Wednesday, December 12, 2012

Long-Term Investing v. Short-Term Investing

Investing for the long-term is the best strategy for the small investor.

Looking at investments over time is an interesting thing.  Some things I bought a long time ago did not seem like a good deal a the time, like some blue-chip stocks, or life insurance.  But over time, they start to pay off, and in the long run - if you live long enough - they pay out.

For example, with my life insurance policies, the cash value increases by about $438.66 every month.  I pay $62.41 in premiums on one of my policies and $44.42 on another.   I also receive about $98.84 in dividends (on a monthly basis) from my Northwestern policies.   So, at the present time, I am making $425.67 a month on these policies, or about $5,108.04 a year.

At this point, there is little to be gained by cashing in the policies, which have a cash value of $98,515.99 and a death benefit of $325,000.  The "rate of return" on this fairly safe investment, based on the cash value, is over 5%, which is not bad.   Of course, the overall rate of return, based on the premiums paid in, is a whole lot less.   But over time, this could end up being a reasonable investment and a good adjunct to my portfolio.

This is not to say buying life insurance is a good investment.   Buying it at age 50 is a horrifically bad investment, as the insurance component will be very expensive.   Insurance is a young man's game, and what made this investment "pay off" over time was the fact that it was a long-term investment I started at age 29, not some short-term deal I started last year.

Similarly, some stocks, while not stellar in performance initially, end up being worth a lot more to me, over time.  For example, if I buy a "blue chip" stock that pays out a dividend at about 2% of the share price, this doesn't sound like much of a good investment, does it?

Over time, however, the stock price doubles, and the dividend increases proportionally.   For someone buying the stock today, it seems like a pretty paltry deal, as the annual dividend is still 2% of the new stock price.  But for someone like myself, who paid half that for the stock, the effective rate of return, in dividends alone, is 4%, which isn't bad in this day and age.   Might as well hang on to that investment!

Short-term investing, on the other hand, is a lot riskier and where I tend to get wiped out.  Trying to buy stocks based on how much they will go up in share price in the next year, is always a dicey deal, as short-term stock predictions are, well, gambling.   I lost my shirt on stupid stocks like Martha Stewart and Syntroleum - and based on recommendations from people on television.

And buying a stock because it pays a hefty dividend now can also be somewhat problematic.   For example, I bought some stock in two tanker companies - TeeKay Tankers and Knightsbridge.  They were both paying out high dividends (on the order of 15%) which sounds swell.   And today they are still paying out 15% dividends. 

There is a catch, of course.  The catch is, they are paying out a lot less in dividends in terms of cash value, and the share price has plummeted as a result, resulting in the ratio of dividend to share price remaining locked in at this 15% rate.

As it turns out, the reason these stocks have such high dividend rates is that they are fairly risky, and the market is saying "I expect a high dividend, relative to share price, as I expect the dividends to decline over time".

And by design, they do.   These types of tanker stocks are interesting beasts, it turns out.  What you are buying is literally a piece of a ship.   The stock represents an interest in a small fleet of ships (bulk carriers, tankers, containers, whatever) and the profits from the ships are paid out directly in dividends, with a small amount taken out for overhead.  When the ships make money, you make money.

But as the ships get older and make less money - or the demand for shipping declines, as it has in recent years - the profits drop as well.  Knightsbridge has sold three of its four tankers, and likely they were scrapped.  It still pays a dividend of 12.05% of the lowered share price - about 6% rate of return based on the price I paid.   The stock price has taken a beating, dropping by half.   Teekay has done better - its stock price actually rose by 40%, then dropped to about -10% in price.  It is cranking out dividends, at 12.88% of share price, which means I am getting back about 10% in dividends, based on the price I paid.

At those rates of return, there is little point in selling the stocks.  And of course, these stocks represent a tiny, tiny part of my overall portfolio.  But the attractive dividends that initially appeared, have decreased over time.  If I hang on to these stocks, I may get my money back, over time.  But the effective rate of return will not be the 15% initial dividend, but likely far less.

Moving forward, profits may go up, as the economy recovers - and dividends may increase.  China's appetite for oil will not taper off anytime soon.  And oil shale or not, we will still import a lot of oil.   But where will Knightsbridge get the cash to buy new tankers?  Well, they use the proceeds from the sale of the old ones, and issue new shares of stock instead of tapping into profits (which are all paid out in dividends).  So they will sell new shares, diluting the value of my old shares, and basically I will end up "owning" a smaller part of a new ship, along with the new shareholders.   The stock, by design, declines in value over time, but pays out hefty dividends.  It is an interesting beast!

It was not necessarily a bad investment but one that I understand better, now that I have bought it.  And it never pays to buy an investment you don't fully understand.   Oh, but the learning curve is steep, ain't it?

Other short-term bets I made, based on stock price alone, have not fared as well.   Picking stocks, as I noted before, is a game for chumps and gamblers (and I am being redundant here).  Investments in CREE lighting and Syntroleum, for example, were foolish gambles.  They were not dividend-paying stocks, and while CREE is profitable, it is getting hammered by cheap Chinese LEDs (Much as the solar market was hammered by cheap Chinese solar panels).  The price went up, the price went down, I got out with half my money - and that was a good thing.  Today, I would have far less.

Long-term, neither of these companies was a good bet at the time I bought them.   Most of the stocks I have done well with were more of the "blue chip" variety.  They have gone up in value, while chugging out dividends at a regular rate.   And since I bought them for a lot less money, in years past, the effective dividend rate of return on my investment, is much higher.

What sort of Companies?  Stanley Tool, for example, which has doubled in value since I bought it, and pays out a dividend of 2.69% which doesn't sound stellar, but at the share price I paid, is well over 5%.  Or United Technologies, up 65% since I bought it a few years back, and cranking out a 2.63% dividend at today's share price (over 4% dividend rate of return at the price I paid).

And as I go down the list, the pattern is the same.  The winners are "old school" companies like Disney, Cosco, BMW, Kaiser Aluminum, Caterpillar, FMC, Exxon, Kraft, 3M, Kraft, WalMart, AT&T, Dell, Altria, Coca-Cola, and even Ford.   To be sure, many of these stocks initially seemed to be poor choices, as they tanked in value after I bought some of them - some by 20-40% or more, such as 3M or Kaiser.   But over time, they increased in value and kept paying out those dividends.  All are worth more than I paid for them - some doubling in value - and all pay out dividends regularly.

And to be sure, there are a few "dogs" in these old-school companies - stocks such as GE, Archer-Daniels, Southwest, Dow Chemical, and Pfizer.  But even these stocks - which have declined by 10-50% in value since I bought them, continue, in most instances, to crank out dividends, often at 3% or more of current share prices.  And the share prices have been edging up, over time.   If I was to sell them today, what would I buy?  Probably the same stocks.  So I hang on.

Of course, I am not suggesting or recommending direct stock investment or stock-picking as a centerpiece of any investment portfolio.   Stock-picking is for chumps, remember?   I have a trading account, and it represents less than 10% of my overall portfolio.   And most of that money is now invested pretty conservatively - in blue-chip stocks that pay dividends and are held for the long-term.

And most of my stock investments are through mutual funds, which overall have done about the same, if not better, than my trading account.  In fact, my trading account seems to be catching up with my mutual funds, as I move more toward long-term and blue-chip stocks.

Initially, when I started this account, I bought a lot of crap - thinking I could outsmart the market by making "smart choices" and buying and selling stocks in the short-term.   And fortunately, I did not get burned too badly.  But I learned quickly that buying stocks that are talked about on the TeeVee as being "real movers" or listening to the shouting guy or other financial channels, was just a bad, bad idea.   All those stocks did was go up in value in the short-term (because they were mentioned on television, and folks like me bought them) and then they would tank for the long-term, as their fundamental value in the marketplace became apparent, once the hoopla died down.

Buy-and-hold is now my strategy, unless I really think a stock is going down for the long-term.   I tend to buy, using the dividend income from my existing stocks, and add to my stock portfolio, rather than try to buy and sell shares and churn my account.   And that dividend income works out to about 2.5% on average, in my trading account, which allows me to add another company to the mix, about every year, from the proceeds of the other investments.

Over time, my investments will get more and more conservative.  Eventually, I will likely be mostly in treasury bills, CDs, Money Market accounts, or other "safe" investments which have low yields, but also zero risk.   Once you are 70, you are not going to make a lot of money from your investments, so you might as well spend it.   Trying to "live off the interest" is just too risky, at that age.

Now, to a lot of folks, that seems like a "boring" strategy, as they want to see huge gains and get-rich-quick schemes.  They want overnight wealth and "secret stock tips" for making lots of money.   And other than committing fraud (for example, by hyping penny stocks through e-mails in a pump-and-dump scheme) you really can't do that.

Sure, once in a while you get lucky, like I did with Avis stock, and it goes up 1200% in value in a few months (and over 2000% overall).   But those are long-shot deals that happen only once in a blue moon (the blue moon in this instance, being the market tanking in 2009, and rumors of the company's imminent bankruptcy proving false).  You can't count on that happening with any regularity.

This is not to say people don't try.  They believe (and believe is the word, as belief and logic are two different animals) in things like Facebook stock and Gold, without doing any math on the basic fundamentals of either - much as I did, with my initial investments in speculative stocks, when I opened my trading account.

Get-rich-quick schemes always fail.  However, if you invest for the long haul you can become comfortably well-off, over time.   The key is to invest, soundly and consistently, over time - and to stop chasing the false God of "get rich quick".