The Often Overlooked Importance of Dividends

I just finished reading an interesting article from Dreyfus regarding the historical impact of dividends on the stock market’s total return. The paper states that since 1926, dividends have accounted for approximately 50 percent of the stock market’s total return. You can read the paper here.

Stocks paying respectable dividends are often considered to be too conservative for many investors, who prefer to search for potential 10-baggers, or stocks that grow in capital appreciation to ten times their initial value. And yet, having grown up in Atlanta, Georgia, the land of Coca-Cola, I am well-aware of the number of millionaires that Coke stock produced simply by investors simply re-investing their dividends.

Since 2000, an increasing number of companies have chosen to reduce or discontinue their dividends in order to avoid taxation of such dividends. Such companies, with shareholder approval, have decided to plow back such money into the company in hopes of creating internal growth and increased capital appreciation within the stock.

While both approaches have merit, it is important to consider the benefits that dividends can provide. One of the most valuable benefits that dividends provide is protection in down markets, as the dividend ensures a certain level of return. As the paper shows, certain dividend paying stocks, known as “dividend aristocrats,” have actually provided a historically greater rate of return with less risk.

I am a proponent of what is known as core-and-satellite investing. Core-and-satellite investing involves creating a sound, fundamental core for one’s investment portfolio. The core usually consists of a sound, well-diversified equity based component and a sound, well-diversified fixed-income based component. To that core we add one or two investments that are chosen in hopes of providing a little extra return the overall portfolio.

The satellites can be chosen based on various factors, including the current or expected condition of the economy and/or the stock market. Depending on the individual investor’s personal goals and other personal investment parameters, we often recommend an investment that provides both growth and income, including investments focusing on dividend paying stocks.

Stockbrokers and other financial advisers often only recommend investments focused on capital appreciation. Investors should stop and consider whether an allocation to growth and income investments and/or dividend paying stocks is a wise choice to help provide a buffer against downturns in the market.

History has shown that the stock market is cyclical, undergoing both bull and bear markets. As the Chinese philosopher Lao Tzu once said, “the best way to manage anything is to make use of its nature.” Dividends help manage the inevitable downturns in the stock market.

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The Best Investment Advice…Period

People that follow me know that “Winning the Loser’s Game” by Charles Ellis is my favorite book on investing. Ellis approaches investing from a different viewpoint that is refreshingly different, and absolutely spot on, than most investment experts. I consider three positions especially significant in promoting successful investing.

We now know to focus not on rate of return but on the informed management of risk.

Simply put, investors cannot control the market. They can control investment expenses and investment risk. Controlling investment risk often focuses on an investment’s volatility and the correlation of one investment’s performance with other investments in one’s portfolio.

Far too often, investors are not provided with correlation of returns data for their investments. Yes, correlation of return data does change, but so does an investment’s return and standard deviation.

From an investment perspective, the goal should be to effectively diversify one’s investment portfolio to hopefully minimize the risk of large losses. By combining investments that have different levels of correlation of returns, that behave differently in different market and/or economic conditions, we can reduce the risk of large losses.

Far too many investors are fooled into thinking that effective diversification can be accomplished by simply holding different types of investments within the same asset class. For instance, I reportedly see investors whose portfolio consists of large cap equity mutual funds, small cap equity mutual funds, and perhaps an international equity fund.

What such investors do not understand is that over the past decade or so, all equity funds, both domestic and international, have consistently shown a high correlation of returns, generally in excess of 90 percent correlation. As a result, many investors are holding portfolios that provide little or no protection against downside risk, large losses.

To quote Donald Trump, “focus on the downside, the upside will take care of itself.”

Even though most investors see their work as active, assertive, and on the offensive, the reality is and should be that stock investing and bond investing are primarily defensive processes.

This perspective confuses a lot of people, but it is absolutely true. Money that is lost investing cannot fully participate in the market’s subsequent recovery. As I tell my clients, you cannot get ahead if you have to spend all of your time catching up.

When I speak to groups, I often use the 50/50 example to stress the importance of defensive investing.  The 50/50 example is simple – if I lose 50 percent of my investment in one year and realize a 50 percent return the next year, what is the status of my portfolio? Many people will say I’m back at zero. But if I lose 50 percent, and then realize a 50 percent return the next year, my portfolio has still suffered a 25 percent loss (50 percent + (50 percent of 50 percent)).

The impact of investment losses and the amount of return required to fully recover from such losses can be easily calculated. The formula is [1/1 – amount of investment loss] – 1, then multiply by 100. For instance, a 50 percent loss would require a return of 100 percent to fully recover such loss.  [[(1/.50), or 2,  less 1] x 100]

Keep in mind, however that an investor suffers an opportunity loss by having to use that market return to recover from the loss rather than being able to use that return to increase their portfolio’s worth. Investing defensively requires giving up a little upside potential, however it acknowledges that the market is cyclical and helps reduce downside risk.

Defensive investing simply makes sense from a proactive perspective. As the Chinese philosopher observed, “the best way to manage anything is by making use of its nature.”

So rational investors should consider the true cost of fees charged by active managers not as a percentage of total returns, but as the incremental fee as a percentage of risk adjusted incremental returns above the market index.

This concept is at the heart of my entire practice and is the fundamental concept behind my proprietary fiduciary prudence metric, the Active Management Value Ratio™ (AMVR). The AMVR is a simple cost/benefit metric that effectively allows anyone to quantify the prudence of a mutual fund, using just incremental cost and incremental return as the input data for simple subtraction and division calculations.

The value of using incremental cost and incremental returns is that it allows us to analyze an investment in terms of additional cost and return beyond what an investor can achieve by using a less expensive alternative investment providing similar returns, for example passively managed index funds.

Many investors are surprised to learn that many actively managed mutual funds fail to outperform comparable index funds. Using the AMVR, many investors are surprised to learn that even when an actively managed fund does outperform  an index fund, the incremental costs associated with actively managed mutual funds often exceeds the fund’s incremental return, thus resulting in a net loss.

Bottom line, using incremental costs and incremental returns provides us with information that is often hidden by simply looking at a mutual fund’s stated total return and stated standard deviation data.

Most library systems have a copy of “Winning the Loser’s Game,” or are willing to do an interlibrary loan to get a copy from another library. If you are serious about investing and protecting your financial security, I would strongly take a couple of hours and enjoy Charles Ellis’ excellent advice.

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Interpreting “Marketing” Returns From “Real” Investment Returns

I am often asked how to make sense out of the return data that is online. For instance, posts various return data. Some of their return data is adjusted for any front-end load that a fund charges. Morningstar’s return data typically is not adjusted for the annual fees that a fund charges. Fortunately, that adjustment just requires subtracting a fund’s annual fees from the fund’s reported annual return. Morningstar also reports a return that allows an investor to see a fund’s return after loads, taxes and other costs are factored in.

The way that funds report their performance also depends on whether the market is in a bull or bear phase. When times are good, funds will report their actual, or absolute, returns. When times are tough, funds will report their returns in terms of their performance relative to their peers, e.g. #1 rated fund in its class. Relative performance numbers are basically useless, as the fact that Fund X outperformed Fund Y can hide the fact that both funds experienced significant losses and significantly underperformed their relative benchmarks.

Investment performance analysis based on a fund’s incremental cost/benefit numbers is gaining acceptance among both the legal and investment industries. Investment industry legend Charles Ellis first introduced the concept of investment analysis using incremental costs and returns several decades ago in his seminal book, “Investment Policy,” now entitled “Winning the Loser’s Game.”

Using a fund’s incremental cost and return provides a more accurate representation of the value of a fund’s management team, as it relates a fund’s cost and return in comparison to the cost and return of a lower cost fund with comparable performance. Incremental investment analysis often reveals that an investor is paying annual fees that are 300% or higher than the low cost alternative, while receiving either no incremental return at all or an incremental return that is less than the added, or incremental, cost. In other words, to borrow from the band Dire Straits, an investor is paying “money for nothing.”

And this is not an isolated incident. Annual studies by Standard & Poors and Vanguard consistently show that the majority of actively managed domestic equity-based mutual funds fail to outperform comparable passively managed index funds. And yet, according to the 2015 Investment Company Institute Fact Book, 80 percent of the money invested in all domestic equity-based mutual funds is  invested in these over priced and underperforming actively managed mutual funds. Go figure! Further proof of the power of the informed investor.

Bottom line – Use the free metric, the Active Management Value Ratio 2.0™, to evaluate and select mutual funds that are efficient in terms of both cost and performance.

Posted in Asset Protection, Common Sense, Investment Advice, Investment Advisors, Investment Portfolios, Investor Protection, portfolio planning, Portfolio Planning, Retirement, Retirement Plan Participants, Uncategorized, Wealth Accumulation, Wealth Management, Wealth Preservation | Tagged , , , , , , , , , , , , , ,

Non-spousal Inherited IRA Traps

When people ask me what I do for living, I tell them that I am a wealth preservation counsel. Then they usually say, “oh, you are an estate planner.” No, a wealth preservation counsel. Wealth preservation is more than just estate planning. It encompasses several topics including estate planning, wealth management, asset protection and retirement distribution planning.

With the rising estate tax exemption ($5.43 million per person in 2015) and the new portability rules, which allow a surviving spouse to also use any unused estate tax exemption from their spouse’s estate, estate planning has become less of an issue for most people. People should still have a will and any medical directives that they wish to have.

I am Scotch-Irish, so I like to explain wealth preservation using the Scottish saying “get what you can and keep what you have – that’s the way to get rich.” And fortunately, there are several easy and effective strategies that anyone can use to protect their wealth.

One of the most common mistakes people make is with regard to non-spousal inherited individual retirement accounts (IRAs). I usually get a couple of call each month from people with questions about receiving and managing non-spousal inherited IRAs. I always enjoy such calls, as it means someone is taking the time to avoid disasterous tax consequences and make the most of the inherited IRA.

Surviving spouses have a lot more options with regard to their deceased spouse’s IRA. The proper choice usually depends on the specific situation and the spouse’s needs. In most cases, the worst choice is to simply take a lump sum distribution of the entire IRA, as it results in immediate taxation on the full amount, with the proceeds taxed as ordinary income instead of the more favorable capital gains tax.

For non-spouses, there are less options and extremely specific rules that must be followed in order to prevent immediate taxation of the full IRA account. The non-spouse can also take a lump sum distribution of the entire account, but again, that is often the worst choice due to the immediate taxation issue.

The better choice is generally to preserve the tax-deferral benefits of the inherited IRA. In order to do so, the non-spouse must transfer the IRA account to a “beneficiary IRA”  account by means of a “direct trustee to trustee” transfer. It is crucial that the transfer be accomplished without the non-spousal beneficiary ever receiving the money. If the non-spousal beneficiary does receive the money, the full amount is immediately taxable and the benefit of tax-deferral is obviously lost. The non-spousal beneficiary is not allowed to place the money back into the original IRA to “correct” the mistake.

One of the most common mistakes occurs in properly setting up the non-spousal inherited IRA. The non-spousal beneficiary is not allowed to set up the inherited in their own name or to rollover the inherited IRAs assets into another existing IRA account. If they do so, it is considered to be a receipt of the proceeds, resulting in immediate taxation of the entire account.

The non-spousal beneficiary account must be set up in the name of the deceased and properly referencing the fact that the account is a beneficiary account. Do not assume that your financial adviser, stockbroker and/or bank knows how to do this properly and will do so! The IRS has the power to grant relief if the account is set up improperly and the non-spousal beneficiary was totally innocent of any error. But this is not a given, and the trend seems to be less relief and allowing the beneficiary to sue the party who made the mistake.

I tell people to require the third party handling the transfer to provide a copy of the paperwork before processing the actual transfer. While there are various methods of properly titling the account to show the required information, one acceptable method would be “John Doe IRA, deceased, FBO Jim Watkins, beneficiary.” Again, show owner’;s name, indicate that they are deceased, in indicate non-spousal beneficiary by name and status.

Non-spousal inherited IRA beneficiaries also have one other option with regard to an inherited IRA. A beneficiary can disclaim, or refuse the inherited IRA. The most common reason for disclaiming an inherited IRA would be for tax reasons, when the the non-spousal beneficiary does not need the IRA’s assets. Disclaiming beneficiaries need to understand that if they disclaim, they do not get to decide who receives the disclaimed IRA. The IRA would pass in accordance with any the terms of the beneficiary designation document or in accordance with applicable laws of descent.

The goal with inherited IRAs is usually to delay, or “stretch,” the taxation of the IRA for as long as possible. Done properly, the benefits of tax deferral can be stretched out over decades. It should be noted, however, that the federal government is reportedly considering eliminating the “stretch” option and requiring non-spousal IRA beneficiaries to payout their inherited IRA within five-years of their inheritance of same.


There are various rules with regard to required distributions from inherited IRAs, depending primarily on whether there is just one or multiple beneficiaries. I’m not going to go over all the rules, as it would probably just confuse the reader. The key to obtaining the maximum benefit of tax deferral and minimizing required annual distributions is to take whatever action is necessary to ensure that each beneficiary has a separate IRA beneficiary account, thereby allowing them to use their own life expectancy in computing annual required distributions.

These are some of issues that should be considered by any non-spouse inheriting an IRA. As I mentioned, several possible changes are being considered by the government that would require eliminate “stretch” IRAs and require the distribution of non-spousal IRAs at a much faster rate. The bottom line is that if you receive a non-spousal inherited IRA, do not do anything with the IRA account until you have spoken with someone who is both knowledgeable and experienced with these accounts in order to avoid disastrous tax and wealth management consequences.

Posted in Asset Protection, Integrated Estate Planning, Investment Advice, Investment Advisors, Investment Portfolios, IRA, portfolio planning, Retirement Distribution Planning, Retirement Plan Participants, Wealth Distribution, Wealth Management, Wealth Preservation | Tagged , , , , , , , ,

401(k) Investors: Avoid These 20 Mistakes

Mistakes involving 401(k) accounts can be very costly, a some mistakes require IRS approval to correct, and there is no guarantee that such permission will be granted. This article provides some sound advice.

401(k) Investors: Avoid These 20 Mistakes.

Posted in Uncategorized

Does Your Financial Advisor Owe You Money?

Happy New Year! As I mentioned in my last post, I write for four blogs, including two in connection with my association with the Paladin Registry, a pro-investor organization that provides advice to help investors protect themselves against investment scams and other questionable practices used by the financial services industry to exploit investors. I recently wrote a two-part post on techniques investors can use to determine if their financial advisor is truly acting in their best interests. The two posts can be found at and

Posted in Asset Protection, Investment Advice, Investment Advisors, Investment Fraud, Investment Portfolios, Investor Protection, pension plans, Portfolio Construction, portfolio planning, Portfolio Planning, Retirement, Retirement Planning, Wealth Accumulation, Wealth Management, Wealth Preservation | Tagged , , , , , , , , , , , , , , , , , , , ,

Does Your 401k Owe You Money?

In addition to this blog, I also write for the Paladin Registry. I just posted a new article on excessive fees within 401k plans. The article is available at

Posted in Asset Protection, ERISA, Investment Advice, Investment Advisors, Investment Fraud, Investment Portfolios, Investor Protection, IRA, pension plans, Portfolio Construction, portfolio planning, Portfolio Planning, Retirement, Retirement Plan Participants, Wealth Accumulation, Wealth Management, Wealth Preservation | Tagged , , , , , , , , , , , , , , , , , , ,