Are Preferred Stocks The Answer To The Growth Gap?

In his Financial Peace University classes, Dave Ramsey bases his math for building wealth on a 12 percent return. He tells his participants to “find good growth stock mutual funds that average 12 percent.” I have coordinated and facilitated over a dozen classes since 2011 and I hear many attendees ask “Where does he find these mutual funds that return 12 percent?”

I can tell you from experience that finding mutual funds that average 12 percent in a company sponsored 401k is nearly impossible. That is not to say that a mutual fund within a given 401k plan might not experience a year where it returns 12 percent, but to find one that averages 12 percent is rare. Most 401k plans are limited in scope and often do not provide access to the best funds out there. The new trend is targeted date funds. I have discussed these in my book Simple Wealth Building Strategies and personally stay away from such funds.

Stepping away from the 401k world, because there are no sure-fire winners there that will grow your assets by 12 percent, you will have to look in your IRAs and other investment accounts to achieve this rate of return. You can find mutual funds that average 12 percent over a ten year period, but as every fund prospectus will tell you “past performance is no guarantee of future results.” Therefore, basing your present investment strategy on the past performance of a mutual fund will result in future disappointment because no fund’s return is guaranteed.

Dave does not recommend owning individual company stocks. I differ from him on this, but admit that if you choose to purchase individual company stocks, do your due diligence and move slowly. The three steps to purchasing individual company stocks are research, research, and research. Individual company stocks are not likely to provide the kind of return you need year over year to average 12 percent, unless that return is a combination of dividends and capital gains. But some actually can produce high returns and, therefore cannot be ruled out as a whole. To get high returns with dividends and capital gains, you will have to sell for a gain when the stock’s value grows more than 12 percent. The cycle of buying and selling can result in a diminished return due to the ups and downs of the in-and-out strategy. Therefore, you are not likely to find a 12 percent return in individual company stocks.

Picking a winner in individual company stocks is much harder than it looks and finding mutual funds that will return an average of 12 percent FOR YOU is equally as difficult. So where can a person find an investment that can offer decent returns and bridge the gap between his or her target and reality? I have become fond of holding a select number of preferred stocks offered by companies that have strong fundamentals. Preferred stocks are securities issued by individual companies that act like bonds. They trade like stocks, but pay a fixed rate of interest usually every quarter.

These can pay 12 percent or more depending on the price at time of purchase and the coupon rate (interest rate set on the preferred shares). The greater the discount to par value these stocks are, the higher the rate of return. Most preferred shares have a par value of $25, although some have $50 and $100 par values. This means that when initially offered, the shares cost the investor either $25, $50, or $100 per share. On the secondary market, this price can be higher or lower. The higher the price, the greater the premium, the lower the price the greater the discount to par. When you buy at a premium, you reduce the yield. When you buy at a discount, you increase the yield.

Here are a few simple rules I follow when purchasing preferred stocks. I hope they will help you enhance your investments so you can use stocks to generate the 12 percent Dave Ramsey uses as a target for growth.

Rule number 1 — Always buy at a discount. That’s the first and most important rule I follow. This is important because if the company calls the preferred shares and you purchased those shares at a premium, you lose the amount you paid above par. If a preferred stock has a par value of $25 and you paid $29, you effectively lose $4 per share, which reduces your return. The yield is another important factor when purchasing a preferred stock. A preferred stock that has a yield of 9 percent at $25 will only yield 7.75 percent at $29. However, a preferred share that pays 9 percent at $25 would pay 10.22 percent if you were to buy it at a $3 discount or $22 per share.

If you have to break this rule, don’t pay more than a 1 percent premium or the value of the first dividend for any shares. On a $25 par value preferred share, you should only pay $25.25 per share or if a preferred share pays a $0.68 quarterly dividend, then only pay $25.68 a share. This will ensure that you make back the premium quickly and eliminate any room for loss. Your effective yield will still be lower, but you will have recaptured the premium in the first dividend cycle following your purchase.

Rule number 2 — Only buy shares that are callable exclusively into cash. Convertible shares will convert into shares of the issuer and this can result in a loss in value depending upon the conversion factors. Some shares have convertible options, but I like to stay with those that are callable exclusively into cash. When you purchase these shares at a discount, you stand to increase your return in the event that the shares are called. If you do purchase preferred shares that are convertible, be sure to research the underlying securities to lower the risk of loss of value. It is less complicated when the shares only convert to cash.

Rule number 3 — Always buy Cumulative shares. This means that if the dividend is suspended for any reason, the dividend will accumulate and when it is unsuspended, the company must pay all accumulated dividends. Of course the key here is to continue to hold the preferred shares even when there is evidence that the issuing company might have financial concerns. It doesn’t happen often, but it can and you have to be mindful about this kind of activity. I have held preferred shares for years and have never had a suspended dividend. I have had several companies call their preferred shares, but I have never experienced a suspended dividend.

Rule number 4 — Understand the different classes of preferred stocks. Research all of the preferred classes of stock issued by a company and choose the one that provides you with the greatest amount of ROI. Companies often offer different classes of preferred stocks. The different classes often carry different yields. Purchasing a preferred stock that gives you the best ROI is not always the one with the highest yield. You can find that a preferred stock selling at a discount will produce a better ROI than a higher yielding stock purchased at a premium. If the premium reduces the yield enough, it might be more advantageous to purchase a different class selling at a discount. Do the math. It will be well worth your time in the long run.

Rule number 5 — Find participating preferred stocks if you can. Participating preferred stocks entitle the holder to receive additional dividends (over and above regular dividends) if the Board of Directors declares them. It also allows the holder to financially participate in the sale of the company by receiving the proceeds based on a pro-rata basis. Unfortunately, the majority of preferred stocks are nonparticipating. I have been looking for a list of these so I might be able to do some analysis and determine if it would be to my advantage to add some to my portfolio. Participating preferred stocks are illusive little creatures and often they are reserved for venture capitalists such as Warren Buffett. If you find one, do your due diligence and research, research, and research before you decide to purchase.

Adding preferred stocks to your portfolio can create a simple income stream that takes the money from one company and makes it available to purchase stocks from another. Dividends from preferred shares are added to the cash reserves of your account where it becomes available to purchase other stocks. Here is the strategy. Find three preferred stocks that pay out on different cycles. Each month you will receive a dividend. This becomes the seed money needed to grow your investments and increase your financial resources. This cash can then be used to purchase other investments, or if held in a regular JTWROS account, it can be used to replenish an emergency fund or as a vacation fund.

I prefer to always use the dividend to increase investments. Money unplugged from an investment is unproductive money. Unless you need the money, keep it where it can work for you and take advantage of compounding. Preferred stocks can add a little life to a portfolio in an economy of low interest rates and minimal economic growth.

Finding Success In A Multitude Of Failures

Thomas A. Edison once said “I have not failed. I've just found 10,000 ways that won't work.” Success can be an elusive little creature. Failure is often more recognizable and when failure is found in financial matters, it can be devastating. Therefore, it behooves you to pay attention to the details and err on the side of caution concerning financial decisions. To say that I am a fiscal conservative is not an understatement, but it wasn’t always that way. In many ways, I have matured in my financial acumen, but mistakes are still made and opportunities are still squandered because, as I said, success can be an elusive little creature.  

Over the years, I have had the pleasure to work with others to create financial strategies focused on building wealth. It is important, no imperative, to develop the right attitude concerning your investments. Part of this attitude is your level of risk tolerance. There are all sorts of online evaluation tools to help you determine how much risk you can tolerate. However, all you really need to ask yourself is “Does the color red bother me?” If you answered no to that question, ask yourself this one. “How long can I stand to look at the color red before I panic?”

The truth of the matter is that if you are invested in the market, you’re likely to experience gains and losses. Seeing red in your portfolio is not a cause for panic. Panicking in the midst of a market move on any given day is one of the “10,000 ways that won’t work.” The best way to reduce your reactionary instinct is to shift your focus from the things that make you anxious to the things that bring you peace. Anxiety is merely a reaction to external stimuli; in particular negative external stimuli. Peace is an internal mechanism that comes from being grounded in your attitude. So how do you become grounded in your attitude towards the things that cause you anxiety?

Here are six ways you can increase your ability to succeed in building wealth even when the market makes you anxious.

First – Set goals: One of the greatest causes of failure, when it comes to finance, is the inability (or unwillingness) to set specific, measurable, attainable, relevant, and time structured goals. Write your goals down using the model I discuss in my book Simple Wealth Building Strategies. Goals need to be predictive and influenceable. That is, if you do what needs to be done, it is predictable that you will achieve what you want to achieve and you will achieve it because you have direct influence over the components of the goal.

Second – Don’t Panic: Remember Geo-Political events will happen. Most of the market’s reaction to geo-political events are based on “what if” instead of “what is.” Remember Brexit? The market dropped 546 points on June 24^th followed by another 215 point drop on the following Monday. A total of 760 points in two days followed by a 700 point gain over the course of the next four days. Including the day before the Brexit vote, the market actually rose 106 points over the span of seven days. The lesson? Don’t panic just because the world does.

Third – Be steadfast: Do not deviate from your plan. Executing your plan is difficult when you turn your focus to the success of others. You worry about your success and not the success someone else is experiencing. When you desire to experience what someone else is experiencing, you lose focus and begin to fail. When you are unable to attain what others have and you turn back to your plan, you will notice that, without regular maintenance, your plan for success is now a plan for disaster.

Fourth – Less is more: This is my wife’s favorite saying. Sometimes the less you do the more impact you have. Your investments do not have to be sophisticated, nor do they have to be large in quantity. Owning a few dividend paying stocks, over a long period of time, can produce substantial growth. Once you have established your portfolio, it should only require a small amount of maintenance. Applying the DRIP philosophy (Dividend Re-Investment Plan), your investments grow on auto-pilot. Owning just a few Dividend Aristocrats can produce healthy results.

Fifth – Know your style: Buffet or Ramsey? Warren Buffet encourages investors to learn to make the right decisions. He said “Diversification is protection against ignorance. It makes little sense if you know what you are doing.” Buffet believes that one only needs to study a few industries in depth to have a more lucrative portfolio. Dave Ramsey encourages diversification through mutual fund purchases. In theory, diversification reduces risk by spreading your investment dollars out over a large number of individual companies held in mutual funds. It is important to know if you enjoy digging deeper into an industry to understand the mechanics of the companies or if you prefer to have mutual fund managers dig for you?

Sixth – Maintain perspective: Building wealth is important, but it is only one aspect of the bigger picture. Learn to keep purpose in perspective. Why are you building wealth? That’s purpose. Faith, family, and finances: that’s perspective. It is not my place to give you either purpose or perspective, but if you have the wrong perspective, your purpose won’t matter. Finances are a means of caring for your family and exercising your faith. If your faith is in your finances, then you have already failed.

When you are able to bury these six ideas deep within your soul, you will find that the internal mechanics of peace will overcome the external stimuli that causes anxiety. Thomas Edison did not become anxious when he discovered yet another way something didn’t work. He just kept moving forward trying different things until he figured out a way to make things work. The biggest idea to always embrace is this. Don’t be afraid of failing. It is alright to fail if only for this one reason. Failure shows the world that you are at least trying.

One of my favorite phrases “Qui audet adipiscitur” (Latin for Who Dares, Wins) is a motto made popular by the British Special Air Service. Daring requires an inner peace in the midst of outer chaos. He who dares not, wins not. You cannot quit and win, you have to engage to win. You can’t be successful unless you learn to measure success in a different way. Remember, when you dare you can say as Thomas A. Edison once said “I have not failed. I’ve just found 10,000 ways that won't work.”

Mergers, Stock Splits, and Building Wealth

In the United States, there were more than nine thousand mutual funds in 2014 and 3,700 publically traded companies, but not all of these choices provide the investor with opportunity. That is because opportunity and availability are not the same thing. To find opportunity in a world of availability, one needs to learn to look beyond the risk of the market and study the actions of the market. This is where 

I start when others ask the following question.

What do you do to find opportunities in the market?

Let me first say for the record, I am not a financial planner nor do I have any licenses as such. Therefore, it is important that you understand that my response to this question is nothing more than opinion. With that said, it is important for you to do your own research and come to your own conclusions about what constitutes an opportunity. Always know your risk tolerance and never invest money you cannot afford to lose or that you might need to meet your obligations and necessities. 

There are two strategies I deploy depending on the current market dynamics. The first is a buy and hold strategy and I usually deploy this strategy during times of steady growth in the market. The second one is a more aggressive (meaning of greater risk) strategy I use for volatile markets and it usually results in many small gains that add up quickly. So, one is a buy-and-hold strategy and the other is an in-and-out strategy. 

Recently I have been moving more to a cash position as the time of the election draws closer. My strategy is to preserve some of the wealth I have built and then position myself to take advantage of opportunities for, what I term, quick hits. That means that I am looking for opportunities in my tax-favored accounts where I can go in and get out quickly and still make a small profit. This usually means a transaction that will last less than 90 days. 

I find opportunity in mergers and acquisitions, stock splits, and the run-up to regular dividend payouts. A recent example would be the Johnson Controls / Tyco merger. This merger constituted several features that provide real value to the shareholder of either or both companies. There were three elements of the merger that provided a strong opportunity. First, shares of the new company (JCI), a cash payout for shares of the merging company (TYC), and a spin-off company. By purchasing these stocks in the $38 range, the share ran up to $45 before the close of the merger. The shares of the new company opened at $48, a cash payout was made for shares of TYC, and in the coming months shares of the spin-off company will be paid out. 

Another example is two recent companies that are offering a 2:1 split. BMI and CHD both have or will execute a stock split in the coming month (September 2016). A 2:1 split reduces the share price and makes the stock more attractive to investors. This means a potential increase in the capital gains the stock will produce when the price begins to climb. This is not always the case though as the share prices sometimes fall after a split. However, the opportunity is there for companies with strong fundamentals.

A final example is when a company pays out a regular dividend. Vector (VGR) pays a handsome 8% annual dividend and adds a one-time 5% stock dividend on top. It is considered a 21:20 split. Here, the value is in both the regular dividend and the split. You have to do some research to find opportunities such as these. Most financial planners will not show their clients these types of opportunities and to be fair, many clients aren’t asking or looking for such opportunities. 

None of these moves are complicated or hard to find, but you have to be positioned to take advantage of them when they come along. In volatile markets I keep a lot of cash on the sidelines. This positions me to have the resources necessary to take full advantage of opportunities such as these when they come along. In a less volatile market, I look for dividend stocks that have growth potential when held for a long time. So, I find opportunity on two fronts. A stable market provides opportunity for a buy-and-hold strategy, especially following a period of volatility when good company’s stock prices have taken a hit. Volatile markets provide opportunity for an in-and-out strategy when mergers and acquisitions, stock splits, and regular dividends pave the path for small returns in large quantities. 

Stay away from programs you do not understand. I do not try to short the market, time the market or over-analyze the market. I have two strategies: buy-and-hold or in-and-out and I use them based on the market conditions. Geo-political events can swing the market and provide a good number of opportunities. Opportunity tends to hide behind risk. If you can train your mind to look beyond the risk to see the opportunity, you can train your will to take action and capitalize on those opportunities. 

Disclosure: Author has held or is currently holding the securities mentioned. However, this information is not an endorsement of any securities mentioned. Always do your due diligence when investing in individual securities.

Your Income: It’s Just The Beginning

It has been said that your income is the greatest wealth building tool available to you, but having a tool and correctly employing it are two different things. There is another saying that reflects most people’s realities. When all you have is a hammer, every problem looks like a nail. Having an income is only half of the process. You have to know how to use it in order to benefit from it. Many believe that an income is meant to be spent and if that is your belief, you have the wrong perspective. One of the best questions I’ve been asked while mentoring those who are seeking financial stability is the following.

What is the key to unlocking the power of my income to build wealth?

The average income in America is somewhere between $48,000 to $53,000 a year (depending on which survey you are using). It is becoming increasingly harder to raise a family on this amount, let alone build wealth. This is why most families resort to both parents working. The dynamics of society have changed drastically since the time of a single bread winner and two parent families.

However, there are some common factors associated with unlocking the power of your income to build wealth. Certainly a single person without children has an advantage. The single person only has to focus on a couple of items. First, control the amount of money he or she spends on consumer products, services, and experiences. Also, don’t use credit to artificially inflate his or her income. This creates debt and introduces the main culprit responsible for diminishing the ability to build wealth. 

The final step for the single person is to save like mad. A single person, appropriately managing his or her money, should be able to save at least a third of his or her income.

For the couple with children, the task becomes a little more complicated. This is because in the process of raising a family, there are expenses that seem to come out of nowhere such as a sick child, school related expenses, and falling into the trap of keeping up with the Jones. Therefore, the first practice a couple needs to concentrate on is to live well below their means. If you have a dual income, live of the greater and bank the lesser. This is a strategy my wife and I used for several years. If the greater income is not enough, only supplement the greater with the lesser to the extent needed to meet your current requirements.

The second practice is the same as the single person, get out of and stay out of debt. Debt is not your friend. Don’t become too friendly with easy credit and don’t fall for the realtor’s assessment of what you can afford. When purchasing a house, the lender and the realtor are looking at two sides of the same coin: interest and commission. That is not to say that there are not good lenders and realtors out there, but you have to know that, in the end, both are working for themselves while working for you. Just because you qualify for a $400,000 house doesn’t mean you have to buy a $400,000 house.

This leads to the next principle, limit your exposure to risk. Do your due diligence in whatever direction you choose to invest your money. Don’t take someone’s word for it. Whether you are talking to a realtor/lender, a financial planner, or an insurance salesman, make sure you hire a competent professional. And that professional’s first priority should be you. I strongly recommend you share your goals with the professional and hold him or her accountable to helping you achieve your goals even when your goals conflict with his or hers.

Most financial planning is influenced by behavior. Therefore, you must learn to say no to yourself and your family. But don’t just say no. Learn to work through the process of making a purchase. Discuss the advantages and disadvantages of saying yes and no. Measure and discuss the opportunity costs. Teaching your children how to make an adult decision will not only help you unlock the power of your income, but it will also position your children for success with money when they begin to make financial decisions.

The single most troubling problem today concerning money management is that there isn’t any! The “I want it all and I want it now” mentality speaks of the instant gratification generation we have become. There are pockets of those who have learned and practiced good financial behaviors, but for a vast majority, managing money is not a strength.

The best way to unlock the power of your income is to lock up the power that spending your income has over you.  You cannot spend you way to wealth. In my book Simple Wealth Building Strategies I provide you with eleven different strategies that collectively help you systematically build wealth. Sometimes taking what someone else has done successfully and adapting it to your situation is the best way to develop your own strategy. Therefore, taking a look at my book might encourage you to develop and implement your own successful wealth building strategy.