Great illustration of the power of patience and growth needed for dividend investing. It also further drives home, for me, Bonds are an inferior investment. Why people slavishly allocate 40% of their portfolio into an asset that is guaranteed to reduce your purchasing power over time is a mystery.
You’re right that bonds lag equities over long uptrends, but when I backtested crashes (dot-com, ‘08, COVID, 2022) they were the only thing that kept the floor from falling out. Cash actually worked even better in a rates shock like 2022, but the tradeoff is you miss the bounce.
Yes, I suspect that is because the price of a business is quoted daily by the stock market. This causes many people to obsess over the short term changes in their total portfolio value. Yet many of the fluctuations are unrelated to the health of the underlying business. If you are a long term investor, you are not forced to sell your holdings during the extreme moves in the market. You collect your dividends, review quarterly business metrics, conference call and other relevant information. People spend too much time and energy on daily pricing of their portfolio. This leads them to hold bonds because it creates the illusion of protection from things that are not so important.
Depends on your strategy. In a buy-and-hold strategy bonds are no illusion. They cushion the inevitable downturn. Periodic rebalancing between bonds and equities is a perfectly defensible, low-touch strategy, especially for retirees who are drawing down capital.
Here’s what I am thinking. Let’s assume a retiree. The strategy should be to maximize long term returns and minimize the underlying business risk of the stocks held. Hold enough cash to cover fixed expenses for 1-3 years. Then hold a diversified collection of great, high quality businesses. Also, I should have been more clear, when talking about the flaw of bonds, I was referring to the long duration (5-30yr) . Bonds with a duration of 2 yr or less I would include as part of cash bucket. The “great, high quality “ part is where the discipline is needed. You need to bias toward predictability and durability with some decent growth. You would barbell businesses like Google and Nvidia with businesses like Berkshire Hathaway, Waste Management and Illinois Tool Works. You would have to pass on businesses like Palentir. You would limit initial position size to 3%. Dividends would be used to replenish the cash bucket. This is not an entirely new concept, it’s modeled off of a passage in one the Berkshire letters where Buffet is railing against bonds.
Yes this makes sense - broadly speaking it’s the Buffett fundamental approach, I think? But dividends are rarer and rarer these days. That worries me as the present value of a series of future dividends is the supposed rock on which the entire limited-stock-company structure has been constructed since the 1600s. If that doesn’t matter anymore, than what even *are* prices? That question keeps me up at night every once in a while…
Funny you mention this. ITW just raised their divvy by 6.8%. Don’t lose too much sleep over this. The key is the free cashflow engine that make dividends and share buybacks possible. About 75% of my stocks pay dividends, and the ones that don’t are really good businesses.
Good read and illustration! Wish someone told me when I was younger
It’s never too late to start!
Great illustration of the power of patience and growth needed for dividend investing. It also further drives home, for me, Bonds are an inferior investment. Why people slavishly allocate 40% of their portfolio into an asset that is guaranteed to reduce your purchasing power over time is a mystery.
You’re right that bonds lag equities over long uptrends, but when I backtested crashes (dot-com, ‘08, COVID, 2022) they were the only thing that kept the floor from falling out. Cash actually worked even better in a rates shock like 2022, but the tradeoff is you miss the bounce.
Yes, I suspect that is because the price of a business is quoted daily by the stock market. This causes many people to obsess over the short term changes in their total portfolio value. Yet many of the fluctuations are unrelated to the health of the underlying business. If you are a long term investor, you are not forced to sell your holdings during the extreme moves in the market. You collect your dividends, review quarterly business metrics, conference call and other relevant information. People spend too much time and energy on daily pricing of their portfolio. This leads them to hold bonds because it creates the illusion of protection from things that are not so important.
Depends on your strategy. In a buy-and-hold strategy bonds are no illusion. They cushion the inevitable downturn. Periodic rebalancing between bonds and equities is a perfectly defensible, low-touch strategy, especially for retirees who are drawing down capital.
Here’s what I am thinking. Let’s assume a retiree. The strategy should be to maximize long term returns and minimize the underlying business risk of the stocks held. Hold enough cash to cover fixed expenses for 1-3 years. Then hold a diversified collection of great, high quality businesses. Also, I should have been more clear, when talking about the flaw of bonds, I was referring to the long duration (5-30yr) . Bonds with a duration of 2 yr or less I would include as part of cash bucket. The “great, high quality “ part is where the discipline is needed. You need to bias toward predictability and durability with some decent growth. You would barbell businesses like Google and Nvidia with businesses like Berkshire Hathaway, Waste Management and Illinois Tool Works. You would have to pass on businesses like Palentir. You would limit initial position size to 3%. Dividends would be used to replenish the cash bucket. This is not an entirely new concept, it’s modeled off of a passage in one the Berkshire letters where Buffet is railing against bonds.
Yes this makes sense - broadly speaking it’s the Buffett fundamental approach, I think? But dividends are rarer and rarer these days. That worries me as the present value of a series of future dividends is the supposed rock on which the entire limited-stock-company structure has been constructed since the 1600s. If that doesn’t matter anymore, than what even *are* prices? That question keeps me up at night every once in a while…
Funny you mention this. ITW just raised their divvy by 6.8%. Don’t lose too much sleep over this. The key is the free cashflow engine that make dividends and share buybacks possible. About 75% of my stocks pay dividends, and the ones that don’t are really good businesses.