Last March I published an article regarding the hazards of volatility
in a stock selection. In that example I
compared a 4% annual dividend payer experiencing no growth against a non-div
stock that experienced value swings up and down.
This post revisits that exercise but in a slightly different
way. As before, I started with a 4% dividend
payer providing no value growth against a non-dividend stock that is uniformly
volatile with regard to value. In other
words, the value of the stock increases a specific amount in one year then
decreases a specific amount the following year. That pattern was repeated
through 20 years.
I was trying to get a sense of how big stock gains have to
be to offset corresponding declines over time while resulting in an outcome
close to the straight 4% growth path.
The table below, built in excel, shows the results.
|
Start
|
$ 10,000.00
|
Annual Growth
|
$ 10,000.00
|
Annual Growth
|
|
1
|
$ 10,400.00
|
4%
|
$ 12,000.00
|
20%
|
|
2
|
$ 10,816.00
|
4%
|
$ 10,800.00
|
-10%
|
|
3
|
$ 11,248.64
|
4%
|
$ 12,960.00
|
20%
|
|
4
|
$ 11,698.59
|
4%
|
$ 11,664.00
|
-10%
|
|
5
|
$ 12,166.53
|
4%
|
$ 13,996.80
|
20%
|
|
6
|
$ 12,653.19
|
4%
|
$ 12,597.12
|
-10%
|
|
7
|
$ 13,159.32
|
4%
|
$ 15,116.54
|
20%
|
|
8
|
$ 13,685.69
|
4%
|
$ 13,604.89
|
-10%
|
|
9
|
$ 14,233.12
|
4%
|
$ 16,325.87
|
20%
|
|
10
|
$ 14,802.44
|
4%
|
$ 14,693.28
|
-10%
|
|
11
|
$ 15,394.54
|
4%
|
$ 17,631.94
|
20%
|
|
12
|
$ 16,010.32
|
4%
|
$ 15,868.74
|
-10%
|
|
13
|
$ 16,650.74
|
4%
|
$ 19,042.49
|
20%
|
|
14
|
$ 17,316.76
|
4%
|
$ 17,138.24
|
-10%
|
|
15
|
$ 18,009.44
|
4%
|
$ 20,565.89
|
20%
|
|
16
|
$ 18,729.81
|
4%
|
$ 18,509.30
|
-10%
|
|
17
|
$ 19,479.00
|
4%
|
$ 22,211.16
|
20%
|
|
18
|
$ 20,258.17
|
4%
|
$ 19,990.05
|
-10%
|
|
19
|
$ 21,068.49
|
4%
|
$ 23,988.06
|
20%
|
|
20
|
$ 21,911.23
|
4%
|
$ 21,589.25
|
-10%
|
|
Advantage
|
1%
|
If a $10,000 portfolio achieves 20% growth in year one but
declines 10% in year two and repeats that pattern through 20 years, the
volatile portfolio lags the steadily compounding portfolio by 1%. This example assumes no money was added or
subtracted from the portfolio.
If the value gains
are moved to 21% each year while holding the 10% declines steady, the
volatile portfolio outperforms. However,
if value gains fall below 20% while the 10% declines remain constant, the
performance advantage offered by the constant growth portfolio widens
considerably.
Things to consider given the
example above:
- Gains have to be significantly greater than losses for a volatile portfolio to achieve parity with a constant growth option.
- Losses should be mitigated as much or as often as possible for a volatile portfolio to achieve parity with a constant growth model.
The effects of volatility perfectly illustrate the following
investing
wisdom:
"The key to success [in investing] lies in avoiding
losers, not in searching for winners." -- Howard
S. Marks
"Avoiding serious loss is a precondition for sustaining
a high compound rate of growth." -- Roger
Lowenstein
"Rule #1: Never Lose Money; Rule #2:
Never Forget Rule #1." -- Warren Buffett
Dividend Farmers
don’t mind following the lead of successful investors. On long journeys it’s often better to go with
an experienced guide than venturing alone.
With the start of a new year we should keep learning, let the dividends
compound, and work on steady growth.
Here’s to a success Dividend Farming effort in 2020. Happy New Year!
Thoughts presented are those
of the author, who is not a financial professional. Perspectives are not
investment advice, but offered for the purpose of discussion and information.
For specific investment advice or assistance, please contact a registered
investment advisor, licensed broker, or other financial professional.
