 10%, you bank the extra $30,000 in your cash account.
Over a decade of history shows stocks return 10% per annum, despite two to three bad years, and half of those returns will be dividends! By the way, that cash buffer, if it gets big enough, can also be used to buy good quality companies at low share prices during a scary crash!
What I propose is not Mission Impossible. As the old TV show used to say: ““Your mission, should you decide to accept…” is to do the opposite of most investors who really resemble speculators.
Mine is a boring strategy of wealth accumulation, but there are some hairy and scary bits and that’s being, as Warren Buffett would put it,: “Greedy when everyone is fearsome.”
Stress test your portfolio and if it doesn’t shape up, change it.
By the way, the greatest threat to your future wealth might be by being too long in term deposits! If you don’t believe me, have a look at what cash returned over 1970-2015.
Who knows, this odd period, where term deposits are unattractive, could prove to be a godsend by encouraging term deposit investors to explore the power of fully franked dividends!
Peter Switzer is the founder and publisher of the Switzer Super Report, a newsletter and website that offers advice, information and education to help you grow your DIY super.
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