Wednesday, April 6, 2016

Your Greatest Wealth Building Asset

You may think your greatest wealth building asset is the stock that has appreciated more than 15% from the beginning of the year and pays you a 3% dividend. Even though that stock has treated you kindly for the last several years, it is not your greatest wealth building asset.

The traditionalist would say your home is your greatest wealth building asset. This is getting closer, but it is not your greatest wealth building asset.

Others would say your job is your greatest wealth building asset. Though your income is important, it is still not your greatest wealth building asset.

So, what is your greatest wealth building asset?

Everyone is born with it. Few realize its importance until they lose most of it. The asset is so valuable it can't be bought. Your most valuable wealth building asset is... time.

As a value-focused investor in dividend growth stocks, I have learned that time can cure many mistakes and provide enormous investment leverage. Consider what would have happened if you purchased these stocks at their high before the tech bubble burst:

McDonalds (MCD) | Yield: 2.8%
In March 1999 MCD hit a high of $94.75. By year-end it had declined 57% to close at $40.31. At the end of June 2011, MCD closed at $84.34, still below its high. However, over that period of time it paid out $12.10 in dividends. If you add the dividends to $84.34 current price the resulting $96.44 is in excess of the $94.75 high. Definitely not a great return, but remember this assumes a purchase at one of the worse times in MCD's history.

The Coca-Cola Company (KO) saw its high of $44.47 (split adjusted) in July 1998. Its June 2011 dividend adjusted close was $40.86 (down 8%).

Stepping back a another decade, let's say on August 25, 1987 you purchased 1,529 shares of Johnson & Johnson (JNJ) at $6.539/share or about $10,000 worth. This was JNJ's closing high for 1987. By December 31, 1987, your investment was only worth $7,156 - a 28% drop. It wouldn't be until June 9, 1989 before you closed above your original purchase price. However, if you held this stock and spent the dividends (which I don't recommend), it would have been worth over $165,000 in March 2016. This is over 10% compound annual return, excluding dividends.

Consider Warren Buffett's Berkshire Hathaway:

Berkshire Hathaway Inc. (BRK.A) | Yield: 0.0%
In December 2007 BRK.A hit a high of $151,650. One year later it had declined 36% to close at $96,600. At the end of June 2011, BRK.A closed at $116,105, still 23% below its high. However, if you continued to hold BRK.A, it is currently trading over $210,000. BRK.A does not pay a dividend, so there is no adjustment to make.

Important Takeaways:

I. Valuation Matters
There comes a point where every stock is simply too expensive to buy. In these circumstances, you are better off to find other alternatives.

II. Time Helps Correct Our Mistakes
The trend of the market and most stocks is up, over time. Given a reasonable entry point, time will most often be on your side.

III. Quality Matters
To take advantage of a long-term uptrend, the company has to be around. There is no substitute for quality in a long-term portfolio.

IV. An Income Stream
A growing income stream can speed the correction process of a bad decision or ill-timed purchase. If the 2000's are considered a "lost" decade, then in some instances the only losses recovered were from dividends received.

The key to reducing your portfolio risk is to hold many different quality companies with a growing dividend, and be prepared to hold them through the good and the bad. Buy-and-hold is not buy-and-forget. We must understand when it is appropriate to buy and when to sell.

Full Disclosure: Long MCD, KO, JNJ. See a list of all my Dividend Growth Portfolio Holdings here.

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Tags: MCD, KO, JNJ, BRK.A,