Make Your List. These Opportunities Don’t Come Around Every Day

We just had the quickest onset of a bear market in history. It took just 21 days for stock prices to drop from all-time highs to losses of more than 20%.

Of course, it didn’t stop there. We’ve plowed through the 30% loss mark, and there very well may be more pain to come. Only time will tell.

But all of that said, this is precisely the time you should start making your buy list. The market overall isn’t wildly cheap. I know that’s hard to imagine after the plunge we’ve seen, but consider the Cyclically Adjusted Price/Earnings ratio (“CAPE”), also called the Shiller P/E after Yale professor Robert Shiller.

The CAPE compares current stock prices to a ten-year average of earnings. The idea is to smooth out the effects of the economic cycle. In any ten-year period, you’re likely to have seen a boom, and bust and everything in between.

Prior to the coronavirus meltdown, the CAPE was trading at nosebleed valuations in line with the levels just before the 1929 crash. The only time in history that valuations were higher was during the late 1990s tech mania.

The recent drop has certainly taken the froth out of the market. But it’s not cheap yet, or at least not by historical levels. Today, the CAPE is sitting at 23.1. That’s lower than the 30.9 we saw just last month. But it’s a long way from the historical average of about 17 and a long way from the 2009 bottom around 13.

Research site GuruFocus ran the numbers and found that valuations at today’s levels imply annual returns of about 2% over the next eight years.

That might end up being a little on the conservative side. They base that estimate on data going back to the late 1800s, and the economy has obviously changed a lot sense then. We live in an era of zero-percent interest rates and quantitative easing, so estimates like these should be taken with a grain of salt.

That said, I’d stand by the point that the market isn’t “cheap” at these prices, or at least not anywhere near the cheap levels we saw in 2009.

Remember though, the stock market is a market of stocks. While the averages might not be down all that much, remember that the major indexes – the Dow, the S&P 500, etc. – are dominated by a handful of tech companies that are less affected by coronavirus disruptions. Elsewhere in the market, there are some bargains I never imagined I’d see again in my life.

Out of fairness to my paid readers, I won’t mention individual stocks. But one of my favorite pipeline stocks is down 55% since the beginning of March and now yields over 20%. One of my favorite REITs, which owns primarily senior living centers, is down over 60% since the beginning of March and now yields just shy of 20%. Another REIT I love, which specializes in entertainment properties, down by two thirds this month and yields over 25%. The list goes on and on.

Amazingly, all of these stocks were already cheap before this meltdown. They’re cheap beyond belief at this point.

Could some of these companies have to cut their dividends? Of course. These are tough times and anything is possible. But some of these companies are priced like they’re going out of business, and that’s unlikely.

There are sectors I’d still stay away from. You won’t see me nibbling on airline or hotel stocks just yet. There’s just too much uncertainty. But the values are out there if you have the iron stomach to buy.

So, do this today. Make a list of stocks you’ve always wanted to buy and the prices you’ve always wanted to buy them at. Check their prices. If they are in your range, make a small purchase. Or maybe a large one.

We should expect more volatility. I don’t believe this is over, and I’m not expecting a V-shaped recovery. But times like these are when fortunes are made.

This article first appeared on Sizemore Insights as Make Your List. These Opportunities Don’t Come Around Every Day

Make Your List. These Opportunities Don’t Come Around Every Day

We just had the quickest onset of a bear market in history. It took just 21 days for stock prices to drop from all-time highs to losses of more than 20%.

Of course, it didn’t stop there. We’ve plowed through the 30% loss mark, and there very well may be more pain to come. Only time will tell.

But all of that said, this is precisely the time you should start making your buy list. The market overall isn’t wildly cheap. I know that’s hard to imagine after the plunge we’ve seen, but consider the Cyclically Adjusted Price/Earnings ratio (“CAPE”), also called the Shiller P/E after Yale professor Robert Shiller.

The CAPE compares current stock prices to a ten-year average of earnings. The idea is to smooth out the effects of the economic cycle. In any ten-year period, you’re likely to have seen a boom, and bust and everything in between.

Prior to the coronavirus meltdown, the CAPE was trading at nosebleed valuations in line with the levels just before the 1929 crash. The only time in history that valuations were higher was during the late 1990s tech mania.

The recent drop has certainly taken the froth out of the market. But it’s not cheap yet, or at least not by historical levels. Today, the CAPE is sitting at 23.1. That’s lower than the 30.9 we saw just last month. But it’s a long way from the historical average of about 17 and a long way from the 2009 bottom around 13.

Research site GuruFocus ran the numbers and found that valuations at today’s levels imply annual returns of about 2% over the next eight years.

That might end up being a little on the conservative side. They base that estimate on data going back to the late 1800s, and the economy has obviously changed a lot sense then. We live in an era of zero-percent interest rates and quantitative easing, so estimates like these should be taken with a grain of salt.

That said, I’d stand by the point that the market isn’t “cheap” at these prices, or at least not anywhere near the cheap levels we saw in 2009.

Remember though, the stock market is a market of stocks. While the averages might not be down all that much, remember that the major indexes – the Dow, the S&P 500, etc. – are dominated by a handful of tech companies that are less affected by coronavirus disruptions. Elsewhere in the market, there are some bargains I never imagined I’d see again in my life.

Out of fairness to my paid readers, I won’t mention individual stocks. But one of my favorite pipeline stocks is down 55% since the beginning of March and now yields over 20%. One of my favorite REITs, which owns primarily senior living centers, is down over 60% since the beginning of March and now yields just shy of 20%. Another REIT I love, which specializes in entertainment properties, down by two thirds this month and yields over 25%. The list goes on and on.

Amazingly, all of these stocks were already cheap before this meltdown. They’re cheap beyond belief at this point.

Could some of these companies have to cut their dividends? Of course. These are tough times and anything is possible. But some of these companies are priced like they’re going out of business, and that’s unlikely.

There are sectors I’d still stay away from. You won’t see me nibbling on airline or hotel stocks just yet. There’s just too much uncertainty. But the values are out there if you have the iron stomach to buy.

So, do this today. Make a list of stocks you’ve always wanted to buy and the prices you’ve always wanted to buy them at. Check their prices. If they are in your range, make a small purchase. Or maybe a large one.

We should expect more volatility. I don’t believe this is over, and I’m not expecting a V-shaped recovery. But times like these are when fortunes are made.

This article first appeared on Sizemore Insights as Make Your List. These Opportunities Don’t Come Around Every Day

Notes From the Bunker…

Well, this just got real for me…

I was in Peru when the coronavirus panic hit, and now I’m stuck here. Around noon yesterday, we started hearing credible rumors that the government was about to declare a state of emergency. We weren’t sure what that meant for us, but we didn’t like the sound of it.

So, we threw everything we could into the car and hit the road to my in-law’s ranch. I figured I’d prefer to be out in the country — surrounded by a wall with plentiful food, water, and, yes, shotgun shells — in the event that order broke down and chaos ran rampant.

If you have to be under lockdown…

I’m not particularly worried about the virus. It’s the reaction of millions of scared people that concerns me.

It turns out my instinct was right.

Not long after we hit the road, the President of the Peru, Martín Vizcarra, declared a national emergency and closed the airport for 15 days, essentially putting into force the same rules in effect over in Italy, France, and Spain. Unless you’re going to the grocery store or pharmacy, you are not allowed to leave your house.

Was it the right move?

Maybe. Maybe not. But it’s the move that government after government is making, and it’s contributing to the fear tanking the markets right now. No one in charge knows what to do because they’ve never had to deal with this before.

But let’s pause for a moment and consider a few things…

What a Time to be Alive

How truly amazing is it that I’m marooned on a ranch in the middle of nowhere Peru during the worst pandemic scare since the 1918 Spanish flu outbreak, yet I still have a functioning internet connection. I can carry on from here as if I were sitting in my desk in Dallas.

My colleagues are all online.

My files are secured in the cloud.

If I need a break, I can flip on Netflix for half an hour to clear my head. The modern world is Armageddon-proof.

Disaster recovery office in action.

Grocery shortages have been a problem, but, even with that, stores are getting restocked quickly… and that’s here in Peru, too. It’s a testament to how robust today’s distribution networks are.

For the life of me, I don’t understand how toilet paper shortages became a thing… If I were stocking my bunker for the zombie apocalypse, toilet paper would be low on my list of necessities. I’d be more concerned with basics: food, water, and medicine. Maybe that’s just me though.

But we’re in the business of tell others how to invest their money and ultimately concerned about how to turn this this crisis into an opportunity.

How Will This End?

I’ll admit, I have no idea where the bottom in this bear market will be. It’s a moving target. As I write this we’re down around 30%, and that number is bound to change a few more times, perhaps even today. The median decline in historical bear markets was around 33%, though we’ve had a few that saw the S&P 500 lose roughly half its value.

So, how will this one end?

Time will tell…

Stock were expensive going into it, and that suggests the losses could be larger than average. But we also live in an era of central bank interventions, so an onslaught of new liquidity injections by the Fed could put in a floor.

In the meantime, this is what you should do: make a list of every stock you’ve ever wanted to buy and enter a limit order with your broker for a price that you’d be willing to buy it at.

If we hit the number, fantastic. You’re now a proud shareholder.

There are already values popping up I never imagined I’d see again in my lifetime. So, if you’re the intrepid sort, now is the time to at least put your shopping list together.

I’ll have more to say later in the week. For now, I have a ranch to attend to…

This article first appeared on Sizemore Insights as Notes From the Bunker…

Notes From the Bunker…

Well, this just got real for me…

I was in Peru when the coronavirus panic hit, and now I’m stuck here. Around noon yesterday, we started hearing credible rumors that the government was about to declare a state of emergency. We weren’t sure what that meant for us, but we didn’t like the sound of it.

So, we threw everything we could into the car and hit the road to my in-law’s ranch. I figured I’d prefer to be out in the country — surrounded by a wall with plentiful food, water, and, yes, shotgun shells — in the event that order broke down and chaos ran rampant.

If you have to be under lockdown…

I’m not particularly worried about the virus. It’s the reaction of millions of scared people that concerns me.

It turns out my instinct was right.

Not long after we hit the road, the President of the Peru, Martín Vizcarra, declared a national emergency and closed the airport for 15 days, essentially putting into force the same rules in effect over in Italy, France, and Spain. Unless you’re going to the grocery store or pharmacy, you are not allowed to leave your house.

Was it the right move?

Maybe. Maybe not. But it’s the move that government after government is making, and it’s contributing to the fear tanking the markets right now. No one in charge knows what to do because they’ve never had to deal with this before.

But let’s pause for a moment and consider a few things…

What a Time to be Alive

How truly amazing is it that I’m marooned on a ranch in the middle of nowhere Peru during the worst pandemic scare since the 1918 Spanish flu outbreak, yet I still have a functioning internet connection. I can carry on from here as if I were sitting in my desk in Dallas.

My colleagues are all online.

My files are secured in the cloud.

If I need a break, I can flip on Netflix for half an hour to clear my head. The modern world is Armageddon-proof.

Disaster recovery office in action.

Grocery shortages have been a problem, but, even with that, stores are getting restocked quickly… and that’s here in Peru, too. It’s a testament to how robust today’s distribution networks are.

For the life of me, I don’t understand how toilet paper shortages became a thing… If I were stocking my bunker for the zombie apocalypse, toilet paper would be low on my list of necessities. I’d be more concerned with basics: food, water, and medicine. Maybe that’s just me though.

But we’re in the business of tell others how to invest their money and ultimately concerned about how to turn this this crisis into an opportunity.

How Will This End?

I’ll admit, I have no idea where the bottom in this bear market will be. It’s a moving target. As I write this we’re down around 30%, and that number is bound to change a few more times, perhaps even today. The median decline in historical bear markets was around 33%, though we’ve had a few that saw the S&P 500 lose roughly half its value.

So, how will this one end?

Time will tell…

Stock were expensive going into it, and that suggests the losses could be larger than average. But we also live in an era of central bank interventions, so an onslaught of new liquidity injections by the Fed could put in a floor.

In the meantime, this is what you should do: make a list of every stock you’ve ever wanted to buy and enter a limit order with your broker for a price that you’d be willing to buy it at.

If we hit the number, fantastic. You’re now a proud shareholder.

There are already values popping up I never imagined I’d see again in my lifetime. So, if you’re the intrepid sort, now is the time to at least put your shopping list together.

I’ll have more to say later in the week. For now, I have a ranch to attend to…

This article first appeared on Sizemore Insights as Notes From the Bunker…

Your Post-Crash Checklist

Yesterday wasn’t a lot of fun. At 2,013.76, it was the single biggest point decline in the entire history of the Dow Jones Industrial Average and the eleventh-biggest decline in percentage terms. If you exclude data prior to the 1930s Great Depression, it was the fourth-largest percentage decline in history. There were two days in 1987 and one in 2008 that were worse… and that’s it.

No matter how you slice it, that was ugly. But is the worst is behind us?

Maybe.

Or maybe not.

It’s far too early to say. If the crude oil price war between Saudi Arabia and Russia escalates, we could see some serious damage in energy, banking and junk bonds. And there is the coronavirus threat that seems to get a little more disruptive with each passing day.

Market corrections end when they end. There’s nothing we can really do about that. But, we still have portfolios to manage and retirements to plan for. So, today, let’s make a correction check list of things we can do to make the best of a bad situation.

#1. Check your allocation

If you’re properly allocated before a market crash hits, you don’t have a lot to worry about. As a very general rule, your exposure to stocks should something in the ballpark of 100 to 120 minus your age. So, if you’re 50 years old, you should have a maximum of 50% to 70% in the market.

Rules of thumb likes these are not hard rules etched into stone. They are guidelines; nothing more and nothing less. Sometimes it makes sense to completely ignore them. But at the very least, they can be helpful as a start. If you have more in the market than your age would suggest is prudent, consider taking some risk off the table. Even after yesterday’s drubbing, we’ve only lost about one year’s worth of market gains. The S&P 500 is sitting at its levels of approximately a year ago. So, it’s far from catastrophic to sell at levels and lock in a loss.

#2. Make you list

While the market may not be in bear territory just yet, there are plenty of stocks that have gotten punished harder than they did in 2008. Yesterday, I loaded up my kids’ college funds with a couple of high-yield pipeline stocks I’ve been following for years. I have no idea if the stocks have bottomed out or if they still have further to fall.

And I don’t care.

The stocks were deep into what I consider buying territory, and I’m happy to reinvest the dividends and let these compound for the next 10 years. Even if the stocks fall further from here, I got a fantastic price.

Make a list of stocks you’ve always wanted to own but were reluctant to touch because of their price. If they are now in your buy zone… what are you waiting for?

#3. Don’t neglect your 401k

If you’re reasonably confident that your job is safe, use this as an opportunity to increase your 401k contributions. You can stuff $19,500 into a 401k this year and $26,000 if you’re 50 or older. And this doesn’t include any employer matching. That’s extra.

You don’t have to invest the funds right away. You can leave them in cash or a money market fund. But you’ll at least get the tax break and you’ll have the funds available for when you’re ready to pull the trigger.

Obviously, if you think your company is in bad shape and may resort to layoffs if the coronavirus scare pushes us into recession, you wouldn’t want to do this. It’s better to hoard cash. But if you’re reasonably confident your job will survive whatever comes next, do everything you can to get to the contribution max.

This article first appeared on Sizemore Insights as Your Post-Crash Checklist

Your Post-Crash Checklist

Yesterday wasn’t a lot of fun. At 2,013.76, it was the single biggest point decline in the entire history of the Dow Jones Industrial Average and the eleventh-biggest decline in percentage terms. If you exclude data prior to the 1930s Great Depression, it was the fourth-largest percentage decline in history. There were two days in 1987 and one in 2008 that were worse… and that’s it.

No matter how you slice it, that was ugly. But is the worst is behind us?

Maybe.

Or maybe not.

It’s far too early to say. If the crude oil price war between Saudi Arabia and Russia escalates, we could see some serious damage in energy, banking and junk bonds. And there is the coronavirus threat that seems to get a little more disruptive with each passing day.

Market corrections end when they end. There’s nothing we can really do about that. But, we still have portfolios to manage and retirements to plan for. So, today, let’s make a correction check list of things we can do to make the best of a bad situation.

#1. Check your allocation

If you’re properly allocated before a market crash hits, you don’t have a lot to worry about. As a very general rule, your exposure to stocks should something in the ballpark of 100 to 120 minus your age. So, if you’re 50 years old, you should have a maximum of 50% to 70% in the market.

Rules of thumb likes these are not hard rules etched into stone. They are guidelines; nothing more and nothing less. Sometimes it makes sense to completely ignore them. But at the very least, they can be helpful as a start. If you have more in the market than your age would suggest is prudent, consider taking some risk off the table. Even after yesterday’s drubbing, we’ve only lost about one year’s worth of market gains. The S&P 500 is sitting at its levels of approximately a year ago. So, it’s far from catastrophic to sell at levels and lock in a loss.

#2. Make you list

While the market may not be in bear territory just yet, there are plenty of stocks that have gotten punished harder than they did in 2008. Yesterday, I loaded up my kids’ college funds with a couple of high-yield pipeline stocks I’ve been following for years. I have no idea if the stocks have bottomed out or if they still have further to fall.

And I don’t care.

The stocks were deep into what I consider buying territory, and I’m happy to reinvest the dividends and let these compound for the next 10 years. Even if the stocks fall further from here, I got a fantastic price.

Make a list of stocks you’ve always wanted to own but were reluctant to touch because of their price. If they are now in your buy zone… what are you waiting for?

#3. Don’t neglect your 401k

If you’re reasonably confident that your job is safe, use this as an opportunity to increase your 401k contributions. You can stuff $19,500 into a 401k this year and $26,000 if you’re 50 or older. And this doesn’t include any employer matching. That’s extra.

You don’t have to invest the funds right away. You can leave them in cash or a money market fund. But you’ll at least get the tax break and you’ll have the funds available for when you’re ready to pull the trigger.

Obviously, if you think your company is in bad shape and may resort to layoffs if the coronavirus scare pushes us into recession, you wouldn’t want to do this. It’s better to hoard cash. But if you’re reasonably confident your job will survive whatever comes next, do everything you can to get to the contribution max.

This article first appeared on Sizemore Insights as Your Post-Crash Checklist

Energy Insiders are Backing Up the Truck

Investors are a fickle sort. As I’m writing this, it’s looking like the Dow and S&P 500 will be down sharply today following news that the coronavirus is spreading faster than previously thought. But just yesterday, we had one of the biggest one-day point moves in this entire multi-century history of the stock market.

It’s hard to draw meaningful conclusions from that kind of buying and selling. No one can argue with a straight face that the people jumping in and out of the market like that are making informed decisions. Investors aren’t whipping out an Excel spreadsheet and updating their discounted cash flow stock valuation model with each new coronavirus headline. To even pretend that would be utterly ridiculous. The average investor has no idea what impact a virus outbreak will have on a company’s sales, let alone what that should imply for the share price.

If you want information you can actually use, watch the trading activity of the people running the companies. The SEC requires all company officers, directors, and shareholders owning 10% or more of a company’s voting shares to disclose any dealings they have in their company’s stock. If the CEO of the company is buying — or selling — the stock of the company he manages, the SEC believes the investing public has a right to know.

Company insiders tend to be fairly decent value investors. They don’t get every bend and twist in the stock price right, but they tend to large buyers near major market bottoms. And near tops, their buying tends to trail off.

This makes sense. If anyone has a reasonably good idea of what a company is worth, it ought to be the people running it.

Now, I should make a distinction here. I’m not talking about stock buybacks. Companies tend to be awful allocators of capital, buying back shares when prices are inflated and issuing new shares when prices are depressed. Stock buybacks are actually often a contrary indicator.

I’m also not talking about executive stock options or other stock-based compensation.

I’m talking instead about the company officers whipping out their checkbooks and buying their company stock with their own money.

The February sell-off wasn’t quite deep enough to bring out the value investors across the S&P 500. But within the energy sector, company insiders are tripping over themselves to buy as much of their own stock as they can get their grubby little hands on.

In February, energy insiders bought six shares of their own stock for every one share sold. Insider buying spiked near the bottom of the 2008 meltdown and again near the bottom of the 2015-2016 energy bust. But today’s insider buying makes those other buying sprees look tame by comparison.

Let’s look at a few examples. On February 28, Richard Kinder – founder and Executive Chairman of Kinder Morgan (KMI) – bought 300,000 shares of his own stock for around $5.7 million. This followed another 300,000-share purchase two days earlier by Mr. Kinder for $6.2 million.

Kinder also purchased 1.2 million shares in the fourth quarter of last year. To say the man is committed would be an understatement.

Not to be outdone, Kelcy Warren, the billionaire founder and CEO of pipeline rival Energy Transfer (ET), bought 300,000 shares of his own stock on February 28 for $3.2 million. This followed a massive 4-million-share purchase the day before for a whopping $42.5 million.

And earlier in the month, on February 19, Warren dropped another $45.2 million buying 3.6 million shares.

Kelcy Warren dropped over $90 million of his own money into to the stock last month. Now, granted, the man is a billionaire. But that $90 million he added was in addition to the roughly $3 billion he already owned. The vast majority of Warren’s fortune is tied up in his company stock. You think he’s not motivated to make those shares move higher?

I picked two high-profile companies as examples, but they’re certainly not the only ones. Across the energy sector, insiders are backing up the proverbial truck.

 Now, none of this guarantees that the share prices soar higher tomorrow. Prices may very well stay low for a while, particularly if demand from China slows due to the coronavirus outbreak.

But when I see this kind of insider buying, it makes me think that having some high-yielding energy stocks in the portfolio makes sense.

Disclosures: Long KMI, ET

This article first appeared on Sizemore Insights as Energy Insiders are Backing Up the Truck

Closed-End Funds: One of My Favorite Sectors Is on Sale Again

Well, February wasn’t a lot of fun. The S&P 500 dropped 8.4% on the month, and we saw the fastest 10% correction in the entire history of the U.S. stock market.

Ouch…

I’ll spare you another lengthy explanation on why the COVID-19 coronavirus either is no big deal or the beginning of the zombie apocalypse. The truth is somewhere in the middle, but that’s a longer conversation for another day.

Instead, I want to focus on the opportunities that crop up at times like these.

The correction may or may not be over. We certainly got a break from it when the Dow jumped by 1,293 points on Monday. But regardless, the chaos of a month like February was bound to create some opportunities, even if more pain is to come.

If you’ve read my work for any length of time, you know I’m a big fan of closed-end mutual funds (“CEFs”).

CEFs are different from their cousins: traditional mutual funds and ETFs. Unlike their cousins, CEFs have a fixed number of shares; there is generally no mechanism to create new shares or redeem old ones based on market demand. This can create some quirky pricing situations where the fund is worth more dead than alive — often much more.

As an example, let’s look at a CEF I recently closed out in my income letter Peak Income.

The Nuveen Preferred & Income Term Fund (JPI) manages a pretty “boring” portfolio consisting of traditional bonds, convertible bonds, and preferred stock. With market bond yields steadily falling over the past year, JPI saw a nice increase in both its stock price and in its net asset value (“NAV”). For those unversed in CEF lingo, the NAV is the value of the fund’s portfolio minus any debt.

It’s normal for a CEF to trade at a slight discount to net asset value. But as investors piled into anything paying a respectable yield last year, JPI’s discount completely disappeared. In fact, at various points along the way, it actually traded at a small premium.

Now, I don’t know about you, but I’m not a fan of paying $1.01 for a dollar’s worth of assets. I’m a big believer in buying things when they’re on sale. And that’s exactly what we got during last month’s rout.

Buying at a Discount

During the month of February, JPI’s net asset value — its portfolio of fixed income securities — dropped in value by about 4%.

But JPI’s stock price cratered by 11%. As a result, JPI started February trading at a 1% premium to NAV but finished it trading at a 6% discount.

Now, I like buying a dollar for 94 cents far more than I like buying one for $1.01.

With a dividend yield today pushing 7%, I consider JPI a reasonably good buy.

But after February’s drubbing, there are plenty of other CEFs with far more attractive discounts to NAV than JPI, many of which also pay higher dividends.

I can’t promise you that the market correction is over. But if you’re buying discounted funds at 7% yields, do you really care?

This article first appeared on Sizemore Insights as Closed-End Funds: One of My Favorite Sectors Is on Sale Again

Some Things Get Better With Age

Some things get better with age. Wine, whiskey, a properly humidified cigar…

Other things… not so much. Take my knees and rotator cuffs, for example. Against all better judgment, I joined an over-40 men’s basketball league, and we had a game last night. We won… and it was a blast. But I’m really wishing I had iced my knees and shoulders after the game. I’m feeling it this morning.

It was worth it. But rather that focusing on my decrepit knees, I’d rather add other item to the list of things that actually get better with time: dividend growth stocks.

I enjoy a high yield as much as the next guy. But focusing exclusively on yield exposes you to the very real risk of losing ground to inflation over time.

The Fed’s goal is to keep inflation at around 2%. Now, we could split hairs about their calculation methods, and I think it’s fair to say that the “real” inflation rate experienced by most Americans is significantly higher than that. But let’s be generous and pretend the Fed’s 2% inflation target is reality.

Like interest, inflation compounds. So, over 10 years at 2% inflation, your purchasing power will decline by 22%. Over 20 years, it’s nearly 50%.

We’re talking about losing half your purchasing power over 20 years… even under a wildly conservative estimate of inflation.

So, bonds, preferred stock and high-yield (but no-growth) dividend stocks might pay you a fantastic income stream today. But over the course of a retirement, you run the real risk of having your retirement standard of living degraded.

Now, let’s compare that with a proper dividend growth stock.

Realty Income (O) is a REIT specializing in high-traffic retail. Think the local gas station or pharmacy.

The REIT generally raises its dividend 4% to 5% per year, and it’s working on a string of 89 consecutive quarterly dividends hikes.

Realty Income is not a particularly high yielder at today’s prices. It’s dividend yield is a modest 3.8%. But let’s imagine you bought the REIT five years ago. Your yield on cost (or the annual dividend today divided by your original purchase price) would be a much more attractive 5.7%.

Now let’s pretend you bought Realty Income 10 years ago. Your yield on cost would be a whopping 11.9%.

Now let’s get really crazy and assume you bought Realty Income 20 years ago. Your yield on cost would be a gargantuan 22.4%.

Yes, you’d be making more than 22 cents per year for every dollar you invested in Realty Income. That’s the power of dividend growth.

I’m not recommending you go run out and buy Realty Income today. Personally, I think the shares are a little too expensive to justify buying with new money. I’d recommend waiting for a significant pullback.

But I bring this up to show you that there’s more to income investing than simply grabbing the highest yield you can find. I even have a name for that. I call it “yield whoring,” and I consider it a vice that’s detrimental to your financial health.

A good income portfolio should have a mix of high-yielding investments and lower-yielding but faster-growing dividend stocks. Ultimately, it’s the only way you’ll stay ahead of inflation in a long retirement.

This article first appeared on Sizemore Insights as Some Things Get Better With Age

Rules for a Trade-Up House

I’ll admit I have houses on my mind these days.

After seeing my friend Alan’s new home – complete with its four-car garage and Hugh Hefner grotto – my wife is bugging me to upgrade. And while I’m not crazy about taking on a major new expense, she makes valid points. Our two boys are the proverbial bulls in a China shop, and they’ve pretty well trashed our existing place. So even if I don’t buy a new house, I’m probably looking at tens of thousands of dollars in repairs and remodeling. And a little extra square footage wouldn’t be a bad thing.

We’ll see. If the right house comes along at the right price, I’ll likely join the millions of my predecessors that got suckered in the trade-up game. Or, I might resist the urge and continue on in my broken-down hovel for another couple years.

This brings up some questions on when and how to trade up. Last week, I really drove home the point that your house is not an asset. It’s an expense and should be viewed as such.

So, today we’re going to continue this conversation. We’ll call it “The Rich Investor’s rules for upgrading your house.”

Rule #1: Retire with a Paid-Off House

I consider this rule the single most important to your financial wellbeing. You do not want to start your retirement with the responsibility of a mortgage.

Once you’re retired, your income stops. You no longer have the ability to work overtime or earn that year-end bonus that helps you wipe the credit card balance clean. You have to live off of Social Security and off of whatever dividends and income your portfolio throws off.

Your expenses in retirement will be higher than you planned. It’s inevitable. And if you let your expenses get out of control early in retirement, you risk depleting your assets and then being forced to move in with your kids later. So, do whatever you need to do to ensure your mortgage is paid off before you retire. That potentially frees up several thousand dollars per month and gives you more flexibility.

So, if you’re thinking of upgrading, do the math. If you’re 45 and planning to retire at 65, will you be able to pay off your trade-up home in 20 years?

If that’s not realistic, then don’t upgrade or do so with a cheaper house. That beautiful home with the perfectly manicured lawn might be a trophy at 45, but at 65 it will be an albatross around your neck.

Rule #2: The Three-Year Rule

This rule is a bit more extreme, but I like it. I have a colleague in Houston that runs a large wealth management practice, and his rule for a trade-up home is simple: If you can’t pay it off in three years, don’t buy it.

The Three-Year Rule is obviously unrealistic for the young couple struggling to save for a down payment on their starter house. But that’s just it. We’re not talking about your starter house. We’re talking about an optional upgrade that you might want but that you certainly don’t need.

It’s important to note that you don’t necessarily have to pay off the house in three years. You just need to be able to pay it off in three. If you choose to keep the mortgage and invest your cash somewhere more profitable or stash it in a 401(k) or IRA, that’s perfectly fine. The Three-Year Rule is more about setting a practical spending limit than on keeping a specific timeline.

Rule #3: Watch Out For Taxes and Expenses

Let’s say you’re disciplined and get your mortgage paid off. Good for you! That’s a major financial milestone.

But your homeowner expenses don’t stop with the mortgage. You also have to pay property taxes, insurance, maintenance and possibly more frivolous things like HOA dues and landscaping.

So, consider your neighborhood closely. If your kids are already out of high school, paying the property-tax premium for a house in a good school district might not be necessary.

Likewise, some houses are far more expensive to insure than others due to their proximity to flood zones. And some neighborhoods have outrageously high HOA dues that are used to pay for services you might not want or need.

You might be able to skimp a little on maintenance, cleaning and landscaping. But once you’re moved in, you’re stuck paying taxes, insurance and HOA dues for as long as you own the property. So, be sure to take those numbers into consideration before you buy.

There’s nothing wrong with splurging on your dream home. It’s your money, and you only live once. But if you bite off more than you can chew, that dream home is going to end up being a financial nightmare for you.

This article first appeared on Sizemore Insights as Rules for a Trade-Up House