Keep Your Powder Dry
In a diversified portfolio, there are three asset classes, stocks, bonds, and cash. I have covered differences between the three classes elsewhere, today I want to focus specifically on the role of cash. You may have heard, “Cash is King.” People say this because cash is liquid – you don’t have to find a buyer for your cash. You don’t have to wait for a settlement or escrow period to expire. Cash is also very safe. When the market is going up, it is hard to watch your cash earning .15% (give or take .10%—yeah, it’s that bad.) But when the market is falling off a cliff, it can be quite comforting—if not peaceful—to see that cash balance tucked safely away.
Where does cash in your account come from? It can build up from dividend payments from your stocks or ETFs (if you are not reinvesting your dividends), interest on your bonds, or cash contributions you make to the account—monthly or lump-sum. I will discuss the annual investment of cash in a future post on rebalancing. In this post, I want to talk about gunpowder.
One of my most favorite mentors likes to say, “Keep your powder dry!”
What does she mean? The phrase derives from the 1800s when soldiers were crossing the river and who required gunpowder to, you know, shoot their gun. It essentially means to be prepared and save your resources until they are needed.
Take a look at the following chart to see how this might apply to investing:
If you have not spent a ton of time looking at charts, let’s walk through this one step-by-step (you can click on the graph and/or print it if you want a larger version):
- The investment we are looking at is CDZ-T (iShares S&P TSX Canadian Dividend Aristocrats Index ETF). It is a Canadian ETF that invests in high-dividend paying stocks that have a history of raising their dividends year after year. (A)
- The chart is showing us the price history over five years. The X-axis (horizontal) is showing you the monthly periods going back to and starting September 2010. The Y-axis (vertical) has the price of the ETF ranging top to bottom from $28 – $19. (B)
- For example, if we put our finger on the point marking January 1, 2013—and move it up—we can see the price on that date was $23. (C)
OK, what can we infer from this line (price journey) on this chart?
First, it has been a bumpy ride! I have seen much, much worse, but there is for sure some turbulence here. And this chart does not even include 2008/2009, which was like, the epitome of evil.
What else does this graph reveal to us? Yes, from September 2010 – September 2015 the price of this ETF has moved up. And quite nicely.
Let’s take a closer look at what I mean:
(again, you can click on any of these charts for a larger image)
Now we see a clear straight line (in orange) from about $19.30 in September 2010 to $24.50 in September 2015 (today). The simple arithmetic return is 26.9% (24.50 – 19.30 = 5.20 / 19.3 = .269 x 100 = 26.9%).
However, ETF and mutual funds returns are reported to include reinvested dividends and compounding. Understanding that, the financial press advises us CDZ-T returned an average of 8.98% per year, over the five year period.
Remind me what is this post about again?
Oh yeah! Keeping your powder dry.
Today is September 1, 2015; the market is down (again), and I am not going to fib—there have been some dark days over the past few weeks. Here is an excerpt from my journal during the flash crash on August 24, 2015.
I want the market to go right back up. Now. I want all of this discomfort and regret and self-loathing to go away. I want to go back to feeling smug, to have my portfolio go up each and every day. I want to go back to feeling like I am a special person who the market loves and never hurts.*
What did I do? Did I climb into bed, pull up the covers and binge watch on Netflix (which was down 7% by the way!)? Well yes, yes, I did do that. But that got boring, and so I took my own advice, dusted off some dry powder I’d been saving for when needed, and I bought some CDZ-T. I purchased mid-date at $23.25 which, with an annual dividend payout of $0.91 gives me an annual dividend return of 3.91%. Yes, that’s right 3.91% on a low-fee, well-diversified dividend aristocrat ETF. And? According to past results, there’s a high probability I can add capital appreciation (an increase in the price of the ETF) to that return.
My God, it’s like Christmas!
Yes, CDZ-T could go lower, it could go higher—I don’t know, despite all my [insert ritual here] sessions, I still can’t predict the market. But did just see four horsemen ride past my window? Nope. And neither do I think the world is ending. Meaning, I still think Canadian banks and utilities and telecoms are going to continue to do just fine, maybe even thrive, over the next 20 years. So if I can pick up CDZ-T at a few cents more than it was in January of 2013, you better believe I’m going to make that move.
If you haven’t heard it before, you’ve just heard it here first: Keep your powder (a healthy cash balance in your account) dry, because happiness really is a market pull-back.