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Have a Plan and Stick To It

The difference in life between success and failure, more than anything else, is having a plan and sticking to it.

Whether you’re talking about launching a business, getting through Navy SEAL training, becoming a concert violinist, or even getting a date on Friday night; success comes from seeing a plan through to completion.

This is particularly true when it comes to investing.

Warren Buffett, the legendary Oracle of Omaha and by most accounts the most successful investor in history, is probably a little smarter than you or me. I say “probably” because Mr. Buffett has never published his IQ score, and measurements of intelligence can be subjective.

But, in Buffett’s own words, in order to be a great investor, “You don’t need to be a rocket scientist. Investing is not a game where the guy with the 160 IQ beats the guy with a 130 IQ.”

To put that in perspective, the average IQ falls in a range of about 85 to 115. An IQ over 140 is considered genius level, and theoretical physicists Albert Einstein and Stephen Hawking were believed to have respective IQs of about 160 each.

So, according to Buffett, you need to be a little above average to be a good investor. But you certainly don’t need to be an Einstein or Hawking.

Buffett attributes his own success to “being greedy when others are fearful and being fearful when others are greedy.”

In other words, Buffett is Buffett not because of his intelligence but rather due to his emotional control, which allows him to stick to an investing plan even when most other investors are pulling the ripcord.

Now, I don’t claim to have Warren Buffett’s talents. But some of my greatest investment successes have come from being equally stubborn about seeing a plan through to completion.

I don’t have a large enough nest egg to retire today. But it’s big enough that I don’t really need to keep adding to it with fresh savings. Even with very modest growth assumptions, the savings I’ve accumulated already should be more than sufficient to take care of me and my wife in retirement when that day comes in another 20 years. Savings I continue to add just put the icing on the cake.

It wasn’t fantastic investment returns that got me to this point. It was having a savings plan and having the discipline to see it through to completion. I max out my 401k contribution every year, even when doing so is painful. Even when the market looks scary. Even when I’d prefer to blow the cash on something else or when I have to tell my children that I can’t afford something they want right now.

I’ve enjoyed competitive returns on those funds over the years, but the high savings rate has had a much bigger impact on my ability to grow my capital base than my returns.

As another example, I bought 288 shares of Realty Income (O) in 2009 that I swore at the time I would never sell. I committed to reinvesting my dividends into new shares and letting it compound… for the rest of my life. My children may sell the shares when I’m dead and in the ground, but I never will. When I’m old and gray, I’ll simply turn off the dividend reinvestment and take them in cash instead.

Well, after a little over nine full years of dividend compounding, those 288 shares bought for an initial purchase price of $6,620 are now 454 shares worth $32,383.

Using conservative assumptions on dividend growth, I would expect my investment to double every eight to ten years. So, in another 20 years, when I’m getting close to retirement, I’ll have something in the ballpark of $140,000 in Realty Income… still trucking along and throwing off dividends. And all of that on an initial investment of just $6,620.

Now, I’m not recommending you run out and buy Realty Income. I wouldn’t make a major new purchase at today’s prices. My point is simply that having a good plan – in this case buying and holding a high-yield dividend stock bought at crisis prices – works when you actually stick to it.

Disclosure: Long O.

Disclaimer: This material is provided for informational purposes only, as of the date hereof, and is subject to change without notice. This material may not be suitable for all investors and is not intended to be an offer, or the solicitation of any offer, to buy or sell any securities nor is it intended to be investment advice. You should speak to a financial advisor before attempting to implement any of the strategies discussed in this material. There is risk in any investment in traded securities, and all investment strategies discussed in this material have the possibility of loss. Past performance is no guarantee of future results. The author of the material or a related party will often have an interest in the securities discussed. Please see Full Disclaimer for a full disclaimer.

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Why Dividends Matter

I’m old school, and I like my dividends.

Yes, I know. I’m being hopelessly stodgy. Dividends are almost inconsequential these days compared to the returns realized from rising stock prices.
Since bottoming out in early 2009, the S&P 500 has exploded higher at a compound annual growth rate of over 15% per year and is up over 300% cumulatively.

What’s a couple percent in dividends when you’re looking at those kinds of capital gains?

Furthermore, very few sexy, high-growth tech companies pay dividends. Amazon, Facebook, and Alphabet (Google) certainly don’t, and none have immediate plans to start.

But it’s important to keep a few things in mind. To start, the 15% annualized returns we’ve seen over the past decade in the S&P 500 are by no means normal. The long-term term historical average is closer to 10%.

And mean reversion being what it is, having a long period of above average returns means we need to have a long stretch of lower-than-normal returns to get us back to the long-term average.

Not even the glassiest-eyed permabull seriously believes returns of 15% per year can continue forever.

Let’s slice the numbers a little differently.

The returns you achieve are ultimately a product of the price you pay. When you buy them cheaply, you put yourself in position to enjoy higher-than-average returns. When you overpay, you set yourself up to be disappointed.

Well, the S&P 500 currently trades at a cyclically adjusted price/earnings ratio of 29.9. That implies it is priced to deliver losses of about 2% per year over the next eight years, assuming the market returns to its long-term average valuation.

Now, maybe we get lucky and valuations remain at historically elevated levels. Hey, stranger things have happened, and there might have even been legitimate justification for it in lower interest rates and stricter accounting standards.

But even assuming valuations remain 25% to 50% higher than their long-term averages, we’d still be looking at returns in the ballpark of just 1% to 3% per year.

When you’re used to making 15% per year, making 3% (or even losing money) is a bitter pill, particularly if you’re already in retirement and have to take portfolio drawdowns.

This brings me back to dividends.

With and Without Dividends

Sometimes a picture is worth a thousand words. So, take a look at the following two charts. The first is a standard price chart of telecommunications giant Verizon (VZ).

It’s not pretty. Nearly 20 years since the peak of the 1990s internet bubble, Verizon has yet to see new highs. Had you had the remarkably bad timing of buying Verizon at its 1999 high, you’d still be under water two decades later.

Now take a look at the second chart. This is also Verizon, but this chart adjusts stock prices to account for dividends paid. For most of the past 20 years, Verizon has sported a dividend yield of between 4% and 6%.

Suddenly, Verizon doesn’t look so bad. Even buying one of the most overpriced major stocks at the peak of the biggest stock bubble in history, you still would have enjoyed total returns of more than 140% after accounting for Verizon’s massive dividend yield.

Now, my point is not to recommend Verizon. At current prices, it’s not cheap enough for me to seriously consider.

But its performance proves a very important point about the importance of dividends, particularly at a time when stocks are expensive and priced to deliver disappointing capital gains.

You can’t always depend on capital gains. You can do everything right – research your stocks, buy them at reasonable prices, etc. – but you can’t make them go up in value.

Ultimately, the market is going to do what it’s going to do, and it doesn’t care what return you need or expect.

When you focus on dividends, you don’t have to worry as much about capital gains. Sure, you want to see your account rise over time. But you don’t need it to.

Disclaimer: This material is provided for informational purposes only, as of the date hereof, and is subject to change without notice. This material may not be suitable for all investors and is not intended to be an offer, or the solicitation of any offer, to buy or sell any securities nor is it intended to be investment advice. You should speak to a financial advisor before attempting to implement any of the strategies discussed in this material. There is risk in any investment in traded securities, and all investment strategies discussed in this material have the possibility of loss. Past performance is no guarantee of future results. The author of the material or a related party will often have an interest in the securities discussed. Please see Full Disclaimer for a full disclaimer.

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My Favorite Corner of the Market

As you probably know, my beat is income. And in my newsletter, Peak Income, I specialize in finding cash-generating investments that are a little off the beaten path.

Well, one of my favorite high-yield fishing ponds – closed-end funds (“CEFs”) – is looking attractive again, and I’ve been aggressively recommending them to my readers over the past two months.

So, today I’m going to tell you why I like closed-end funds and why they look particularly juicy today.

Let’s start with the basics. What is a CEF?

CEFs are a type of mutual fund that trades on the New York Stock Exchange, and they work a little differently than traditional mutual funds and ETFs.

In a traditional open-ended mutual fund, you (or the brokerage house you use) send money to the mutual fund manager. The manager then takes your cash and uses it to buy stocks, bonds and other investments. When you decide to sell and move on, the manager sells off a portion of the portfolio and sends you the proceeds. There is always money sloshing in and out of the fund.

Closed-end funds are different. They have an initial public offering (IPO) like a stock, and after that point the number of shares is fixed. Barring a secondary offering or a share buyback or tender (both of which are rare), new money does not enter or leave the fund. If an investor wants to buy or sell, they do so on the stock exchange.

From my description, CEFs look a lot like their cousins, ETFs. Both trade intraday on the stock exchange.

But there is one critical difference…

For example, if the ETF shares are worth less than the underlying stock portfolio, the big boys can buy up ETF shares, break them open, sell the underlying stocks they hold, and walk away with a risk-free profit. Not bad work if you can get it!

CEFs don’t have this mechanism in place. This means you regularly get situations where the price of the fund shares is vastly different than the value of the portfolio it owns.

And this is when I get interested. It doesn’t happen every day, but once in a while you can pick up a dollar’s worth of high-quality stocks and bonds for just 80 or 90 cents.

If you’re a patient value investor like me, you can buy the shares and wait for them to return to something closer to fair value… all while collecting dividends along the way.

Three Ways to Profit

Closed-end funds have three components to their returns.

The first is the easiest to understand: the dividend yield.

CEFs are popular among retirees and other income investors because they tend to throw off a lot of cash. It’s not uncommon to see tax-free municipal bond funds yielding over 5%, and taxable bond, preferred stock or dividend-paying stock funds can often sport yields over 8%.

In a world in which the 10-year Treasury note still yields less than 3%, that’s a solid income return.

But that’s just the start. CEFs are actively managed, and the fund managers also try to grow the net asset value over time. When the value of the stocks, bonds or other assets the CEF owns rises in value, the price of the fund generally follows.

And finally, there’s my favorite component: the change in the premium or discount to net asset value.

As I just mentioned, you regularly get situations where the price of a CEF varies wildly from the value of its underlying stock or bond holdings. As a general rule, I never buy a CEF trading at a premium to its net asset value. Philosophically, I have a real problem paying $1.05 for something worth a dollar.

But when the discounts get wide, I get interested. Let’s say a given CEF typically trades at a discount to NAV of about 3% to 5% but because of a short-term market panic, that discount widens to 15%. All else equal, buying the fund at that discount and waiting for it to return to a more normal level can add an additional 10% to 12% to your return. And that’s on top of the dividend yield and any improvement in the value of the portfolio itself.

When you time these right, it’s not hard to pocket total returns of 20% to 30% in a year.

Not bad!

Disclaimer: This material is provided for informational purposes only, as of the date hereof, and is subject to change without notice. This material may not be suitable for all investors and is not intended to be an offer, or the solicitation of any offer, to buy or sell any securities nor is it intended to be investment advice. You should speak to a financial advisor before attempting to implement any of the strategies discussed in this material. There is risk in any investment in traded securities, and all investment strategies discussed in this material have the possibility of loss. Past performance is no guarantee of future results. The author of the material or a related party will often have an interest in the securities discussed. Please see Full Disclaimer for a full disclaimer.

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The Stocks Buffett Wishes He Could Buy

John Del Vecchio is a cheapskate after my own heart.

While he doesn’t mind spending a little cash on the things he enjoys (I won’t tell you how much he and his wife spent on their last vacation), he’s about as hard nosed and tightfisted as it gets when it comes to his investments.

He’s also one of the few truly independent minds I’ve seen in this business. In an industry dominated by herding and groupthink, John is unafraid of taking unpopular or contrary positions, which you’ve probably picked up on in his writing here in The Rich Investor.

Maybe it’s his two decades of experience as a short seller… or maybe it’s because he grew up in upstate New York and has a chip on his shoulder from never seeing the sun. Or maybe it’s a little of both. But I can tell you that John is as independent as they come.

And as an investor, he’s a stone-cold killer that doesn’t blink.

At any rate, John and I were swapping investment ideas at the company Christmas party a few months ago, and I was telling him about some new developments in my trading service Peak Profits, which focuses on small- and mid-cap value and momentum stocks.

Well, that’s about as animated as I’ve ever seen John get (remember, he’s from upstate New York). John told me he was working on a little project of his own that focused on small-cap stocks and, specifically, small-cap stocks priced under $10 per share.

These are two very different things. “Small cap” refers to market capitalization, or the value of all the company’s shares. There is no “official” definition for what constitutes a small cap, but we’re generally talking about companies valued at around $300 million to $2 billion.

But importantly, this had nothing to do with the price per share. A small-cap stock can just as easily have a share price of $5, $50, or $500. It’s not the price of the stock that is relevant but rather the value of the entire company.

Both small-cap stocks and low-priced stocks are good fishing ponds for investors and for essentially the same reason: You’re buying companies that other investors either can’t or won’t touch. It gets back to what I said about John being independent. He’s willing and able to go where others won’t.

I’ll start with low-priced stocks.

These are simply off limits to most large investors. Most institutional investors such as insurance companies, pension funds, endowments and even a lot of mutual funds are forbidden in their mandates from buying stocks priced under $5, as these are considered penny stocks.

But, as a practical matter, most also avoid stocks priced under $10 per share. Smaller shares tend to get whipped around more, and institutional investors don’t want the headache.

Of course, the same institutional investors that wouldn’t touch a stock at $9 per share might suddenly get interested once it trades at $12. So focusing on these lower priced stocks allows you to get in before the big boys.

The story is similar with small-cap stocks. If you run a multi-billion-dollar mutual fund or endowment, you can’t build a meaningful position in a small-cap stock without distorting the market.

We’ll use my hometown as an example. The City of Dallas employee pension plan has about $3.6 billion in assets, making it relatively small as an institutional investor. A 1% allocation would amount to $36 million. You can’t simply go out and buy $36 million of a small-cap stock. That might represent fully 10% of the total shares outstanding.

At that point, you’re no longer a passive investor. You’re likely the largest shareholder and need representation on the board of directors. And even if you somehow managed to get invested without moving the share price higher and managed to avoid the complications of being the effective owner of the company, good luck ever getting out. You couldn’t sell without tanking the share price.

Now, if a small institutional investor like the City of Dallas has this problem, imagine a large institution with hundreds of billions under management. Investing in anything but a mega-cap stock is next to impossible.

Warren Buffett bemoans this fact regularly. The Oracle’s holding company, Berkshire Hathaway, is worth $500 billion, most of which is in publicly-traded stocks. At that size, the investments realistically open to Buffett are limited.

Buffett has repeatedly said that, were he still running a $100 million fund, he could make his investors 50% per year. But at Berkshire’s size, he’s lucky if he beats the S&P 500 by a point or two.

This is the beauty of John’s new project. John’s buying stocks that are off the radar of the big boys. Or, as I like to think of it, buying stocks they’d like to buy but can’t.

Disclaimer: This material is provided for informational purposes only, as of the date hereof, and is subject to change without notice. This material may not be suitable for all investors and is not intended to be an offer, or the solicitation of any offer, to buy or sell any securities nor is it intended to be investment advice. You should speak to a financial advisor before attempting to implement any of the strategies discussed in this material. There is risk in any investment in traded securities, and all investment strategies discussed in this material have the possibility of loss. Past performance is no guarantee of future results. The author of the material or a related party will often have an interest in the securities discussed. Please see Full Disclaimer for a full disclaimer.

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The Highest Yield Left in the Market

If you’re looking for income these days, your options are a little limited. The S&P 500 yields less than 2%, which is bordering on pitiful, and government bonds aren’t much better.

REITs, as a sector, are reasonably high yielders at 3.9%. But in order to get the yields I like to see, you really have to cherry pick. You’re not paying many bills with a 3.9% payout.

Corporate bonds?

Meh. Investment grade bonds yield 4.4%, and “high-yield” junk bonds yield only slightly better at 5.2%. Sure, that’s better than Treasury yields. But hardly worth the risk. At the first whiff of an economic slowdown, junk bond default rates tend to jump.

Preferred stock still sports a respectable yield, which is why I added exposure last month in my income service Peak Income, as do emerging market bonds for those with the stomach for the volatility.

But frankly, there’s only one asset class right now that sports what I would consider to be a truly impressive yield, and that is oil and gas master limited partnerships (MLPs). The Alerian MLP index, which you can think of as “the S&P 500 of MLPs,” yields over 8%.

[Click to Enlarge]

I know of no other sector where those kinds of yields are possible without taking substantially more risk. (Business development companies, or BDCs, offer comparable or higher yields, but I consider them a little riskier at this stage of the business cycle.)

Too Good to Be True?

Call me a cynic, but when I see yields that high compared to virtually everything else, I want to know why. There has to be a catch, right?

Well, there is and there isn’t.

Yields are high in part due to rising payouts over the past few years. But the far bigger reason is the total collapse in MLP share prices since late 2014. After years of gains, the sector hit a rough patch when the price of crude oil started to fall, and before the dust settled the Alerian MLP index has dropped by about 60%.

The story on MLPs had always been that they were largely immune to energy price swings. MLPs own energy infrastructure, such as pipelines, and most of their revenues come from fixed fees.

The problem came down to leverage. Like much of the rest of corporate America, MLPs took advantage of the low interest rates of the past decade to absolutely gorge themselves on cheap debt. And their business model was dependent on it.

MLPs paid out substantially all of their cash flow from operations as distributions to investors. That meant that when they needed capital to expand their businesses, they had to get it from the capital markets via new debt or equity sales.

That model worked fine so long as stock prices were high and bond yields low. But when crude oil prices started tumbling in late 2014, MLPs had a big problem. Even if their business models were only minimally dependent on energy prices, they had no margin of safety.

When share prices started falling, it became harder to sell shares to raise capital, and raising more via debt wasn’t an option because they were already overleveraged.

So, the MLPs raised cash the only way they could: by slashing their distributions.

It’s a case of once bitten twice shy. Investors that saw their payouts slashed back in 2015 and 2016 and lived through a 60% share-price collapse have been reluctant to come back to the sector.

But their timidity is our opportunity. After years of debt reduction and a focus on financing growth projects with retained profits like normal companies, MLPs as a group are in the best financial shape in recent memory. If we have another energy-price rout, they’re in a much better position to ride it out.

2019 should be a good year for MLPs and the other income investments I recommend in Peak Income. I just added two MLPs the model portfolio last week, one that yields close to 10% and another 8%.

A “sweet spot” for income investments tends to be moderate economic growth, benign inflation and a 10-year Treasury yield under the psychologically important level of 3%.

The Fed’s recent reversal of course shows that they’re worried about growth starting to cool, which usually means inflation expectations tend to cool with it. And the 10-year Treasury is hovering around 2.7%.

So, it’s looking good in income land.

Disclaimer: This material is provided for informational purposes only, as of the date hereof, and is subject to change without notice. This material may not be suitable for all investors and is not intended to be an offer, or the solicitation of any offer, to buy or sell any securities nor is it intended to be investment advice. You should speak to a financial advisor before attempting to implement any of the strategies discussed in this material. There is risk in any investment in traded securities, and all investment strategies discussed in this material have the possibility of loss. Past performance is no guarantee of future results. The author of the material or a related party will often have an interest in the securities discussed. Please see Full Disclaimer for a full disclaimer.

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