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Investment Strategy for 2014

2013 Proved That No One Has Crystal Ball

Despite major headwinds (like the Government shutdown, the fiscal cliff and fears of Fed tapering), the stock market was very kind to faithful investors in 2013. The S&P 500, which finished the year up almost 30%, notched its best annual return since 1997. The tech-heavy Nasdaq and small-cap focused Russell 2000 fared even better, gaining 35% and 37%, respectively. Many investors (ourselves included) cautiously prepared for a market pullback as the year came to a close…but the correction never came.

2013 certainly reminded investors (albeit in a friendly way) that no one has a crystal ball when it comes to the market and that there is no substitute for a solid investment plan. The bulls and the bears come to play every year and our good friends “fear” and “greed” will get the best of us if we let them. If you don’t have an investment plan for 2014, we highly recommend that you make it your New Year’s resolution to establish one!

Is a Correction Coming In 2014?

Most folks define a correction as a stock market decline of 10% or more and we haven’t seen one in quite awhile. In fact, it has now been ~565 market days (~2.25 years) since the last 10% pullback. Historically, market corrections happen approximately every 2 years on average, but the million dollar question is…will we finally see one in 2014?

Even though the correction bandwagon seems to get louder every day, there have been much larger correction droughts historically. Since 1928, there have been 5 periods with correction gaps that were longer than the one that we are currently in. The record drought was 1,767 market days (from October 1990 to October 1997) and the second largest drought was 1,153 days (from March 2003 to October 2007), both of which occurred in the last 25 years. Basically, this tells us that a market correction won’t necessarily be a self-fulfilling prophecy and that we shouldn’t be surprised if stocks continues to chug along in 2014.

But what about current valuations? The S&P 500 is currently trading at almost 20 times trailing earnings (vs. an average multiple of 15.5x since 1871)! Again, history is littered with examples where above average P/E multiples were sustained for prolonged periods of time. In fact, during the last bull run (2003-2007), stocks spent more than a year trading north of 20 times earnings.

Bottom line is that none of us know when (or if) a correction will occur in 2014 and the best we can do is stick to our investment plan (do we sound like a broken record yet?).

Dividends Are Still The Only Constant In Investing

In our opinion, dividends are the only constant in investing. Statistics have proven that asset allocation accounts for over 90% of long-term term portfolio returns and we believe that dividend stocks should be the foundation upon which your investment portfolio is built. In the current low interest rate environment, stocks are really our only hope of generating a reasonable return on our capital and dividends have accounted for the bulk of stock market returns over the past 15-20 years. This is why we recommend that investors (especially income investors) consider allocating 60-80% of their investment portfolio in dividend paying stocks. A diversified pool of dividend stocks will give you the equity exposure you need to generate a reasonable long-term portfolio return and you receive current income (i.e., dividend checks) while you wait for the long-term price appreciation.

DIY Dividend Investment Plan for 2014

As you know, the goal of our dividend research is to help fellow DIY investors carry out (and stick to) their investment plans. While our research will certainly help you identify the best dividend stocks as well as low risk entry points for those stocks, another key ingredient to long-term success is portfolio diversification (using proper asset allocation targets and concentration limits). Although the details of each Member’s allocation plan will vary based on age, risk tolerance, income need, etc., our research is also geared to help you maintain your allocation targets as well (by helping you identify specific stocks that will meet your criteria).

All that said, the start of a new year is the perfect time to examine your portfolio and reallocate if necessary (or set up an allocation plan if you don’t already have one). We recommend that investors consider allocating capital to the main asset classes below:

  • U.S. Dividend Stocks (60-80% of total portfolio)
  • Foreign Stocks (0-10%)
  • Bonds (0-10%)
  • Commodities (0-10%)
  • Cash (0-20%)

Within your Dividend Portfolio, we recommend investing in a diversified pool of 20-25 stocks and adhering to the following concentration limits:

  • Maximum stock concentration (5.0% of total dividend portfolio)
  • Maximum industry concentration (20% of total dividend portfolio)
  • Maximum high-yield concentration (20% of total dividend portfolio)

In addition, we recommend monitoring the ex-dividend dates of your dividend portfolio to help diversify your income stream by month or by quarter.

It should be noted that the non-dividend assets classes above are recommended to dampen overall portfolio volatility as these asset classes tend to exhibit low correlation to U.S. dividend stocks. For simplicity, we recommend that investors use ETFs for these asset classes:

  • Foreign Stocks (VEU, VWO, or EFA)
  • Bonds (BND or AGG)
  • Commodities (DBC and GLD)

Your “cash” position should be used for tactical risk management purposes. Raising cash during times of uncertainty (or selectively taking profits on some of your winners) is prudent portfolio management. In addition, excess cash can be used to smooth out monthly income distributions while you are waiting for dividend checks to be paid.

Research Initiatives for 2014

We appreciate each and every Premium Member and we take your feedback seriously. At the end of the day, we want to provide as much value as possible for you through our research. That said, we are making some changes to our various research reports in 2014 based on member feedback that we received last year.

  • Monthly Parsimony Ratings & Newsletter – Starting in 2014, in lieu of the monthly newsletter (which was essentially just a snapshot of various portions of the ratings spreadsheet) we will supplement our monthly Parsimony Ratings spreadsheet with expanded versions of our Parsimony 50 list (highest-rated stocks yielding over 2.5%) and our “Dividends in the Rough” list (which is a new screen made up of stocks that have a relatively low overall rating, but warrant consideration for other reasons). In addition, by the end of Q1, we plan to roll out supplemental ratings for MLPs and REITs (as these stocks have various industry specific metrics that are not always comparable to standard industry metrics).
  • Buy Zone Reports – We will continue to expand our Buy Zone Universe in 2014 and we will work diligently to make sure that all reports are updated at least once per quarter. Please don’t hesitate to reach out to us with Buy Zone report requests.
  • Idea Zone & Watch Lists  – We are expanding our Idea Zone screens in 2014 to include screens for: 1) stocks by sector, 2) high-yield stocks (yield > 6%), and 3) low-yield growth stocks (yield< 2% w/ high growth history). In addition, we will make these tables available in excel format as well.
  • Model Portfolio & Commentary – We will be launching a new model portfolio next week that will include some of the non-dividend asset classes highlighted above. Our weekly commentary will resume once the new model portfolio is rolled out.

Please don’t hesitate to reach out to us if you have any additional suggestions/feedback. We’ll continue to do our best to alter our research around the needs of the Parsimony Community.

Kind Regards,

The Parsimony Research Team

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