Prune Your Portfolio For Healthy Growth
My wife Carole was born and raised on a farm in South Dakota. Accordingly, she has a green thumb and she’s an avid gardener.
As Carole often says, it’s important to trim dying plant life and remove weeds to keep your garden green and healthy. The same rule applies to your portfolio.
Evergreen no more…
Managing your own portfolio can feel overwhelming and highly complex. But I like to think about financial challenges in simple terms. Whenever I assist Carole in yanking dandelions away from her tomatoes and cucumbers, I think about the time-sensitive or moribund aspects of my portfolio that need to get trimmed back.
In less volatile environments, blue-chip stocks were considered “evergreen” investments. They historically delivered consistent earnings growth and stable dividends. These assumptions have been challenged lately. Many erstwhile “Nifty 50” stocks have become long-term laggards.
The woes of General Electric (NYSE: GE), once the world’s biggest company, are emblematic.
For decades, GE was considered the bluest of the blue chips and its CEO, Jack Welch, was seen as a managerial genius. Fact is, we now know that Welch ruined GE by migrating the firm away from its industrial roots, to focus on financial legerdemain.
The following five-year price chart, comparing GE’s stock to the S&P 500 index, tells the sad story (as of market close June 8). The S&P 500 gained 71.10% during this time frame, whereas GE fell 64.10%.
While blue-chip stocks may not be the salve for longer horizon portfolios, it doesn’t mean there aren’t financial vehicles to include to help your assets grow steadily over a long period.
Highly rated bonds are usually the most stable investments. A bond promises a fixed interest payment annually, and as long as the company meets its commitment to repay the bond at its due date, you will receive your principal back.
Firms like Moody’s and Standard & Poor’s do a good job at assessing the risk of large companies issuing debt. These firms analyze each company’s cash flow to determine its ability to pay interest coupons and eventually pay off the debt. If a bond is paying an interest rate that looks too good to be true, it’s likely the market is worried about the company’s ability to pay off its debt.
Stocks with a long track record of paying dividends and a healthy stream of profits and cash flow usually have long shelf lives. These stocks don’t need to be growing earnings at a super fast rate. In fact, turbocharged earnings growth typically requires a big spending budget, which can cripple cash flow.
Further down the shelf-life timeline are high growth, more expensive stocks. They rarely pay dividends but offer the prospect of healthy capital appreciation if the stock catapults. Many tech stocks and biotech stocks fall into this category. It’s good to have a few on hand, but you’re best to sell them after a big move.
The last and least shelf-stable financial instrument for your portfolio is options. These instruments literally have an expiration date. If you buy a call option and the stock price is below your strike price on expiration date, that call will expire worthlessly. The mirror image exists for a put option; if the underlying stock is trading higher than your strike price at expiration, your option is worth zero.
Options can add quite a bit of spice to your portfolio. They are incredibly volatile and offer geometric gains if time and price move in your favor. Predicting a stock price one year out is terribly difficult and it’s nearly impossible to do so in a consistent fashion in a shorter time frame.
That doesn’t mean you shouldn’t have any options in your portfolio. If you’re interested in tapping the wealth-building power of options, one of the most skilled practitioners I know is my colleague, the legendary investor Dr. Joe Duarte.
Dr. Duarte has developed a system that pinpoints trades that make money, regardless of economic cycles or market ups and downs. In fact, his system is a veritable cash machine. Want to know his secrets? Click here now for details.
John Persinos is the editorial director of Investing Daily.