Monday, February 1, 2010

THE APPROPRIATENESS OF THE APPROACH


Invest for long term
Diversify portfolio with equities and fixed income

By Don Promhouse, For Canwest News Service;
Regina Leader-Post
February 1, 2010


I often advise clients to use the Rip Van Winkle approach to investing, and the last two years have confirmed the appropriateness of this approach.

The children's fairy tale, Rip Van Winkle by Washington Irving, tells of a good-natured fellow who fell asleep under a tree for 20 years. Upon waking, everything had changed and most of his friends had moved or passed away, including his wife. For the rest of his life, Rip Van Winkle was respected as one of the patriarchs of the village.

The Rip Van Winkle approach to investing involves building a portfolio that will last a lifetime. This means setting an asset mix and sticking to this mix through good markets and bad, making strategic changes along the way.

So, if you set your asset mix at 25 per cent cash and fixed income and 75 per cent equities, and equities come to make up 80 per cent of your portfolio, you should sell off five per cent of your equities and add to your cash and fixed-income portion.

Also, your fixed income and equities should be diversified through each sector of the economy and globally.

If you had adhered to this philosophy and held more cash and fixed income than equities, the 2008 market decline would have affected you much less than the market decline. Similarly, your portfolio went up in 2009 much less than the market.

So how do you build a portfolio that can grow for 20 years? One method I have had success with is investing in fundamentally strong companies that pay above-average dividends.

Between 1926 and 2004, dividends represented 42 per cent of the S&P 500s total return. The S&P/TSX Total Return returned only 5.5 per cent annually in the last 10 years, but historically the returns have averaged closer to 10 per cent annually.

Currently, you can purchase fundamentally strong companies paying a dividend between four and six per cent, and that's all you need to compound your returns at 10 per cent. The problem is it takes time and patience to beat the fastest-rising stars.

One feature of the current investment climate, and one I expect to persist through 2010, is that short-term interest rates are extremely low, if not zero. Given the drag on economic growth and inflation from an overvalued Canadian dollar, the Bank of Canada could leave rates on hold right through next year.

Traditionally, dividend investors have looked to telecoms and utilities for healthy dividend yields, and those two sectors indeed top the pack in terms of TSX payout ratios and yields.

But today there are other groups where dividends now pay out close to four per cent or more of the share price, including media and real estate.
Photo by: Greg Westfall

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