Personal Finance Hobgoblins

The Trader Column in this week’s Barron’s devoted a lot of pixels to personal finance issues which is somewhat unusual. The first bit was in making the case for Financial Engines (FNGN) with some grim retirement-preparedness stats.

The article rightly notes that many portfolio short comings are “self inflicted.” I might use the word behavioral but it is the same difference, people are often their own worst enemy when it comes to their finances and portfolios for things related to poor spending decisions and occasional panic selling or panic buying.

Barron’s cited an unnamed study that concluded “nearly three-quarters of 401(k) participants are not on track to meet their retirement goals” and “based on their present performance, they won’t replace even half their current income in their retirement years.”

I’m not sure what the best number is to consider for average 401k balances as there have been numbers ranging from the 20’s (thousands) up to $100,000. In terms of confronting our more immediate problems the country should probably care most about the average balance for people 55 and older, then make a priority of educating the hell out everyone between 40 and 55 while just providing normal education of financial literacy for people under 40.

Not that I know, but isn’t there a Czar for financial literacy or wouldn’t this come under the purview of one of the Czars? I’m thinking the cost for building a couple of spreadsheets for mass distribution would be pretty cheap–of course they wouldn’t even need to build them as they already exist. As far as teaching financial literacy in highschool I think they could build a list of 20 learning points such that each one can be discussed each morning for three minutes (attention span) and then each one repeated once a month all school year, every school year starting in ninth grade.

The other personal finance topic in the column was about reinvesting dividends noting that 42% of US equity market returns from 1926 forward come from dividends. The 42% cited is a number that has been kicking for years and while I wonder whether the events of the last three years could have changed it slightly it still makes the point that dividends are quite important.

As far as actually reinvesting the dividends to buy more shares one dividend at a time; if you do this with taxable money (as opposed to an IRA of some sort) make sure you are a meticulous record keeper.

That little bit of caution out of the way I certainly have nothing negative to say about reinvesting dividends but I prefer to target an above market yield without reinvesting. Among other things if a portfolio yields 3% and that 3% goes back into the stocks or funds they came from then it potentially throws the asset allocation out of balance requiring sales at some point. More practically the cash from dividends can help with any income needs which some clients have and also be available for new additions to the portfolio.

On this topic someone somewhere asked why I feel it is difficult to have a portfolio yield 4%. He said that his portfolio yields 8% and he cited the names he owns to get this yield. My context was that 4% is difficult from a diversified portfolio that takes in holdings with many types of attributes. Either this person understands the risk he is taking or he doesn’t. If I can get 100-125 basis points of dividend yield beyond the S&P 500 then I am pretty pleased.

The way I think of it, that much extra yield can mean taking a little less risk in the portfolio. As a building block, if the market were to have 10% total return every year for the next ten years (it won’t be that linear this is just an example) with 2% of that coming from dividends then getting the same 10% with 3% coming from dividends would be a better risk adjusted result. Put another way it would be a smoother ride.There is an element of diminishing return in there as at some point a higher yield becomes riskier than a lower yield. I think a portfolio yielding 9% would really be putting people through the wringer.

About Roger Nusbaum 169 Articles

Roger Nusbaum is an Arizona-based financial advisor who builds and manages client portfolios using a mix of individual stocks and ETFs. Roger writes a popular blog, which focuses on risk management, foreign stocks, exchange traded funds, options etc.

Roger has been recognized by many in the investment management industry for his expertise in portfolio management. Roger has been regularly interviewed by the financial press, trade journals, and television news shows. He has also had numerous technical articles published and has been quoted in a number of professional trade journals, newspapers, and consumer finance magazines. He appears frequently on CNBC Asia as a market commentator.

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