Still questioning growth vs. income investments

November 24th, 2008 · 4 Comments

I came across a very intriguing article recently thanks to Google Finance: Michael Lewis, the author of ‘Liar’s Poker‘, has written an anecdotal analysis of the mortgage meltdown that both shocks and scares me. The picture he paints leaves me seriously wondering what Wall Street will look like when the current market turmoil resolves.  It has also inspired some significant internal debate in me regarding what we should be doing to best position ourselves to reach our goal of geographic independence.

Is now a time to bet on growth?

Is now a time to bet on growth?

In Mr. Lewis’ article, “The End of Wall Street’s Boom“, there is an absolutely shocking recollection of one mortgage that I never would have believed could have been closed.  A person who appears to be a migrant farm worker in California, earning only $14,000 a year, was given a 100% LTV mortgage for a $720,000 home purchase!   Even at a fixed rate of 1% for 30 years, that’s a $2,315 mortgage payment per month — or almost 100% ($13,780) more than this man makes in a year!  Worse, this loan appears to have been packaged and sold as part of an investment to poor slobs like you and me.   There isn’t a low enough rating in the world to properly classify how unlikely you would be to make any money off that investment!

If you read the whole 9 pages of the article, you’ll gain a good understanding of how quick many Wall Street firms were to jump on the short-term, money-making bandwagon that was mortgage-backed securities for fear of being left behind.   And this was so clearly at the cost of their long-term reputation.   If this were a game of musical chairs, no one in their right mind could have thought the music wouldn’t come to end, and soon.  Yet everyone kept acting like the band would never tire.  The saddest thing to me right now is how we’re bailing out a lot of these very same institutions.

Anyway, at the end of Mr. Lewis’ article, I’m left wondering what to do with the money that I am able to invest right now.  Wall Street certainly isn’t earning my trust on the investment advice they’ve been dishing out, so I’m not exactly inclined to listen to anything they have to say.  It seems to me that staying away from any sort of derivative or repackaged basket of any kind is an obvious step — and I’m not just talking about baskets of mortgage debt.  But that still leaves a lot of uncovered ground.  And how do I trust any analyst, company, or fund to correctly disclose any exposure they may still have at this point?   Yet after saying all that, it makes obvious sense that the best time to invest is when everyone else is panicking and selling (the ol’ buy low and sell high thing) so I want to do somethingJust like Warren Buffet.

I wish I felt more confident, but I haven’t had time to even come to a conclusion on how much we should be focusing on income vs growth investing right now.   I know we want to establish and grow an income stream (that’s the whole reason I started this blog after all) but can we really give up the chance of fast asset growth by not investing for growth in this so obviously depressed market?   There are a lot of companies whose stock is selling for less than book value after all!   That being said, I’m not even sure I’d have the guts to go for individual stocks should we choose to pursue asset growth — I’d probably argue to continue our move toward broad market index funds.   Does that mean we shouldn’t pursue growth though, because we’d be betting on a rising tide to raise all boats rather than a few well-placed company or sector bets?  I’m thinking that my natural tendency severely limits our chance of riding any early, big, growth-based rally.

One thing I’m confident of is that if we do put our money into income-focused investments, it will be by first buying stocks of individual companies with a track record of raising dividends in all types of markets.   I think we can keep the expenses down by using a brokerage firm like ShareBuilder where initial investment transaction costs are relatively low, dividend reinvestment is easy and has no transaction fee, and you can put all your money to work by being able to buy fractional shares.  At some point, for diversification purposes, we’d likely start judiciously looking into some high-yield bond fund ETFs, or one or more of these high-dividend-yield ETFs, even though I expect the expenses will be higher due to the annual asset-based charge.

If you have any advice on all of this, I’m all ears.

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Tags: Equities · Investing · Passive Income

4 responses so far ↓

  1. 1 fee only financia advisor // 2008.12.29 at 2:10 pm

    Nice article. Since your article links to one of mine, I’d like to add two links here that are relevant to your point.

    One is Bob Shiller’s old paper that basically says dividends don’t fluctuate as much as prices:

    http://tinyurl.com/bx35af

    The other is my own research that investing in top 30% dividend paying stocks would have saved you in the Great Depression:

    http://tinyurl.com/amhrvy

  2. 2 davmp // 2009.01.02 at 6:06 am

    @fee only: Thanks for the links. Since this post I’ve been doing alot of reading and discussing with my wife. We’re mostly leaning toward the idea that, with a proper buying strategy, we can acquire investments that pay dividends and have lots of room for dividend growth, yet also have a significant chance of price appreciation as well. Certainly the focus on income fits best with our geographic independence goal, whether its just acquiring income at all or trying to ensure we don’t suffer too much in a market downturn.

  3. 3 fee only financia advisor // 2009.02.12 at 4:42 pm

    Dave,

    There are two caveats using the dividend oriented approach. In the past 100 years, there are only three other recessions as bad as this one. Though dividends held up well during all three, still three does not make a rule. Dividends are not tax-efficient. You’d better have a number of tax-deferred accounts to hold all those dividend stocks.

  4. 4 davmp // 2009.02.13 at 7:21 pm

    @fee only: I’ll agree that three does not a statistically valid sample make. However, careful choices in investments (say the S&P Dividend Aristocrats) can help ensure that our choices will continue to pay dividends even in this recession / depression. Plus, dividends have certainly helped in other market conditions too. For example, a number of studies have shown that 80% or more of the increase in the market people have seen since the depression is due to dividends. (Though I will admit I’m parroting other people’s conclusions rather than reading the studies myself.)

    And while getting that dividend income may not be tax-efficient, it is pretty much the only way I know of to generate a recurring income stream from securities without frequent trading (which also doesn’t get favorable tax treatment.) If you know of other ways, I’m eager to learn!

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