“Everything should be made as simple as possible, but not simpler.”- Albert Einstein
Whether the client intends to take income (now or later) or to build a legacy to be gifted to others, we assert that the universal goal of investing is to create a present or future source of rising income. Rising income is defined as income that grows at a rate that exceeds inflation. Sometimes that income is spent, sometimes it is reinvested. When past or present income is spent, the investment portfolio is deemed to be in the “Distribution” phase. When new funds are being added or income is reinvested, the investment portfolio is deemed to be in the “Accumulation” phase. There are only three sources of income from investments: A) Interest; B) Dividends; and/or C) Capital Appreciation.
We believe that a simple way to illustrate this concept is to use the analogy of investing compared to farming. A farmer can take income in three ways: A) Renting the land; B) Growing and selling harvested crops or mature livestock; and/or C) Selling off parts of the land. Rent is like interest. Dividends are like the income from growing and selling harvested crops or mature livestock. Capital Appreciation is like income from selling off parts of the land that have become more valuable.
Unfortunately, too many so called “investors” believe that investing is all about Capital Appreciation. Coming from a family with a long farming tradition, we can say that most farmers and growers do not calculate the value of their farmland on a daily or monthly basis. And, few even think about selling it off. Farmers understand that the source of their wealth is the land, but that the value of the land is determined primarily by the income derived by growing and selling harvested crops. We like to think of the client’s investment portfolio as the “land” and dividends and interest as the “harvest”. If we don’t need the income from the “harvest”, we buy more “land” by “reinvesting” the dividends and interest (Accumulation). If we need the income, we take money from the “harvest” and spend it on ourselves (Distribution).
We tell our clients that the value of their investments is determined primarily by the income generated now or likely to be generated in the future, from dividends and interest. We worry little about the daily market value of the “land” except when we are adding new money and “buying” more. If we learn that the value of “land” has increased, we have mixed feelings..we feel wealthier, but..if we are buying land, we will be able to buy less with our money.
We submit that the only time that Capital Appreciation is important is if we intend to sell, and the only time we would sell our “land” is if our income was insufficient for our needs. (Or maybe if we want to buy more “fertile” land that will produce more income.) The goal of investing, particularly for retirement is for our portfolio to produce income sufficient for our needs. This is investing as opposed to speculation.
While earning interest (renting the land to another farmer) is an important and relatively stable way to create income, unless the portfolio is very large and our income requirements are very small, dividends are generally the most important source of income. Owning stocks, in the farming analogy, is like the growing and selling harvested crops. Some stocks are like growing corn or milking dairy cattle, where the income comes right away, some stocks are more like planting orchards or trees, where income comes after a period of time.
Spend less energy worrying about the daily value of your investment portfolio and more about how much income it is producing or will be producing in the future.
This commentary and information is provided for the benefit of clients and should not be considered a sales presentation.
Whether the client intends to take income (now or later) or to build a legacy to be gifted to others, we assert that the universal goal of investing is to create a present or future source of rising income. Rising income is defined as income that grows at a rate that exceeds inflation. Sometimes that income is spent, sometimes it is reinvested. When past or present income is spent, the investment portfolio is deemed to be in the “Distribution” phase. When new funds are being added or income is reinvested, the investment portfolio is deemed to be in the “Accumulation” phase. There are only three sources of income from investments: A) Interest; B) Dividends; and/or C) Capital Appreciation.
We believe that a simple way to illustrate this concept is to use the analogy of investing compared to farming. A farmer can take income in three ways: A) Renting the land; B) Growing and selling harvested crops or mature livestock; and/or C) Selling off parts of the land. Rent is like interest. Dividends are like the income from growing and selling harvested crops or mature livestock. Capital Appreciation is like income from selling off parts of the land that have become more valuable.
Unfortunately, too many so called “investors” believe that investing is all about Capital Appreciation. Coming from a family with a long farming tradition, we can say that most farmers and growers do not calculate the value of their farmland on a daily or monthly basis. And, few even think about selling it off. Farmers understand that the source of their wealth is the land, but that the value of the land is determined primarily by the income derived by growing and selling harvested crops. We like to think of the client’s investment portfolio as the “land” and dividends and interest as the “harvest”. If we don’t need the income from the “harvest”, we buy more “land” by “reinvesting” the dividends and interest (Accumulation). If we need the income, we take money from the “harvest” and spend it on ourselves (Distribution).
We tell our clients that the value of their investments is determined primarily by the income generated now or likely to be generated in the future, from dividends and interest. We worry little about the daily market value of the “land” except when we are adding new money and “buying” more. If we learn that the value of “land” has increased, we have mixed feelings..we feel wealthier, but..if we are buying land, we will be able to buy less with our money.
We submit that the only time that Capital Appreciation is important is if we intend to sell, and the only time we would sell our “land” is if our income was insufficient for our needs. (Or maybe if we want to buy more “fertile” land that will produce more income.) The goal of investing, particularly for retirement is for our portfolio to produce income sufficient for our needs. This is investing as opposed to speculation.
While earning interest (renting the land to another farmer) is an important and relatively stable way to create income, unless the portfolio is very large and our income requirements are very small, dividends are generally the most important source of income. Owning stocks, in the farming analogy, is like the growing and selling harvested crops. Some stocks are like growing corn or milking dairy cattle, where the income comes right away, some stocks are more like planting orchards or trees, where income comes after a period of time.
Spend less energy worrying about the daily value of your investment portfolio and more about how much income it is producing or will be producing in the future.
This commentary and information is provided for the benefit of clients and should not be considered a sales presentation.
No comments:
Post a Comment