Monday, March 09, 2009

Finding a New Sweet Spot for Investing

From 1985 to 2007, the sweet spot for investing was a diversified equity portfolio, which returned about 12% annually during that time. Investors did very well buying and holding the S&P 500 index, or similar diversified stock index. However, since October 2007, the stock market and the indices have been pummelled, declining 50% or more.

I don't believe that buy and holding index funds will re-emerge as the sweet spot of investing again. Therefore, I am looking for what are potential sweet spots for the future.

Here are two areas I am considering.

  • High dividend paying stocks. Dividend payments have been about 70% of stock market real returns after inflation. According to Credit Suisse Global Returns Yearbook 2009 page8, the stock market has returned 6% real returns since 1900, but only 1.7% if dividends are not reinvested. In addition, dividends are giving favorable tax treatment, being taxed at the capital gains tax rate. With some good companies paying dividends in the 5 to 10% range, e.g. DuPont (DD) pays almost 10%, I think these stocks may be worth purchasing. For some ideas, see this Barron's article The 20 Best Dividend Plays for 2009.

    Risk: The dividend is cut significantly, as has happened to many financial companies in the past few months.

  • Treasury Inflation Protected Securities (TIPS). These are Treasury bonds that have a nominal interest rate and an inflation adjustment to principal. I believe the economic stimulus packages and the bailouts (banking, mortgage, credit, etc) will soon lead to a significant increase in inflation. TIPS bonds will allow me to always earn a fixed percentage over inflation.

    Risk: Deflation occurs, which reduces the principal and the effective earned interest rate.
  • At this point, I will only be putting a small amount of money into these new areas. However, if the stock market keeps falling, I will divert more funds to these options.

    Disclosure: At time of publication, we own DuPont through our managed account and TIPS in our trading account.

    For more on Strategies and Plans, check back every Monday for a new segment.

    This is not financial or investment advice. Please consult a professional advisor.

    Copyright © 2009 Achievement Catalyst, LLC

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