Cash Flow Portfolios

Mike S. Magreehan, CFP
December 19, 2011
Written by Mike S. Magreehan, CFP
Break out the champagne: 2011 is drawing to a close. This year’s seesaw market left many questioning their investment process. Looking in the rear-view mirror, the Japanese tsunami was a major surprise, but the United States and European debt debacles really shouldn’t have been. 

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As the steward of the world’s reserve currency, the U.S. government has been less than responsible. Just 50 years ago, the United States was a manufacturing powerhouse and the world’s largest creditor, boasting the highest standard of living built upon a productive economy and strong currency.  Since then, the U.S. has gradually raised its debt ceiling 74 consecutive times, to where it is now the most indebted nation on the planet, with a struggling economy and a recently downgraded currency.

The U.S. response to the latest recession was not uncommon. Most of the influential governments around the world acted in concert. They slashed their interest rates and created massive amounts of money in an effort to stimulate their lacklustre economies. However, they now find themselves even further in debt and still with severe economic challenges. This nonsensical approach attempts to solve a debt and easy money problem with more debt and more easy money. 

This type of government intervention has made it tough for investors to understand and take actions that make sense in an insane world.

How should investors position their portfolios in this new reality of low interest rates, low growth, high volatility and high uncertainty? Since the majority of investment decisions are based on emotion, uncertain times call for some certainty. This is the precise reason my articles of the past few years have focused squarely on the need to create a defensive
portfolio built on “cash flow.”

Portfolio progress amid insanity
Cash flow portfolios own investments that pay you for the use of your money. A properly designed portfolio should be purposefully created to generate a stream of recurring income, through some combination of interest, dependable dividends and other payments. 

Cash flow portfolios often include both companies that pay dividends and companies that grow their dividends. This is critical to portfolio outperformance. For the past 25 years, companies that paid dividends provided a 10.5 per cent annual return, while companies that consistently grew their dividends returned 12.2 per cent per year. Compare these to a non-cash-flow portfolio, which returned only 1.6 per cent. 

Why does cash flow investing work in today’s ‘new reality’?
Accelerated Wealth Building: When markets are frustratingly flat, cash-flow investments have a profound effect on improving your rate of return. When markets are rising, the cash-flow effect compounds returns.

Portfolio Protection: When markets slump, cash flow mitigates the drag on your portfolio. Although prices may retreat, you can count on regular cash flow to provide support.
Reduction of Emotional Decisions: When markets are volatile, a stream of regular cash flow will help you think twice about selling an otherwise solid investment. When share prices weaken, the income as a percentage of the share price actually increases. This fact provides a supportive floor to share prices as more buyers will rush into the investment, thereby bidding its share price back up.
Diversification: As your investments begin to generate cash, and those regular cash deposits accumulate in your portfolio throughout the year, this cash can be used to purchase new investments at prime opportunities. 
Staying on Track: When your portfolio is earning a regular paycheque, this reminds you that you are continually being paid for the use of your money.
When you purchase an income-producing investment, you are effectively buying an income stream. Dividends from good companies are predictable, and often increase over time. 
Cash flow investing is similar to owning a rental investment property. The property’s market value will increase and decrease over time, but the rental income is largely fixed. The landlord’s success is attributed to his ability to find a good-quality, long-term tenant. 

In my previous articles, I’ve recommended real estate investment trusts (REITs), utilities, preferred shares and gold (which acts as a hedge against the insanity). How have these assets fared? 
Including cash flow, Canadian REITs have returned 14.7 per cent this year, utilities 12 per cent, preferred shares 5.1 per cent, and gold an astounding 26 per cent. An equal weighting in each would have provided you with an impressive 14.4 per cent, compared to a loss of 7.4 per cent for the TSX.

Investment strategies do not have to be fancy, but they need to be well thought out and they must provide solutions in the new reality. 

As is the case with most areas in life, if you are looking to maximize your success, it is best to surround yourself with a qualified team. Not only is this true when it comes to your personal health, but it is also true when it comes to your financial health. A passionate team of financial professionals will equip you with the tools and knowledge you need to make informed decisions that enhance your portfolio returns and, ultimately, your quality of life.

Canaccord Wealth Management is a division of Canaccord Genuity Corp, member -– Canadian Investor Protection Fund. The views in this article are solely the work of the author, and not necessarily those of Canaccord.  The information herein is drawn from sources believed to be reliable as of November 4, 2011 (Canaccord Genuity, TSX, Dynamic Funds), but its accuracy and completeness is not guaranteed, nor in providing it does the author or Canaccord assume any liability.

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