Portfolio Management
Investing is reinvesting
People often ask, why invest with an advisor, rather than do it on my own? My short answer - investing is reinvesting. Once you make the choice to invest, the process of reinvestment becomes essential. In an account compounding at 8.5% a year, reinvestment decisions will have allocated one-third of your balance by Year Five. Put another way, you must reinvest, over five years, half the dollar volume you initially invested in such an account. And an investor whose time frame spans decades may reinvest a half-dozen dollars for each one put aside in earlier years.
The need to reinvest is a wonderful problem to have, but it is a problem from which most individual investors are shielded. The dividend yield from large American companies has diminished for decades, many of the largest firms today have never paid any dividend, and index funds that encourage automatic reinvestment of dividends monopolize most investors’ equity accounts. Reinvestment happens nonetheless, but over the last several years the largest companies and asset managers have commanded an increasingly bigger share of the dollars available to be reinvested. To butcher a phrase, it is Big Tech's and Big Index Fund Manager's reinvestment world, we merely live in it.
So investors need to reinvest, and it is largely already happening for them. Why fret over reinvestment control then? If you take the default path for reinvestment offered by the big institutional reinvestors, which is, simply, “Don’t Sell,” reinvestment will happen mainly on their terms. And if they are not in the habit of providing you cash as a portion of your return, your only access to cash may be through manually ‘opting-out’ of this arrangement with some portion of your capital. How many investors, though, planned to sell X% of their holdings by March of 2020 to cover their cash needs, only to find that they needed to sell 2X% instead because of plunging stock prices? They learned the hard way how a lack of reinvestment control challenged their financial plans.
Ever hear a market commentator say “stocks look a bit pricey” or “this is the most expensive market since 19XX?” Were they to put a finer point on the economics of their call, they could say “an investor buying Acme Inc. shares today must rely on Acme generating an excellent record of reinvestment over the next seven to ten years, producing growth compounding annually at an unusually high rate, for the purchase of shares at these prices to provide a satisfactory return.” The sports broadcaster puts it best: “They need a miracle.” Miracles support very few business models, though, and support even fewer stocks bought at prices requiring near-perfect future reinvestment.
Imagine if Americans approached home buying this way. The realtors, home builders, and contractors could come together and say “Let’s start selling $250,000 homes for $350,000, but we will throw in five years of renovations and upkeep for the excess cost. Heck, let’s sell them for $500,000 and throw in 10 years’ worth!” Suppose enough consumers buy in to this scheme that the supply of such homes in desirable neighborhoods dwindles. More homes get built, renovation promises stretch further into the future (12 years… 15!), and yet buyers still outbid one another. At least the proverbial home buyer can shelter under such a capital commitment; the buyer of overpriced stocks can burn worthless stock certificates for warmth only once.
Maybe the high-rolling home buyer gets lucky, and the neighborhood gets even more desirable, and contractor prices go up even more than initially bid in his “auto-reinvestment” home purchase. He broke even or even made a little by the time he sold. Many other hearty home buyers will not be so lucky, and all will have to service a mortgage for, and grow equity in, a home that only might be worth the price paid many years in the future. Such is the fate of the hearty stock buyers, leaving the uncertain work of reinvestment to the whims of the captains of industry, incentivized as they are to promote a high stock price. They would rather reinvest all their shareholders’ return for the chance to have even more to reinvest next year, rather than distribute part of the return in cash and be certain to have less.
Investing is reinvesting. Exercising control over that reinvestment provides value. Control comes from paying modest prices for corporate shares and requiring a healthy cash dividend yield, criteria that do not come naturally to today’s average index-fund-using, tech-stock-loving investor. Auto-reinvestment may be very low cost, and bandwagon stocks are exciting to chase after, but a businesslike investment program requires labor and focus that is not cost-free, and not particularly exciting. You do not put candles on a Ho Ho and call it a birthday cake. Your baker lovingly crafts a custom confection for a special occasion. You do not want to sit and watch him prepare it, but you appreciate the skill that went into the task. Spring for the baker, and the advisor with reinvestment control. Your stomach will thank you for both.