A friend in the financial industry provided the following quote to me, and while it may take more than one time through to truly understand its meaning, it describes the current market and many similar times we have had before to a tee. The first few paragraphs of Chapter 2 provide a summation of what speculation is all about. His advice about trading panics stands up well even a hundred years later. Henry Clews in 1908 authored Fifty Years in Wall Street and wrote the following:
"But few gain sufficient experience in Wall Street to command success until they reach that period of life in which they have one foot in the grave. When this time comes these old veterans of the Street usually spend long intervals of repose at their comfortable homes, and in times of panic, which recur sometimes oftener than once a year, these old fellows will be seen in Wall Street hobbling down on their canes to their brokers' offices.
Then they buy good stocks to the extent of their bank balances, which have been permitted to accumulate for just such an emergency. The panic usually rages until enough of these cash purchases of stock is made to afford a big, "rake in." When the panic has spent its force, these old fellows, who have been resting judiciously on their oars in expectation of the inevitable event, which usually returns with the regularity of the seasons, quickly realize, deposit their profits with their bankers, or the overplus thereof, after purchasing more real estate that is on the upgrade, for permanent investment, and retire for another season to the quietude of their splendid homes and the bosoms of their happy families."
If individual stocks are held in financial portfolios, most likely many were selected because they pay dividends. Many equity mutual funds also hold stocks that pay a dividend, but the yields of these funds are reduced due to the quantity of stocks in the fund which do not pay dividends. Thus, most funds only pay an income dividend at the end of the year along with a capital gain distribution. The income dividend from many mutual funds may only represent a 1 to 3% payout; and while this is better than many money markets, there are dividend paying stocks with higher payout rates. These dividend rates may change due to the financial crisis, yet the reduced rate in many cases may still exceed interest yields on money market accounts. For taxable accounts, dividend payments also receive a more favorable tax treatment than interest income.
With the rapidly changing prices and recent decline in the markets, many of the original purchase prices for individual stocks may be higher than the stock's current value. For stocks paying a dividend, one option is to hold the existing shares and to collect the dividends. Once the markets recover and since the shares were not sold, the portfolio will not miss the recovery in the stock's price. The other alternative is to sell out taking the loss on the stock and hold the cash. While this may avoid further declines, less income is collected because of low interest yields and the recovery of the market may be missed.
However in many cases, it is better to average down the cost basis. This means to purchase additional shares at the now lower price, thus the average cost of all shares owned is lower. This achieves a couple of benefits for the portfolio. If the dividend rates hold, the average income rate is now higher for that particular position. And, the dividends received while the position is held add to the overall return.
By averaging down the cost of the portfolio's holdings with additional purchases at a lower price, there is the possibility of selling at a price lower than the initial purchase and still record a profit. But, if the position is held and the price continues to recover beyond the initial purchase amount, far greater returns may be achieved. By making more than one purchase in the stocks you own, the average cost is kept low, so the profit may be achieved as the recovery occurs.
Periodic reviews of all stock holdings should be made comparing the cost basis to the current price and decisions made as to whether it is appropriate to make additional purchases. While this is somewhat complex, find a Certified Financial Planner and sit down with them to discuss your financial future and seize the opportunities for your portfolio.
Would you like a response to a financial question? Send your question to Doug Horn, 115 W. Broadway, Maryville, TN 37801. Be sure to mark your envelope Money Matters. Doug Horn, CFP, is an area financial planner with more than 24 years financial experience and founder of Quality Financial Concepts, located in downtown Maryville on Broadway. Doug Horn, CFP, Registered Investment Advisor in Tennessee and Texas and Registered Principal, Branch Office of and Securities offered through CUE Financial, Member FINRA, SIPC.