Improving Investor Behavior: Overcoming inflation using a familiar friend (Part 2)

For investors, inflation is the erosion of your money, a “cancer,” if you will. It is the slow, subtle decline in what your money buys or the purchasing power of your money. Last month we covered what inflation is, how it works, and where it may be heading in the future. If you’re unfamiliar with inflation, I’d encourage you to refer to my column published on Jan. 17.

People invest in income, either for today or tomorrow. Protecting the purchasing power of that income is critical. But investors want to have their cake and eat it too. To grow investments and income at a rate that outpaces inflation, one must be willing to endure the “wiggles” that come with stock investing. Investors may seek protection from volatility through bonds or fixed-income investments that don’t fluctuate like owning businesses (stocks), but this strategy is shortsighted.

Steve Booren

Inflation punishes bond investors. In today’s financial market environment, you lose the purchasing power of your money in “low-risk” investments like bonds. The Fed has lowered interest rates to nearly zero, so you get paid less than inflation on a current return basis. More importantly, inflation over time compounds against the value of your bond investment. At a 3% inflation rate, a bond’s purchasing power value declines by 50% in just 24 years. Imagine a 60-year-old who may want less fluctuation in their portfolio; any money allocated in bonds will lose half of its purchasing power by age 84. Investors might believe this to be a “safe” investment, but a better definition is “secure.” That investor will get the nominal money back in the future but will lose half of their purchasing power. “Safety” is found in growing purchasing power, not cash stuffed in the mattress.

That is why we believe in investing in businesses that grow their dividend income by innovating day-in and day-out, selling their goods and services to everybody, every day, everywhere. They are incentivized to constantly do better; they can adapt to changes that arise, and we all know changes happen. Bonds cannot adapt; they don’t change. You bargain for a rate and a date to get your principal back.

Dividends are simple to understand. They are a portion of company profits paid to shareholders as a reward or sort of “thank you” for investing or being an owner in the company. Typically, dividends are paid on a quarterly basis and are a predetermined dollar figure, which can be expressed as a percentage of the momentary price of the stock. Dividends are often symbolic of a companies’ underlying strength. If a company can continue to pay shareholders through thick and thin, it is believed to be a stronger company. Furthermore, if they can continue to grow those dividend payments over time, they are seen as being in an even better position. Companies that have a track record of consistent dividend payments and continue to increase those payments at a frequent interval are those we like.

There are has two primary benefits to this approach. First, …read more

Source:: The Denver Post – Business


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