During the initial years of investing the focus should be on growth. As one accumulates assets and gets ever nearer to retirement, however, the focus should shift towards preservation of funds, if ever so gradually. Preservation is achieved both through diversification and the types of assets chosen. Diversification was discussed in a previous post, so here we will discuss the types of assets that help provide preservation of assets.
While corporations are not people, they have a life cycle similar to people. There are the initial years when they are fiscally weak and maladies that a more mature company would weather with ease might wipe them out. They then have the growth years when they are expanding, going into new regions, adding new products, and perhaps buying out competitors. At some point they reach a state where they are nearly fully mature, start to grow a lot less (at least in terms of percentages – it is a lot easier for a company making $1 million per year to double revenues than one making 1 billion dollars per year).
Companies that are either late in their growth cycle or entering their mature phase are stronger financially than their younger brethren. Their prospects for price appreciation are less, because they would need to increase their revenues by a lot to increase their price by a like amount, and as stated before, this is difficult for a large company to do, but they are able to withstand downturns in the economy and challenges by competitors fairly easily. These companies also are likely to pay a sizeable portion of their profits out as dividends since they need less money to grow the company.
While these are not the kind of stocks that will go up 1000% percent over the next several years, the chances of them disappearing completely are relatively low (although it does happen eventually for every company). In addition, the payment of a dividend means that the investor will receive some income even if the economy and therefore the market is fairly flat. The dividend will also protect the investor somewhat from decreases in price since as the price drops the yield of the company will increase (assuming the dollar amount of the dividend remains the same).
So the kind of stocks that provide stability are older, larger companies that pay a good dividend. Other suitable assets are REITs, which have a good interest payout due to the rents collected on properties owned by the trust, and corporate bonds. Limited partnerships are also a possibility, but one must be careful since buying into one may greatly complicate one’s taxes. For this reason, buying them inside of a tax sheltered account like an IRA may be prudent.
Speaking of IRAs and taxes, because the assets described tend to pay a larger dividend or interest rate, the investor will be generating income each year on which taxes must be paid. This will greatly reduce your return over the period of several years. In addition, the tax rate will be at the highest rate since the income will be on top of your income from working. It is therefore wise to place as many of these types of assets as possible in your IRA or Roth IRA, where they will be tax deferred or tax-free, and then keep mainly growth stocks that don’t pay a dividend in your taxable trading account until the ratio of dividend paying stocks to non-dividend paying stocks becomes so great that you must start to keep them in your taxable account.
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Disclaimer: This blog is not meant to give financial planning or tax advice. It gives general information on investment strategy, picking stocks, and generally managing money to build wealth. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. Tax advice should be sought from a CPA. All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.