A Little Planning Goes a Long Way

05/27/2013 10:00 am EST

Focus: MARKETS

Kelley Wright

Managing Editor, Investment Quality Trends

Successful investors know that a long-term plan is key to providing a steady flow of capital, says Kelley Wright of Investment Quality Trends.

In order to be a successful investor, you need to understand why you are investing in the first place.

The knee-jerk answer is the desire to have more money. Money—cash, to be specific—is how we fulfill our needs. A need is anything that makes you feel safe and secure: Food; clothing; shelter; transportation; education; recreation, etc.

For the most part, our cash needs are met by a paycheck, until of course you no longer have one. At that point, you will need a pool of capital and a stream of income from that capital to meet your cash needs. This is why we invest; to build capital and income to meet or augment current and/or future cash needs.

So if investing is about building capital and income, your sole objective is to realize a return on investment. Now, there are many ways to pursue a return on investment.

As you well know, our preferred way is through the shares of very high-quality companies with long histories of dividend payments and dividend increases. Why is that? Because dividends represent the most basic and fundamental measure of return on investment—cash on the barrel head.

Besides high quality and a long history of dividend payments and dividend increases, what is ultimately of most importance is that the shares be purchased when they offer good value. Good value—by our definition—is a repetitive area of high dividend yield, where past price declines have halted and the stock stabilizes, then reverses course and begins to move higher.

The primary reason buying at good value is so important is that there is a greater probability for capital preservation and price appreciation at the repetitive area of high dividend yield than there is for further price depreciation. Put another way, when you buy shares at the repetitive high yield area, your risk is much lower and your odds for long-term success are much higher.

Your odds for success are even greater when you purchase shares that offer good value when the broad market also offers good value. Unfortunately, those opportunities are few and far between.

However, we have observed that many of our Select Blue Chips perform well even when the broad market has not. This is one of the many benefits of value investing.

I would be remiss if I did not mention that based on our long-used measures of value, the broad market is by no means a screaming buy. Nonetheless, there are still excellent companies that offer good value in the Undervalue area.

In the event of a correction or a major sell-off, however, it would be unreasonable to assume that these stocks would be unaffected. What we know from experience, though, is that these stocks tend to recover quickly once the selling has abated.

This is why it is important to understand your investment time horizon, meaning you need to know when you will need to tap into your capital to meet your cash needs.

As you well know, the markets can experience periods of significant volatility for an extended period of time. Think of the number of years it took the broad market to recover from the last two major declines in 2000 and 2008-2009. For this reason, we recommend that investors who purchase shares of stock should have, at minimum, a five-year time horizon. Ten years or more is even better.

Successful investing requires thoughtful planning—having an idea of how much capital you will need, what you will need it for, and when you will need it.

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