Money Talks: The big trade off
Here we go again, those of us living here in paradise have become familiar with the summer hurricane season. As we head into what is referred to as “peak hurricane season,” we have become quite familiar with this particular “trade off” here in the tropics.
There are many perceived trade offs as it pertains to portfolio holdings and their ability to deliver the anticipated returns based on investors objectives. By now it is no surprise that many have embraced stock ownership, especially in light of the perceived market strength from the “Trump Rally”. As the stock market continues to grow to the sky, it is important for investors to understand that there may be some trade offs as it pertains to performance.
Many retried investors have turned to the ability of certain stocks to deliver an income stream that, in theory, should last throughout retirement. One of the big tradeoffs comes when we take a closer look at income derived from preferred stocks as well as many dividend paying stocks. The big tradeoff here comes in the form of growth versus income. These portfolio holdings have been fairly predictable over the years in their ability to deliver a steady stream of income. Of course, lost on many is the very real fact that when the next stock market correction occurs, these stocks generally participate in the losses as far portfolio values are concerned.
The good news is that most will continue to generate the same predictable stream of income even as the stock price goes down in value. The tradeoff here is that although the monthly statements will shows losses in value, the income stream should stay consistent, even during times of crisis. Of course, perhaps the most obvious tradeoff comes with the ever so coveted growth stocks. The tradeoff here should be obvious; great returns also expose investors to great losses. The ability to capture these gains cannot be overstated as the big tradeoff here lies in the ability to achieve growth while accepting the reality of losses.
Another tradeoff lies within the mysterious realm of bond ownership. For many, it has been so long since the bond market has endured any meaningful losses that the concept of bonds representing safety has been overblown. Here’s the tradeoff; the ability of bonds to offer safety lies in their ability to return the original investment upon bond maturity. So, where’s the tradeoff? Well, unless an investor plans to hold their 20 years bond until maturity, the the whole concept of safety goes out of the window. Of course, very few investors want to own any investment which requires such a long holding period to simply achieve the “safety” aspect.
The tradeoff here lies in the fact that while the bonds generally generate a predictable stream of income during ownership, they are completely exposed to portfolio losses based on the direction of interest rates. Here is where bond investors must embrace the reality that as we matriculate through now a decade of record low interest rates, there should be no confusion as to the ability of bonds to generate losses. Again, there is safety upon maturity and potential losses during ownership; tradeoffs indeed.
Another tradeoff which may also be described as a “misconception” is the insured index strategy and their ability to grow assets. Generally speaking, the big tradeoff here lies in their proclivity to generate muted returns based on the stock market while avoiding market based losses along the way. The reality is that these portfolios generally lag the overall stock market in total return. However, this tradeoff has a balancing factor lost on many. The ability to achieve even muted growth while avoiding market loss can, in certain circumstances, outperform the overall stock market, especially in times of market turmoil. Again, the tradeoff for lower returns is the ability to avoid market loses.
A $100,000 investment collecting 100 percent of the Dow Jones returns from 2000 – 2015 grew to roughly $152,000 while during the same timeframe capturing only 50 per of the Dow and avoiding the losses grew $100,000 to roughly $184,000. Understanding the tradeoff can lead to the life of a SWAN, Sleep Well At Night.
William F. Hague is a managing partner of Hague Wealth Management; 239-389-1999 or WFHague@earthlink.net. The opinions and observations stated above are those of the columnist.