The Importance Of Stock Dividends

Stock returns come from two sources: capital gains and dividends. A capital gain occurs when a stock you purchase appreciates in price. Dividends are payments made directly to shareholders and are not affected by the day-to-day changes of a stock's price.

Capital gains tend to be the most exciting portion of stock returns since stock prices fluctuate daily, but dividends have the potential to make a huge difference in your total return over time. 

Price Return vs. Total Return

Return figures of indexes like the S&P 500 are often based on the "price return" that only includes price changes of the index (i.e. capital gains or losses). The "total return" figure also includes the dividends that were been paid out by the companies in the index.

The S&P 500 averaged a total return of 9.7% per year over the past 40 years. With dividends removed the return falls to 6.4% per year. So over the past 40 years dividends made up around 1/3 of the total return of large US stocks.

S&P 500 Returns (12/31/1972 – 12/31/2012)

With Dividends	9.7% Per Year
Without Dividends	6.4% Per Year

To put this into perspective, a $10,000 investment would grow to over $400,000 if it compounded at 9.7% per year over 40 years. That same investment would only be worth around $120,000 if it grew at 6.4% per year. That’s a huge difference and illustrates the impact of letting stock dividends compound over time.

Initial Investment Of $10,000 Over 40 Years

@ 9.7% Per Year	$405,756
@ 6.4% Per Year	$119,582

*For educational purposes only and does not take into account taxes, investment costs, and other fees.

 
How To Profit From Dividends

Hold Value Investments – Adding “value” investments to your portfolio can increase your dividend income since they tend to pay more dividends than “growth” investments. Keep in mind that growth and value tend to fall in and out of favor over time, so you might want to have a mix of both in your portfolio.

Don’t React to Market Swings – Instead of panicking out of stocks during downturns, focus on the fact that you’re able to buy shares at a discount with your dividend income. And remember that you won't receive the dividends if you sell your stocks during the downturn.

Be Careful Of Equity-Indexed Products – Some advisors sell annuities and insurance that promise “equity returns” without losses. Unfortunately most of these products use the “price index” that leaves out dividends, so your long-term expected return will be much lower than you might think.

To learn more about our company - and find out how we are different from other financial advisors - call (210) 587-6433 or visit www.VannoyAdvisoryGroup.com. 

Investing On Margin (Beware The Double-Edged Sword!)

Investing on margin is similar to purchasing a home. Most home buyers borrow money to be able to purchase a larger home than they could afford if they had to pay cash for the entire purchase price. Investors that use margin borrow money to increase the amount of stocks they're able to buy.

The primary reason investors use margin is to increase their investment returns. Unfortunately, using margin can work against you just as easily as it can work in your favor.

Investing Without Margin

Let's start by looking at an investment made without the use of margin. Assume you purchase 100 shares of ABC Industries when it's trading at $50 per share. Your total investment would be $5,000 (100 shares x $50 per share = $5,000 investment).

Assume the stock price of ABC Industries climbs to $55 per share and you sell your total holdings for $5,500 (100 shares x $55 per share = $5,500 proceeds). This would give you a profit of $500 ($5,500 proceeds - $5,000 investment = $500 profit) which represents a 10% gain on your initial investment ($500 profit / $5,000 investment = 10% gain).

Using Margin To Magnify Gains

Now let's assume you used margin for your initial investment in ABC Industries. Assume you invest $2,500 of your own money and borrow $2,500 from your brokerage firm for the initial investment. You then purchase the same 100 shares for a total of $5,000 (100 shares x $50 per share = $5,000 investment).

You would still realize a profit of $500 if ABC Industries climbs to $55 per share and you sold your shares (100 shares x $55 per share = $5,500 proceeds - $5,000 initial investment = $500 profit). However, due to the fact that you only used $2,500 of your own money, that $500 profit now represents a 20% gain on your money ($500 profit / $2,500 investment = 20% gain).

In this scenario, borrowing 50% of the initial purchase amount doubled your gain from 10% to 20%! Of course in the real world you'd pay interest on the money you borrow and might pay trading commissions, but you'd still end up better for using margin in this scenario.

Stocks Don't Always Go Up 

Margin is a double-edged sword. Using margin is great when stocks go up, but even a small drop in price could be enough to wipe out your initial investment if you are using a lot of margin.

To illustrate this risk, assume you purchase 100 shares of ABC Industries on margin at $50 per shares as you did in example above, but this time the price of the stock declines. You would realize a -$500 loss if you sold your holdings when ABC Industries was at $45 per share (100 shares x $45 per share = $4,500 proceeds - $5,000 investment = -$500 loss).

You only invested $2,500 of your own money since you borrowed 50% of the initial investment using margin, but this loss now represents a 20% loss on your investment because you used margin (-$500 loss / $2,500 investment = -20% loss)! Investing on margin looks great when stocks go up, but it doesn't take much of a price decline to realize how dangerous using margin can be!

Some Of The Risks Associated With Buying On Margin

(1) Stocks don’t always go up – Using margin magnifies your losses when stocks decrease in value.

(2) You can lose more than you deposit – If the securities you purchase decline in value, you may be required to deposit additional funds to cover the losses. This is called a margin call.

(3) Your brokerage firm can force the sale of securities – If you are required to deposit cash to cover your losses, your brokerage firm has the right to sell securities in your account to meet the margin call if you don’t deposit money in time.

(4) You pay interest even if you lose money – Interest will be charged on your margin balance whether or not you make money on the trade, and paying interest to lose money just adds insult to injury!

Using margin as a way to increase returns is one of the biggest mistakes that investors make. Make sure you know what you're doing - and understand all of the risks involved - before using margin in your accounts.

To learn more about our company - and find out how we are different from other financial advisors - call (210) 587-6433 or visit www.VannoyAdvisoryGroup.com.

The Basics of Stocks

This is from one of my recent weekly "Smart Money Monday" Segments on Waco/Temple/Killeen NBC affiliate KCEN 6.

1. What is a stock?

Stocks – also known as equities – are securities that represent ownership in a corporation. And if you’re a “shareholder” of a business, you have a claim to part of the company’s earnings and assets.

2. There are two basic types of stock - common and preferred shares. What should someone know about each type?

Shareholders of common stock usually have voting rights and investors purchase common shares for growth potential. While preferred shareholders usually don’t have voting rights, they have priority over common stock if a company goes bankrupt. Investors purchase preferred shares for income since they pay higher dividends than common shares.

3. What are some of the basics involved in purchasing a stock?

To buy stocks you’ll need a brokerage account either online - where commissions and fees tend to be lower – or through a traditional stockbroker.

The most important aspect of buying stocks is thoroughly researching companies. You can use research from companies like Standard & Poor and Value Line, and www.morningstar.com is a useful website.

4. What are some of the types of stocks investors should consider?

Location (Domestic vs. Foreign) – Most investors should have a mix of US and international stocks since foreign markets can do better than the US market at times (and vice versa).

Style (Growth vs. Value) – The earnings of “growth” stocks are expected to grow at above-average rates and “value” stocks are thought to be undervalued. It's usually a good idea to have a mix of both styles in your portfolio.

Size (Market Cap) – Larger companies tend to be more stable and pay higher dividends while smaller companies have been more volatile but have performed better historically. Since past performance is no guarantee of future results, consider having exposure to both large and small stocks.

To learn more about our company - and find out how we are different from other financial advisors - call (210) 587-6433 or visit www.VannoyAdvisoryGroup.com