A Native Guide to Investing: Eat Bite-Size Chunks of Stock

Steve Russell
8/26/14

There is practically no end to the ways you, the investor, can slice and dice the stock market, as I mentioned briefly when discussing ETFs in a previous column.

RELATED: Alphabet Soup Can Be Delicious: An Investor’s Guide to Ticker Symbols

The key for how you carve it up is diversification. Especially in the size of portfolios you and I can afford, we don’t want stocks that trade together. When I say, “trade together,” I mean something in addition to the tendency of the entire market to move up and down in concert. The state of the market moves all stocks but they all do not move equally. The state of the particular market sector moves stocks within that sector. Diversification cushions both. The former because non-cyclical or “defensive’ stocks are somewhat resistant to general downturns and the latter because, if you are properly diversified, you never have most of your money in one sector.

Toward the goal of accomplishing a diversified portfolio when it’s limited in size, I want to talk about some ways to divide up stocks.

Keep in mind that there are two ways you can make money investing long (betting that the price will go up). The obvious one is “capital gains,” which is the difference between the price you paid and the higher price you get when you sell, less commissions. If the sale price is not higher than what you paid, you have a capital loss that can be offset against your capital gains for tax purposes on Schedule D, with which you will become familiar if, like me, you do your own taxes.

The other way to make money is dividends. Stocks likely to produce large capital gains – “growth stocks” or “momentum stocks”—seldom pay dividends. A dividend declared by a corporate board returns capital directly to shareholders. Growth stocks seldom offer dividends because those companies need capital to expand the business.

Generally speaking, dividend stocks are a bit safer, because the dividend, when it’s safe—meaning the company will be able to continue paying it—tends to establish a floor for share prices. A dividend amount is normally expressed in the percent return you will get on your investment over a year. That sum puts the stock in competition with money kept in savings accounts or certificates of deposit on the low end, and corporate bonds on the high end.

Since the Federal Reserve has hammered interest rates down in an attempt to stimulate the economy, savings accounts pay next to nothing. The low interest on Treasury notes also bleeds over to corporate bonds. That’s how low interest rates stimulate the economy. It becomes a good time to borrow (issue bonds) and expand, which means jobs. But lower interest rates also drive money into the stock market in search of yield, when what the bond investors are used to is safety.

The corporations that can pay dividends over long periods of time and have a cash flow to support dividends are among the safest stocks to own, which is why they are called “granny stocks.” Should the share price begin to fall, the dividends, which are expressed as a yearly return on investment based on the current share price, go up. As the return goes up, more buyers are attracted, and the shares quit falling.

Back before the dot-com crash, very few tech stocks paid dividends, because expansion was the name of the game. When the bubble burst on March 10, 2000, what followed was a lot of bankruptcies and mergers and acquisitions. After it all shook out, some tech companies had become parts of the establishment and, after the scare was over, they began to return some of their robust cash flows to shareholders in the form of dividends.

The tech bubble is why you won’t find as many tech stocks as you might expect on the lists of reliable dividend paying granny stocks. Apple only started paying a regular dividend in 2012. Google does not pay a dividend. Amazon not only does not pay a dividend, it has not yet consistently turned a profit.

The dividend paying lists dominated by granny stocks are:

*Dividend Achievers, U.S. companies that trade on the NASDAQ or the New York Stock Exchange and have increased their dividend for 10 or more consecutive years.

*Dividend Champions have increased their dividend for 25 or more consecutive years.

*Dividend Aristocrats have increased their dividend yield for 25 or more consecutive years and are members of the S & P 500.

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