Achieving Investing Efficiencies
David is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
In today's increasingly complex financial arena, it's important to stress certain fundamental investing principles. Among these, first and foremost simplicity is often best. Moreover, we'll examine some strategies that support this concept and are suitable for comfortable, worry-free long-term investing. In brief, there are specific axioms which each successful investor should utilize, sometimes with some variation, to excel in often turbulent markets.
So, let's examine a few. First, don't sell. By investing and holding quality companies, long-term investors avoid both capital gains taxes as well as often stiff brokerage commissions/fees. Another advantage of the "buy and hold" strategy is it avoids often complicated paperwork inherent to active trading. As mentioned earlier, investors should aim to buy quality companies, preferably at a discount. By doing so, they lessen the probability their portfolio will experience some form of financial collapse or experience significant loses based on the failure of a single enterprise. However, nothing is a sure thing. At one time Eastman Kodak was a stellar company, once considered a "blue chip," producing traditional photography products such as film, cameras, and ink cartridges. However, the corporation did not successfully transition and market itself to emerging digital imaging technologies, reported only one profitable full year of profit since 2004, and has now filed for Chapter 11 bankruptcy--thereby rendering it obsolete
Second, investors should reinvest their dividends. By doing so, fees are usually minimal and avoid often costly commissions in the process. Also, although investors are taxed on reinvested dividends, since the tax is amortized over time, this somewhat softens the blow of an otherwise large tax bill. In my experience, the overall tax burden produced by incremental dividend reinvestment is very little, so investors should embrace this long-term investment technique. Also, if you want to get very particular regarding the ROI of dividend reinvestment, it avoids chasing down a plethora of loose dividend checks (perhaps 12-15) for a roughly medium-sized focus-based portfolio, by all estimation, a lot of work. Each check is dated differently, usually requiring separate trips to the bank (unless an investor sets up direct deposit) and the entire process is very inefficient in time, effort, and overall transportation expense.
Another advantage of quarterly dividend reinvestment is the effect of dollar-cost averaging (DCA). Over time, DCA can produce handsome returns. Next, investors should avoid investing in American Depository Receipts (ADR's). Typically with an ADR there is a small bookkeeping fee from the depository bank issued on the total stock owned . Therefore, it's typically more expensive to invest in foreign companies, although these fees are usually minimal. Also, another disadvantage of investing in foreign companies, is most of them, possess foreign withhold dividend taxes separate from the ones owed to Uncle Sam. Obviously, this process can get expensive depending on the country and its U.S. tax treaty.
For example, Ericsson (NASDAQ: ERIC), a Swedish telecommunications company, is a prime example of a highly inefficient stock. Sweden taxes dividends at a 30% rate. In addition, although once a promising emerging technology, Ericsson currently manages to squeak out only 2.5% margins. Therefore, due to ERIC's lack overall lack of profitability and financial inefficiencies (i.e. high foreign dividend withholding rates), the stock should be avoided by long-term passive investors. However, in terms of passive income, many countries (e.g. Canada, the Netherlands) tax dividends at half that while others (e.g. UK, Argentina) don't withhold any taxes for U.S. investors. So again, although dividend specifics vary, passive / efficient investors need to keep (the above-mentioned) factors in mind.
Yet, other investors, beginning a retirement portfolio (assuming it's not in an IRA), could wisely select index-based funds, where trading (and therefore taxes) are low and fees minimal. Similarly, exchange traded funds (ETF's) such as the Vanguard Total Stock Market ETF (NYSEMKT: VTI), boast little (if any) taxes and minimal fees, a 0.05% overall expensive ratio, and because the ETF is based on an index (i.e. the total stock market), trading is kept to a minimum, thus drastically reducing capital gains taxes. Altogether, this makes VTI (and similar ETF's) even more efficient, cost-effective long-term investments. Whereas, investors should generally avoid actively-managed funds, they won't often beat the market, and could cost you a bundle. Even if an actively-managed fund exists in an IRA, investors are still on the hook for return-eating (higher) fees.
These are just a few possibilities! There are even more investment options. While, no investment is a sure thing, each one has its advantages and disadvantages and must be carefully weighed prior and during investment. But some stocks (and funds) are a lot better quality than others. By examining each opportunity carefully, and by adopting a long-term passive investment approach you'll go a long way toward improving your investing skills and learning how to separate out the most attractive investments, efficient or otherwise, from the rest.
dmercer1 has no position in any stocks mentioned.This article is to be used for educational, research and informational purposes only and does not constitute investment advice. There are no guarantees, expressed or implied, of future positive returns in regards to the subject matter contained herein. Understand the risks inherent in investing before making the decision to invest or consult an investment professional for more information. Reasonable due diligence has been performed in regards to the information in this article. However, the author expressly disclaims any liability for accidental omissions of information or errors in fact.