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Smart Contributions & Distributions, Plus An Attractive Dividend Growth Stock

Investors generally go through multiple phases during their investment life cycle, including the contribution phase and the distribution phase. This week’s Blue Harbinger Weekly reviews a couple smart strategies for each of these two important investment phases. And we also provide an update on an attractive dividend growth stock that is flashing a buy signal right now (and yes, we own it).

The Contributions Phase of an Investors Life Cycle

If you are fortunate enough to be in a position where you are able to make regular contributions to an investment account, do it! Any money you sock away now will be worth far more in the future due to the amazing power of compounding. For example, have you heard of the rule of 72?...

The rule of 72 is a method for estimating an investment's doubling time. The rule number (e.g., 72) is divided by the interest percentage per period to obtain the approximate number of periods (usually years) required for doubling. 

For example, if you put your money in the stock market and earn 8% per year, it will take you approximately nine years to double your money (72 / 8 = 9). Whereas if you earn only 4% it will take you 18 years!

If you can set up a regular contribution plan whereby you automatically add money to your account every month, it will add up fast, and your future self will thank you.

And with regards to what to add your money to each month? We recommend adding money to your worst performing investments. That’s right, don’t add money to your best performers because there is a tendency for investments to “revert towards the mean,” and your best investments over the last year (for example) will often be your worst investments over the following year. By adding to your worst performers it will help keep your investment acount diversified (i.e. you won’t end up with all your money in a few investments that performed well in the past), and instead you’ll be investing in the investments that likely have a better chance of outperforming in the future.

For your reference, here is a link to the annual contribution limits for individual retirement accounts (IRAs). (Note: It’s generally $5,500 per year ($6,500 if you’re age 50 or older), and this allowable amount is generally increased annually).

The Distribution Phase of an Investors Life Cycle

If you are lucky enough to reach retirement age, and you’ve been able to save up a nest egg over the years, congratulations! That’s no small feat. But now when it comes to living off your nest egg, it’s obviously important to NOT make silly mistakes. In our view, one of the silliest mistakes retirees often make is to invest their entire account in stocks with the highest dividend payments. In our view, this lack of diversification results in greatly increased risk and it is totally unnecessary.

The mistake usually begins with an investor thinking they want to live off only dividend payments and never spend capital. Next they search for “safe” stocks with a track record of paying high dividends. And the result is they end up with an undiversified portfolio owning only stocks in a few segments of the market that have already performed well in the past and may be due for some mean reversion (underperformance) in the future.

In our view, a better approach for retirees that need income is to generate it from a combination of dividend payments, interest payments (owing some fixed income/ bonds is often smart) and capital gains (selling some of the stock you own). This results in far less risk through diversification. Specifically, it’s not uncommon for a specific concentrated segment of the market to underperform following periods of outperformance, and the very strong outperformance by many high dividend stocks recently could be setting them up for a fall (or at least some very significant underperformance relative to the rest of the market). 

In fact, we suggest generating capital gains income by selling your winners (i.e. selling some of your stocks that have performed best). This helps you avoid the fall (or mean reversion) that the winners may be setting themselves up for, and it also helps you to naturally rebalance your account so you aren’t overly concentrated in the investments that have performed the best recently (which is a good thing because they’re often the ones that are most likely to underperform going forward).

For your reference, this link shows the required minimum distributions from your individual retirement account (IRA). The distributions are required beginning in the year following the year you turn 70 and ½, and they start out at slightly less than 4% of your total account value per year.

This Week's Members-Only Investment Idea:

This week's members-only new investment idea is Accenture. Accenture is a management consulting, technology and outsourcing services company that offers a growing dividend (currently a 2% dividend yield), and an attractive valuation indicating significant price appreciation potential. The shares have fallen over 5% in the last two weeks making for a more attractive buying opportunity for long-term investors. We own shares of Accenture in our Blue Harbinger Disciplined Growth Strategy. You can read this week's full write-up on Accenture here... 

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