There have been countless reports on the so-called “fiscal cliff” by media outlets from around the country. This has resulted in many questions for the country regarding the future of the economy. Investors have paid especially close attention, as the ramifications of the activities in Washington could potentially affect bottom lines.
For the most part, these reports have been dramatized as a way to cause a panic in the public to boost viewership ratings. Nonetheless, the uncertainty is out there and investors want guidance on how to invest in the new year.
No matter what year it is, no matter the socioeconomic and political climate, there are always hurdles for investors to see the greatest return on investment possible. The smart investors will be able to navigate the given obstacles to end up with positive wealth over the long term. Though certain economic situations can affect short-term gains, the goal for an investor is to see wealth grow over the long-term regardless of “fiscal cliffs” or whatever media spin wants to portray to the public. Here is what you really need to know about investing in 2013, specifically with the goals of generating dividend income and long term wealth in mind.
The Tax Questions
Because of the “fiscal cliff,” there are a lot of questions about the potential hike in tax rates starting on January 1. In all likelihood, federal income tax rates will rise, especially for those in the highest tax brackets. On top of that, the tax rate on dividends might change from the current status of the 15% capital gains tax rate for qualified payouts, to the equivalent to an individual or household’s income tax rate (it’s possible this change could also only affect the highest tax bracket). Even though tax hikes are probably imminent, many investors do not have to worry about that possibility; it all depends on the income situation for certain individuals. The tax rate increases are especially a limited issue for those investors who have holdings in tax deferred retirement accounts.
The increase in tax rates might make it seem that dividend investing might not be the safe-haven investing strategy that it has been in the recent financial downturn (and throughout history in general). However, many analysts point out that prior to the 2003 “Bush-era tax cuts,” dividends were taxed at a higher rate than the capital gains rate. This did not prevent dividend stocks from appreciating or continuing dividend payouts at attractive yields. From 1979 to 2002, right before the current dividend and capital-gains tax rates took effect, dividend stocks still outperformed non-dividend paying stocks, gaining +14.4% annually compared to +11.3%. Clearly, investors needn’t worry that an increase in dividend taxes would hinder the performance of dividend stocks.
Also, in today’s ultra-low interest rate climate, dividend stocks still yield far more than other income-centric products like bonds, savings accounts, or CDs. Consider that the S&P 500 Index yields 2.25% in dividends compared to a 10 year Treasury note paying 1.59% in interest. Not only is an investor seeing the possibility for higher income yields from dividend stocks compared to other investment opportunities, but there is the more than likely possibility of the dividend paying stocks seeing capital appreciation over time. An investor needs to realize that smart dividend stock investing will minimize risk while equating in the best reward compared to other investment vehicles.
An increase in taxes is not the greatest news for investors, but it does not mean its the end of the dividend world either. Dividend investing has been, is, and will probably always be, a steady source of investing no matter what the economic climate is like; that is an important takeaway as the calendar moves towards the new year.
When it comes to investing it is all about making the right choices. It is easy to get caught up with what the short-attention span investing strategies seen on TV or online. However, the goal is not to make out good on short term trades; it is to put money into companies that will grow steadily over time and realize substantial income through dividends.
An investor should put money only into areas that they are comfortable with and understand. Right now, investing in markets abroad is probably not the greatest strategy as there is a lot of turmoil all over the world. It is better to focus on investing in the domestic markets where information is more readily available to make smart decisions.
Also, focus on investing in companies that pay dividends at a yield between 3% and 7%. These potential returns are the best opportunity for a good amount of dividend income throughout the year and beyond. However, while dividend yield is a good statistic to analyze when deciding what stocks to own, be sure to pay attention to other metrics like dividend payout ratio to make sure a company is healthy enough to be paying out the dividends.
Investors should be picky about what stocks they own. They should not just jump into any company in any sector in any market without doing the homework necessary to make smart decisions. There are many factors that can make or break investing strategies depending on the level of analysis by an investor. In 2013 and beyond, make sure the right decisions are made to increase wealth into the future.
Just Say No to Overhyped IPOs
An investor can weather the uncertain market climate if smart decisions are made in certain areas. Staying away from popular initial public offerings is probably a smart move for an investor, no matter the economic climate. Late 2011 and 2012 saw a number of big name IPOs that ended up being disasters for investors who tried to get in the game early.
The Facebook (FB) IPO is a good example of an initial offering gone wrong. The stock started out trading at $38 on May 17, 2012. Since that date the stock has had a much publicized fall, plunging -39.45% from its IPO price as of November 16. Investors who initially bought into the company early now see their holdings fall substantially. This does not mean that the stock will rally in the future and be a strong investment; it just shows that jumping into an IPO early could spell disaster for investments in the short-term, and potentially long term.
Internet companies Groupon (GRPN), Zynga (ZNGA), and Pandora Media (P) are some more examples of other IPO disasters since 2011. The firms have depreciated -89.66%, -76.33%, and -45.6%, respectively, since their initial offerings. These firms all had high expectations going into their entry into the stock markets, but it shows that poor financials will bring down the value of a company no matter what the media portrays. It is better for an investor to stay away from these high publicized IPOs until the true strength of a company shines through over time.
These four examples show the negatives of IPOs in recent history, but that does not mean that all IPOs are disasters. The take away here is that there is a lot of turmoil in initial public offerings that investors need to be aware of when making smart investment decisions. Looking forward, investors should be aware that putting money into these areas is not always the safest bet.
Forget “Value” Stocks
For some investors, it seems that buying low or cheap is the best way to get in the market, as they view that the stocks can only go up. “Buy low, sell high” is the popular phrase that these investors look at in their strategy. However, this point of view does not take into consideration the factors that have pushed the prices of these cheap stocks to these low levels in the first place.
Investors should focus on the strength of a company rather than the actual price. The S&P is up roughly +10% in 2012; investors do not want to miss out on the gains made by market stalwarts because they were searching for “value” stocks at cheap prices. Value investing does not mean that only cheap stocks need to be bought; it focuses on the overall strength of the company in relation to the price. Cheap stocks are cheap for a reason — no one wants them. The bargain bin is no place for a serious investor, so buy strength, not weakness.
The Bottom Line
Looking forward to the new year, investors should keep in mind that the strategy of buying high quality dividend stocks with nice yields (think 3% to 7%) has worked for decades and will continue to do so in 2013. Investors should stay disciplined and keep on track with smart investment decisions. It can be easy to be distracted by media noise that causes second guessing of investments in the future. Just remember that whether its the “fiscal cliff,” the hottest IPO, or whatever sensational story the business media portrays, it is being fed to the public for ratings. By keeping with the sound investing fundamentals and the recommendations above, investors will continue to see positive returns in 2013 and onward.
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