Portfolio management serves two purposes; a manager or advisor needs to control risk and work to capture returns. An expert prudently diversifies the portfolio to protect against systematic risk. A good advisor will go to great lengths working to decrease the vagaries of market prices. Market volatility harms those making periodic withdrawals from their accounts. Volatility can as easily aid them, when prices move higher, but safety considerations deal with the downside risk.

Buy and Hold is not the Answer

Academic research over the last half century, as well as recent experience shows us that there may be no ultimate buy and hold strategy. The “solid names” in the stock market can as easily respond to macroeconomic factors as any other stocks. The idea that one could construct a finite portfolio that would last into perpetuity dates from the beginning of the last century, before expertise in portfolio management and asset allocation began.

Earnings power is the second half of portfolio management. Anyone can get some information, like earnings per share number or price to earnings ratio. Not everyone can properly evaluate more esoteric issues like retained earnings and diluted earnings per share. In order to properly evaluate the purchase of a company, these details should be examined for every individual even when the individual must delegate the task.

Dividends May not be a Key to Value

Dividends, a cash back form of earnings may or may not provide more value than stocks which do not pay them. In the early 20th century, transaction prices for any stock trade often represented 6% of the total transaction in trading and spread costs. Someone who wanted retirement income or income for pensioners could avoid those costs if he could find a stock that turned out cash dividends. The income requirement for the portfolio might be had in its entirety or at least augmented by income that was transaction cost free.

Even today, some investors chase high dividend stock issues like Canadian Investment Trusts or try to find the highest interest rate with New Zealand Bonds both of which purport to deliver up to 13% in cash dividends. While investments such as these cannot be categorically denied, the Prudent investor will asses the inherent risk of the return stream before purchasing any. Further, a portfolio with proper asset allocation will have a relatively lower number of such issues compared to the total portfolio value.

Part of the reason that Dividend Reinvestment Programs (DRIPS) have waxed and waned in popularity is the transaction free nature of the reinvestment. Few investors in these programs have a large enough portfolio to properly diversify against the risks they invariably take by over-weighting only dividend reinvestable stocks in order to participate in the program.