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Watching, waiting, deliberating…

With the US elections over and the political terrain pretty much unchanged, the investment world has gone back to worrying about a host of problems that never really went away.

 

Top of the pile is the so-called ‘fiscal cliff’ that the US economy will apparently drive over at the end of December 2012 when the Bush era tax cuts are slated to end and mandatory spending cuts kick in. The fear is that this double-whammy will send the fragile US economy back into an economic death spiral and drag the rest of the world with it.

 

In Europe, Greece needs to roll over billions in debt this week or face crisis (again) and the International Monetary Fund (IMF) and EU policymakers are at odds over how to fill the gap. The Spanish are on the ropes and need tens of billions of Euros. Mass strikes are erupting across Europe, Germany is catching the Euro-flu, and China’s economy is rapidly cooling thus hammering commodities and natural resource-based economies like Brazil, Australia and Canada, which also suffers from a supremely overvalued housing market that is starting to crack as people struggle under record debt levels.

 

All of this means that volatility is up in the stock markets, panic is starting to rear its head and money is pouring out of stock markets and into the so-called safe haven of government bonds, pushing up bond prices yet again and depressing yields to levels rarely seen before.

 

So what does this mean for the Child Millionaire portfolio builder and what should we be doing?

 

As I’ve mentioned before, one of the key components of success with the Child Millionaire portfolio is to purchase high quality dividend aristocrats when they go on sale to achieve the highest possible yield [yield = the annual dividend / the share price]. Over the long term this results in turbo-charged compounding.

 

So right now the time is ripe to be assembling a shopping list of candidate shares for your Child Millionaire portfolio and be ready to pull the trigger if/when any of the on-going crises kick-starts a full-blown stock market panic.

 

Remember that when share prices drop, risk is being squeezed out of the system and you want to be buying when everyone else is selling. Most people do the opposite, which explains their poor investing performance.

 

The key points to choosing companies to invest in:

 

  • Long, unbroken track record of paying dividends with a yield above 2.5% but preferably closer to 5%
  • Payout ratio of dividends as a percentage of net profit <75%
  • Long track record (10+ years but preferably 25+ years) of increasing the dividend year after year – this is fundamental!
  • Dominates an industry sector with the top brand(s) and/or has another ‘moat’ that makes it highly resistant to competition such as expensive hard-to-duplicate infrastructure like pipelines
  • Is not susceptible to company-level catastrophic risk – think BP and the Deep Water Horizon
  • Growing sales and market value year after year, even if very slowly

 

I’ll cover some of the specific shares I’m looking at in the next posting, but for now start researching and create a short list of shares and be ready to pull the trigger when the next crisis erupts and panic ensues.

 

 

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The Itchy Trigger Finger

With the FTSE hovering around 5,750, Europe in recession, a looming US election and the Fed poised to do something or nothing, it’s times like these that can really burn an investor without a plan and without the number one investor virtue – patience.

 

What do I mean by this?

 

I write these blog postings as much to help with your Child Millionaire portfolio construction as I do to prevent myself from doing anything rash and stupid. Rash and stupid in this context means giving into emotion, specifically the fear of missing out on gains, when in all likelihood the price and risk is too high.

 

When it comes to successful dividend investing your entry point into a given company share matters significantly to your overall return. If you pay too much for a share you acquire fewer shares for your money, your yield suffers and your overall dividend take is lower. The effect of paying too much up front is compounded over time because the lower dividends reduce how quickly your reinvested dividends acquire more shares and compound your capital.

 

Let’s look at an example.

 

A fantastic company and share to be holding right now is SSE (formerly known as Scottish & Southern), which is the second largest energy generator and supplier in the UK. As I’ve mentioned before, people need what SSE produces.

 

SSE recently announced that its final 2012 dividend would be 56.10p, payable in 21 Sept 2012. Coupled with the interim dividend of 24.00p paid on 25 January 2012, the total annual dividend will be a fantastic 80.10p per share. This continues their policy of upping the annual dividend year after year by 2% over the Retail Price Index (RPI) until at least next year and above inflation after that. This track record puts them in the top 5 of FTSE 100 companies in terms of dividend increases since 1999. SSE also recently raised its retail energy prices by 9% commencing 15 October 2012. Bad news for energy users, good news for SSE shareholders.

 

So far so good. I have spare cash in my ISA trading account and my itchy mouse trigger finger wants a piece of that dividend action…

 

But what about the share price and how does this affect the current yield and the long term potential return from SSE shares? And is now a good time to buy or should I wait?

 

At today’s price of about 1,375p per share, the yield on SSE based on the 2012 dividends is 5.825% [80.10p dividend / 1,375p share price], which is pretty tasty. Yet just a month ago on 25 July 2012 SSE closed at 1,294p per share after plummeting from an annual high of 1,445p only two weeks earlier on 10 July 2012.

 

Here’s how your dividend yield compares if you buy today or bought on 25 July or 10 July 2012:

 

Date Share price in pence Yield
29 August 2012 1,375 5.825%
25 July 2012 1,274 6.287%
10 July 2012 1,445 (annual high) 5.545%

 

So the difference between the best and worst yield of these three dates is 0.742%. It seems insignificant doesn’t it? But how would this difference affect the long term return in your Child Millionaire portfolio and is it worth worrying about or should you just buy now?

 

Let’s assume that you purchase £1,000 worth of SSE shares, rounded down to the closest whole share, for your Child Millionaire portfolio and reinvest all dividends over time. Let’s also assume that SSE shares appreciate at 2% per annum on average into the future and SSE continues to increase the dividend by 6% year-over-year.

 

Using the Child Millionaire calculator, here is how the results would play out over 10, 20, 30, 40 and 50 years:

 

Future Value of £1,000 worth of SSE Shares

 

End of Year 72 shares at 1,375p (5.825% yield) 78 shares at 1,274p (6.287% yield) 69 shares at 1,445p (5.545% yield)
10 £2,393 £2,535 £2,333
20 £7,943 £9,099 £7,382
30 £41,815 £53,673 £36,270
40 £429,378 £649,502 £337,047
50 £11,532,466 £22,071,225 £7,844,393

 

So for shares purchased on three different dates a mere 7 weeks apart in 2012, during which nothing changed with the company’s business model, and with a maximum difference in yield on only 0.742%, the results in the long term, which is what Child Millionaire investing is all about, are astounding. By year 10 the difference appears negligible between buying at the high of 1,445p per share and the low of 1,274p per share. A mere £202. However, because of the power of the time element of compound interest, by year 30 the difference is nearly double and by year 50 the difference has amplified nearly three fold to a staggering £14 million.

 

So like a super tanker heading for a reef or an asteroid bearing down on earth, a tiny nudge at the beginning results in a massive movement over time. The point is that all things being equal, the less you pay for a high quality Dividend Aristocrat type share, the higher your initial yield and the more dramatic the Child Millionaire outcome.

 

So should I buy SSE today for Mia’s Child Millionaire Portfolio? If I wait will the price come down to 1,274p again or will I miss the boat and look back on 1,375p as a missed opportunity as the share price leaves 1,500p in the dust?

 

I’ll be covering how you might determine what price to pay for a given company’s shares and how much is too much in some later posts. For the moment, suffice to say that with the FTSE 100 not far off its annual high, no resolution of the euro zone crisis in sight and China’s economy crashing before our very eyes, cheaper shares, even in high quality dividend machines like SSE, which tend to get pulled down with the overall market, seem all but inevitable as soon as the next crisis erupts.

 

So for now I’ll keep my powder dry and wait for a lower entry point on SSE and thus a better yield and eventually a much bigger pay-off.

 

Be still my itchy trigger finger…

 

 

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A few words on ‘fear’ and ‘risk’

I’ve been in a bit negligent on the CM blog front lately with a host of other projects on the go including child minding, travel, development of another one of my businesses and embryonic planning for the purchase of some land and the construction of a low-cost, low-energy sustainable house. A new blog should follow soon where I will write about these projects.

 

Today’s CM post continues a theme I’ve covered in The Child Millionaire ebook and elsewhere on this blog, which are the twin sides of the investment coin: fear and risk.

 

My last post was 8 December 2011. In the meantime lots and not much has happened in the stock markets, which illustrates a few key points about fear and risk.

 

On 8 Dec 2011, the FTSE 100 stood at 5483 on the cusp of a multi-month rally that saw it hit a high of 5965 on 16 March before slumping back down to 5260 on 1 June and then creeping higher to about 5600 today.

 

What jerked the FTSE and all other major stock markets around over the past six months were twists and turns in US jobs reports, the woes of Greek elections, bond rate spikes in Portugal and Spain, French elections, Spanish bank bailouts, more Greek elections and more Spanish pain along with monetary juicing here and there by central banks, markets clamouring for more cash injections like back alley junkies and looming over everything the twin prongs of a euro zone on the edge of disintegration and the US presidential race.

 

Yet an investor with a very long term horizon who had simply gone to sleep for the past six months [much like I metaphorically did] would see that not much has really changed. Dividend paying giants with rising dividends continue to pump out the cash and with each reinvested dividend the size of our holdings increase which compounds our capital by spawning larger future dividend payouts that are also reinvested in an ongoing cycle.

 

So what about fear and risk? Simply put anyone who paid attention to the news over the past six months [something I don’t recommend doing] would have seen a world apparently awash in fear and risk. Yet this is because risk is woefully misunderstood by the average investor, which partially explains why fear takes over and small investors tend to do poorly in the long run.

 

Most people have risk completely backwards. Most would see the FTSE 100 dropping by 12% in two-and-a half months to 5260 on 1 June as ‘risk’ in action – i.e. the value of your invested capital diminishing. What this means is that most people trip over each other to sell when the market is dropping, fearing that it will never stop dropping. Yet these same people can’t wait to pile in when the market is spiking upwards for the fear of missing out on big gains.

 

What we should be doing with our Child Millionaire portfolio is the exact opposite. When the market drops, risk is actually being squeezed out as the probability and size of further declines diminishes and high yields put a floor under the market of high quality shares. As the share price of our favourite Dividend Aristocrats get pulled down with the overall market, regardless of the performance of the businesses themselves, the yield [dividend / share price] increases and we get more shares for our money. Simply put, when the market drops you should be backing up the truck to load up on your favourite Dividend Aristocrats. Risk has been squeezed out; the shares are on sale and the yield, and thus your return over time, increases.

 

Correspondingly, when the stock market is flying high and Dividend Aristocrats get pulled upwards, risk increases both in terms of the probability and size of future capital declines but also because you get fewer shares for your money and the yield on these shares, and thus your future return, is lower.

 

So contrary to what you might think and what the media churns out, a dropping market indicates risk is dropping and a rising market indicates risk is increasing.

 

Buying when everyone else is selling is contrarian and it’s smart and it works. But it’s also hard because it requires you to conquer fear, which is a powerful human emotion peddled relentlessly by the media. As social animals we want to do what everyone else is doing, which explains most asset bubbles and why average people buy at the top and sell at the bottom be it stocks or houses or tulip bulbs. Yet we need to do the opposite.

 

The most practical way to do this is through automatic regular investments that take advantage of pound/dollar cost averaging. Or for those elusive, stoic individuals of Spartan discipline who can cultivate what I’ve referred to as ‘strategic ignorance,’ a well-structured and executed investment plan built on the patience to wait for low share prices and the conviction that the world is not coming to an end. It’s the rare person with this discipline, which is why most of us are better off following the automatic regular contribution approach.

 

So you need to get it into your head: when markets drop, risk is being squeezed out and it’s time to buy, when markets rise, chill out, buy less and plan what you will buy during the next drop.

 

Or as Baron Rothschild bluntly put it: ‘buy when blood is running in the streets.’

 

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Buying Strategies III: Using Short-term Trades to Turbo-charge your Yield

In my last post I covered doubling up and doubling down as a strategy for buying high quality dividend aristocrats. Today’s post covers a more advanced and risker trading strategy that may be suitable for some Child Millionaire investors looking to boost their yield by improving the price they paid for a given share.

 

On 18 April 2011, I purchased 250 shares of Standard Life (LSE: SL.) for Mia’s Portfolio. The share price was 211.202p including the dealing costs for a total investment of £528.01. I currently hold Mia’s portfolio within my Individual Savings Account (ISA) [a tax-free investment account available to UK residents] and the 250 shares were purchased as part of a larger lot of 1,515 shares of which 250 were for Mia and 1,265 shares were for my own portfolio.

 

I have no idea where the SL share price is headed in the short-term but I know it’s a high quality dividend machine worth owning long-term. On 5 October 2011, well past the share price low of 172p on 8 August, I bought 5,000 shares at 194.197p including dealing costs and stamp duty for a total investment of £9,709.85. This was intended as a large short-term holding for the purpose of lowering my overall price for the smaller number of SL shares that I want to hold long-term. The next day the price had risen and I sold 5,000 shares for 199.83p including dealing costs.

 

So at the end of the day on 6 October 2011, I was back to having 1,515 shares – 250 for Mia and 1,265 for my portfolio. On the trade I pocketed £281.66 in tax-free cash for ten minutes of work, but this is incidental to the main purpose which was to lower my overall ‘book value’ i.e. the price I paid for the SL shares. Here’s how it worked:

 

18 April 2011 bought 1,515 shares at 211.202p = £3,199.71 [including dealing costs]

5 October 2011 bought 5,000 shares at 194.197p = £9,709.85 [including dealing costs]

 

So at the end of 5 October I held 6,515 SL shares with a total cost of £12,909.56 for an average price of 198.151p per share.

 

On 6 October I then sold 5,000 shares at a price of 199.83p [including dealing costs] for a total of £9,991.50. The difference between the £9,991.50 I received on the sale and the £9,709.85 I paid came out to £281.65 which was a profit on the trade. For the purposes of the long term investment in SL, the 1,515 shares that I continue to hold now have an average book value – i.e. cost – of 198.151p rather than the 211.202p I originally paid on 18 April 2011. So by using a sort of turbo-charged ‘doubling down’ tactic overall I’ve lowered the cost of our positions in SL by 13.051p per share which is £32.63 saved for Mia (£0.13051 X 250 shares) and £165.10 for me (£0.13051 X 1265 shares).

 

Going forward this means that the yield on the shares in Mia’s portfolio has now increased from 6.16% (trailing dividend of 13p / 211.202p X 100% = 6.16%) to 6.56% (trailing dividend of 13p / 198.151p X 100% = 6.56%) and her portfolio has £32.63 in additional cash to be deployed in future investments.

 

Obviously this worked for me because of a number of factors: I had sufficient spare cash in my investment account that could be used for a short term trade; Mia’s SL holding was amalgamated with my holding so the dealing costs were averaged across more shares; and crucially, the share price of SL rose the following day and I was able to get out of the trade quickly before the market turned down and the plan backfired.

 

As it turns out had I held on to the shares a bit longer the price of SL hit 224p on 27 October, which would resulted in a much larger windfall. Mind you, by mid-November the share price was again dropping over euro zone worries, hitting 185.10p on 25 November, which would have put me underwater. The point being that I didn’t know where the share price would go, thought I did have the momentum of the overall market behind my trade, and with nearly £10,000 on the line I wanted to get in and out of the position quickly.

 

A few key points. The above example is an advanced strategy that blends long-term investment objectives with a short-term trading strategy that I do not recommend for the Child Millionaire portfolio or any other portfolio unless you are a seasoned investor and you understand and accept the risks. What it does illustrate though is the basic principle that if you purchase shares in a single company at two different times and two different prices you can manipulate your book cost. If the market moves favourably you can lower your book cost, pocket a small immediate profit and boost your overall yield and long-term return. If the market moves against you, then you may well be stuck with more shares of a single company than you want thus dramatically increasing the risk to your portfolio.

 

 

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Buying Strategies II: Doubling Down / Doubling Up

In my last post I looked at the buying strategy of ‘dollar / pound cost averaging.’

 

When it comes to building a share position without worrying about the direction of the share price or overall market, this is the easiest and most useful strategy and the one I recommend above all. It can also be automated, which is a key principle of the Child Millionaire strategy.

 

In some circumstances, such as when you have a one-off lump sum to invest, or because you are a keen market watcher – an obsession I don’t recommend for the Child Millionaire or any other long-term investing approach – and you want to take advantage of a substantial sell-off in the overall market, jumping in all at once can be justified. As discussed previously, the lower the price on a dividend paying share the higher the yield and the better the return over time. So occasionally it pays handsomely to leg in at certain points.

 

‘Doubling down’ or ‘doubling up’ is an active strategy of buying shares in the same company at two different times and prices to get an overall better price for your shares when the market is trending up or down.

 

So let’s assume that you wanted to invest roughly £1,000 into Standard Life shares for your Child Millionaire portfolio but you don’t know where the market is going.

 

Like me, on 18 April 2011, you purchased 250 shares of SL for your Child Millionaire portfolio. The share price was 211.202p including the dealing costs for a total investment of £528.01. This is roughly half of your intended investment and you wait and see whether the share price is trending upward or downward before pulling the trigger on the second half.

 

After watching the price of SL plummet in early August on the Greek bond death spiral, US unemployment data and mountains of other macro-economic data generally unrelated to the performance of SL as a company, the price hits 172p a share on August 8. You are on holiday and you miss this low but buy on 10 August for 181p a share. With the dealing costs of £12.50 commission and £22.63 in UK stamp duty your total cost is £487.63. When added to the original purchase of £528.01 your total cost is £1,015.64 / 500 shares = 203.128p per share. So by doubling down you’ve bettered your initial price of 211.202p and thus boosted the yield on the shares from 6.16% (13p trailing dividend / 211.101p X 100% = 6.16%) to 6.4% (13p / 203.128p X 100% = 6.4%), which means greater long-term compounding.

 

So this is doubling down. You bought half your initial intended investment at one point and price and the second half at a lower price thus doubling the initial investment downward with a lower overall price than if you’d have bought the full 500 shares on 18 April.

 

Doubling up is simply the same method but in a rising market. Say you bought your initial 250 shares on 10 August at 181p a share and then you think the price is going to trend upward so you buy the second lot of 250 shares on 27 September at 207p per share. Your average price is thus 250 shares x 207p per share = £517.50 plus £12.50 commission and £25.88 stamp duty = £555.88 plus the £487.63 for the 10 August purchase so your total cost is £1,043.51 / 500 shares = 208.702p per share. Note the impact of dealing costs on your final cost.

 

A few key points about doubling up or down:

 

  • You need to watch the market quite closely to pick your entry points, though in all probability you will never hit the optimal price point. You might double up on a rising share price but then the share price drops and had you waited you could have doubled down. Conversely you might miss a good entry point because you think the share price is going lower but instead it rebounds. Or perhaps emotions interfere with your ability to pull the trigger when the price is dropping because you fear that it will drop even more and your portfolio will be wiped out. There are techniques to mitigate these issues that I’ll address in later posts.
  • Be aware of how dealing costs and other charges affect your final price. When doubling up or down you will pay twice the commission that you’d otherwise pay with a single investment. You will probably also pay more than if you use a broker that allows you to make regular purchases at a very low commission. These dealing charges and stamp duty (if you live in the UK or a jurisdiction that charges it) will have a profound impact on your overall average price, especially if you are making relatively small investments. In the double up part of the above example, the effect of the dealing charges and stamp duty resulted in the average overall price being relatively high. In fact higher than the price of the second share purchase because of the amplified impact of the charges on such a small purchase. For small investments stick with low-cost dollar / pound cost averaging to minimize the impact of dealing costs.
  • Doubling up or down is more time consuming and stressful than passive dollar / pound cost averaging and it suffers from all of the issues around market timing that I’ve discussed previously.

 

Despite the impact of dealing costs and the issues around market timing, in the right circumstances and with large enough purchases, doubling up or down can be a powerful strategy. I’ll look at a turbo-charged version of this strategy in my next post.

 

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Buying Strategies I: Dollar / Pound Cost Averaging

As I mentioned in my last post, in an ideal investing world we’d always buy shares at the lowest possible price. When a share price drops for a Dividend Aristocrat, the yield increases because yield arrived at by dividing the annual dividend by the share price.

 

For example, with Standard Life (LSE: SL.), if you buy in at today’s price of about 203p per share and the trailing dividend – i.e. last year’s dividend – is 13p then your yield is (13p / 203p) X 100% = 6.40%. If the price of the share was 250p when you bought then the yield would be (13p / 250p) X 100% = 5.20%, while if the share price dropped to 175p then the yield would be (13p / 175p) X 100% = 7.43%. Consequently, assuming the dividend stays constant or increases over time, the lower the price you pay for the share the higher the yield and the better your return.

 

Many shares boast a high yield but whether the dividend will be maintained let alone increased over time is often in question. With Dividend Aristocrats, which have a history of 25+ years of paying and increasing the dividend year after year, the case is clear. The cheaper you buy the shares for your Child Millionaire Portfolio, the greater your initial yield, the greater your dividend payment because you will have more shares earning a dividend, and the more shares you’ll be able to purchase thorough automatic dividend reinvestment. As the number of shares your child owns increases with each quarterly or semi-annual dividend payment and reinvestment, the greater the future dividends and the greater your child’s future wealth as compounding over time does its work.

 

Now given that the direction of markets and share prices is unpredictable, how do we secure shares at a good price to ensure a high yield?

 

There are numerous methods investors employ. Some use fundamental analysis; some use the sometimes esoteric methods of ‘technical analysis’ or charting and some simply guess. I’ll get to some of these techniques in future posts. For now, though, I’d like to focus on ‘dollar or pound [or euro or yen] cost averaging,’ the most idiot-proof method for buying shares. Dollar / pound cost averaging is a widely known but often misunderstood and certainly poorly employed method for acquiring shares at a good price – not the lowest price but also not the highest – and best of all it can be fully automated.

 

The basic premise of dollar / pound cost averaging is that the method reduces your risk and uses volatility, of which markets have plenty these days, to get an overall lower average price for shares by buying more shares when the shares are cheap and buying fewer when the shares are expensive. I get into dollar / pound cost averaging in quite a bit of detail in Child Millionaire but here are the basics of how it works compared to buying at a single point in time.

 

Let’s assume you wanted to buy £1,200 worth of SL shares for your Child Millionaire Portfolio and we’ll compare three scenarios over the past six months from 9 May to 9 October 2011: scenario 1, buying all the shares on 9 May; scenario 2, buying by pure good luck, all of the shares at the absolute bottom of this period; and scenario three, dollar / pound cost averaging by making six equal investments of £200 starting on 9 May and then on the subsequent ninth of the following five months. We’ll then look at where we’d be today, 9 November 2011.

 

Assumptions: for simplicity we will use the closing price on each of these days as our notional purchase price and round down to the closest whole share. I’ll address dealing costs at the end.

 

Scenario 1, investing the full £1,200 on 9 May 2011 at the closing price of 218.20p per share: £1,200 / 218.20p per share = 549 shares purchased at 218.20p per share.

 

Scenario 2, investing the full £1,200 at the lowest point of the past six months (8 August 2011) at the closing price of 172p per share: £1,200 / 172p per share = 697 shares purchased at 172p per share.

 

Scenario 3

 

Dollar / pound cost averaging by purchasing £200 worth of shares on the 9th of each month [or the next open day for the markets] for a period of 6 months as follows:

 

9 May 2011 closing price: 218.50p

£200 / 218.50p = 91 shares purchased

 

9 June 2011 closing price: 206p

£200 / 206p = 97 shares

 

11 July 2011 closing price: 205.20p

£200 / 205.20p = 97 shares

 

9 August 2011 closing price: 174.10p

£200 / 174.10p = 114 shares

 

9 September 2011 closing price: 190.20p

£200 / 190.20p = 105 shares

 

10 October 2011 closing price: 210.50p

£200 / 210.50p = 95 shares

 

Total of 599 shares purchased at an average price of 200.75p per share

 

So how have we done in terms of yield and paper capital gains to 9 Nov 2011?

 

In scenario 1, using the trailing dividend of 13p per share, our share holding would be 549 shares and the yield would be (13p / 218.50p) X 100% = 5.95%. At today’s closing price of 202.6p the value of the holding would be £1,113.92 for a paper loss of £86.08

 

In scenario 2, using the trailing dividend of 13p per share, our share holding would be 697 shares and the yield would be (13p / 172p) X 100% = 7.56%. At today’s closing price of 202.6p the value of the holding would be £ 1,412.12 for a paper gain of £212.12.

 

In scenario 3, using the trailing dividend of 13p per share, our share holding would be 599 shares and the yield would be (13p / 200.75p average price) X 100% = 6.48%. At today’s closing price of 202.6p the value of the holding would be £1,213.57 for a paper gain of £13.57.

 

In all cases no dividend was paid because the 27 May semi-annual dividend payment was only paid to shareholders on record as of March 16, however in all three scenarios the next dividend payment on 18 November will be paid to all shareholders who were on record as of 17 August 2011. In scenario 1, the dividend will be paid on 549 shares, scenario 2 on 697 shares and scenario 3 on 599 shares.

 

So what can we conclude from these scenarios?

 

Clearly, buying at the bottom is the best strategy while buying at or near the top is a poor strategy. As I’ve mentioned before, this is blindingly obvious yet in practice it’s difficult if not impossible because the future is unclear and nobody knows which way a share price will go. The difficulty of making your full investment in one shot is that you could hit a high, a low or somewhere in between. You just don’t know and the difference between a poor price, a good price and an amazing price can be a matter of days. For example during the volatile summer of 2011, on 28 July SL closed at 200.90p, on 8 August it closed at 172p and 16 August it closed at 212.40p and had you bought on 27 October 2011, you’d have paid 224.40p, the highest price in six months. Over the entire 6 months, the price was only below 180p for three trading says so setting yourself up for scenario 2 would have required extraordinary insight and timing or dumb luck. You blink and you’ve missed it.

 

However, with scenario 3, the dollar / pound cost averaging approach of consistent regular buying regardless of what the share price does, you end up with a good overall price and yield without the risk of hitting a high or the impossibility and unlikely case of perfectly timing the low and actually buying while everyone else is panicking and selling. Best of all it can be set up automatically in your brokerage account so you don’t have to do anything or pay attention. This means that on 9 August when you automatically picked up £200 worth of shares for 174.10p you could have been sunning yourself of a beach rather than sweating over a keyboard as the markets plunged and investors panicked, wondering whether you should sell your holdings and run for the exits or buy more in the face of meltdown.

 

Dollar / pound cost averaging also applies to the reinvestment of dividends. When the dividend for SL is paid on 18 November, with an automatic reinvestment plan, you will effortlessly purchase shares to the value of the dividend at whatever price they are on that day, be it much higher or lower than today.

 

So what are the lessons?

 

Market timing is difficult if not impossible and requires watching share prices like a hawk and trying guess which way the market will move. This is a very active, probably obsessive, and definitely stressful investment approach and almost always fails to pick the highs and lows. The result is a strategy dictated by greed and fear rather than a cool methodical approach, with the most likely outcome that you will do exactly the wrong thing at the wrong time.

 

Dollar / pound cost averaging applies the Child Millionaire mantra of ‘strategic ignorance’. You set it up to happen automatically and then simply ignore the market and the short term direction of the share price and benefit from buying more shares when the price is low and fewer when the price is high while you get on with life.

 

What about the impact of dealing costs?

 

Using TD Waterhouse, UK as an example, you’d have paid £12.50 commission for a typical purchase in scenarios 1 and 2 along with Stamp Duty [not payable in many other countries] of 0.5% of the transaction value. With scenario 3, had you paid £12.50 per £200 transaction (£75 in total commissions plus Stamp Duty), this would be detrimental to your share holdings and future return. For small regular investments you want to avoid punitive dealing costs by making less frequent, perhaps quarterly, regular purchases or you may be able to find a brokerage account that offers a low-cost regular purchase facility. Brokers are able to do this by bundling orders and buying in bulk once a month on a predetermined day. TD Waterhouse UK has an account that does this for £1.50 per regular transaction so in scenario 3 the total dealing costs would be 6 X £1.50 = £9 for all six purchases. However, bizarrely and inexplicably [I know because I’ve asked them] this account does not allow automatic dividend reinvestment.

 

Different brokerages in different countries offer different prices for commissions, regular investments and dividend reinvestment so you will need to shop around for a broker that works best for your location and situation.

 

Set it up, automate it and relax.

 

 

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Principles of the Child Millionaire Portfolio I

Investing can seem complicated to the uninitiated, but it doesn’t have to be this way. The perception that you must read the financial press, know complex mathematics or have ‘secret’ insider knowledge is simply not true. Anyone can setup an investment portfolio for themselves or their child and grow rich. There’s no secret to it once you understand the basics. Investing really is (almost) as easy as opening a bank account and going shopping for groceries.

 

The Child Millionaire investment philosophy and methods are geared towards very long time horizons. Unlike an actively managed investment portfolio with shorter time horizons where the risk and consequences of losing money are amplified, the Child Millionaire system is designed to be:

 

  • Easy to set up and run with little or no knowledge of investment or economics, by absolutely anyone.
  • Automated as much as possible and requiring little or no active management.
  • A true robust investment system where you purchase and own real, wealth-generating assets, not a speculative bet or ‘play’ on the market. If you are looking to speculate or get rich quick then this system isn’t for you. We are looking to build real, long-term wealth for your child.
  • Not dependent on, or even concerned with, which way the market is headed.
  • Geared to very long time horizons of 20, 30, 50 or even 80 years where risk and volatility are flattened.

 

The principles of the system are also applicable to your own retirement planning if you have 20+ years to go. However, the system may not be suitable for shorter-term investment horizons such as saving for a house deposit. With shorter horizons, market volatility and risk are amplified, particularly Black Swan type events such as market crashes, which could lead to severe, if only temporary, losses of capital. As with all types of investment and any investment system, it is possible to lose money; however, I have a serious allergy to losing money so I’ve designed this system to minimize the chances of capital loss and maximize the potential for gain.