Weekend reading: Some reads for when the sun goes down

Weekend reading logo

Our articles from this week, plus whatever else caught my eye.

From Monevator

We’ve another freshly laundered broker comparison table for you – Monevator

Lars Kroijer makes the case for DIY financial modelling – Monevator

Out of the archive-ator: How to work out which platform is cheapest for you – Monevator


Note: Some links are Google search results – in PC/desktop view these enable you to click through to read the piece without being a paid subscriber.1

The stock market is up, but a lot of high-end goods and assets are lower – Bloomberg

The great London property squeeze [Long read]Guardian

Morgan Stanley predicts only a handful of robo-advisor start-ups will survive – Business Insider

Most people will have to work until 70, says the World Economic Forum – Guardian

Proof! CEOs hurt companies by playing too much golf – CNBC

Evil EU bans rip-off mobile roaming charges, but will deal survive Brexit? – Guardian

Goldman Sachs research finds ‘factor investing’ is trending – Joe Weisenthal on Twitter

Products and services

Zopa will offer ISAs from next month, but it’s set to scrap its Safeguard protection – Telegraph

Bitcoin is up 180% in 2017; £1.38 of Bitcoin in 2010 is now worth a million – ThisIsMoney

The best value SIM-only smartphone deals – ThisIsMoney

Religious ETFs are coming to the bond market – Bloomberg

Vanguard LifeStrategy 60: Two-year update – DIY Investor (UK)

Crunching the numbers on Vanguard’s new direct platform – ThisIsMoney

The People’s Investment Trust has picked its five active asset managers – Telegraph

Comment and opinion

Good investing is easier and cheaper than ever, but are lower returns the cost? – Of Dollars and Data

The West’s wealthy Millennials are right to scrounge off mum and dad – Financial Samurai

A backlash-let: Vanguard’s ‘irritating’ perch on the moral high ground – Bloomberg

Martin Lewis: The hidden thousands parents pay for university living expenses [Search result]FT

Alternative asset allocation in retirement – Wade Pfau

If you want to invest virtuously, you’ll have to accept lower returns – AQR

Curious idea: ‘Mononational ETFs’, to enable stricter geographic diversification – Abnormal Returns

The burden of wealth (or winning the lottery…) – The FIREStarter

Is efficient market theory becoming more efficient? – The Economist

How can we buy the freehold of our flats? [Search result] FT

Beware the pseudo-quants – The Mathematical Investor

How investors are using Smart Beta funds – ETF.com

Market predictions are a fool’s errand… – Investing Caffeine

…and beware charts that tell you what will happen next – The Value Perspective

A handful of barriers to entry are still left in the markets – A Wealth of Common Sense

High-conviction and new money purchases from the ‘ultimate’ stockpickers – Morningstar

How giant pension funds and other investors are looking for an edge – Institutional Investor

Off our beat

It’s never too early to fire someone – Lars Dalgaard

You never have time, only intentions – Raptitude

Deep trouble: How to improve the health of the ocean – The Economist

Older Americans are more Millennial than Millennials – The Atlantic

And finally

“Turning humans into space colonizers is Elon Musk’s stated life purpose. ‘I would like to think that humanity has a bright future,’ Musk said. ‘If we can solve sustainable energy and be on our way to becoming a multi-planetary species with a self-sustaining civilization on another planet – to cope with a worst-case happening and extinguishing human consciousness – then,’ and here he paused for a moment, ‘I think that would be really good.’

“If some of the things Musk says and does sound absurd, that’s because on one level they very much are. On this occasion, for instance, Musk’s assistant had just handed him some cookies-and-cream ice cream with sprinkles on top, and then he talked earnestly about saving humanity while a blotch of the dessert hung from his lower lip.”
– Ashlee Vance, Elon Musk

Like these links? Subscribe to get them every Friday!

  1. Note some articles can only be accessed through the search results if you’re using PC/desktop view (from mobile/tablet view they bring up the firewall/subscription page). To circumvent, switch your mobile browser to use the desktop view. On Chrome for Android: press the menu button followed by “Request Desktop Site”.

from Monevator http://monevator.com/weekend-reading-some-reads-for-when-the-sun-goes-down/

Why you should build your own financial spreadsheet

Why you should build your own financial spreadsheet post image

This article on building a financial spreadsheet is by former hedge fund manager Lars Kroijer, an occasional contributor to Monevator. He also wrote Investing Demystified.

We’re living in a world where financial advice is omnipresent online. All kinds of calculators and portfolio management systems are easy to find and free to use.

You might wonder then why you should bother to do any maths or projections of your own. Something on the Internet can take care of all that, right?

I have a different perspective. I fear it’s now so easy to avoid doing any real work on our financial planning that many of us have lost – or never gained – a real understanding of how and why all the numbers fit together.

People may intuitively understand that they need to put money aside over the long run in order to benefit from the power of compounding. But finding out how much and for how long? It’s a mystery that they use websites, software and apps, or financial advisors to solve.

That’s a shame, because building this kind of financial modelling spreadsheet is pretty simple if you know how. And by demystifying the financial modelling, you’ll get a much better handle on your own circumstances.

The answer to all some of your questions

Appreciating that anybody who has not spent decades in finance may find the task daunting, I decided to build a DIY financial model spreadsheet from a completely blank slate.

To get started, I assume you are a 23-year old who is putting money together for retirement at age 67. I then built the first version of the spreadsheet to start answering some interesting questions.

For example, how much will you end up with if you put aside £1,000 a year in equities? What about £2,000? What if equities compound not at 3%, but at 6%? What if you don’t want to put it all in equities, but choose to diversify some of your money into a lower risk asset? How would that impact your expected outcome?

These may all be random sounding numbers. But the point is you can easily change them to reflect your own questions by simply entering a new number in the model once you’re up and running.

You can also keep adding complexity to your model. And by working through the spreadsheet as you do so, you will naturally be asking a lot of the right questions.

Say we want to understand how the risk of the equity markets will impact the range of outcomes that we can expect from a long-term exposure to shares. That’s a very fair thing to ask, without an easy answer! Doing so involves questioning what standard deviation to use – and if you can even use the standard deviation, fat tails, and so on.

There are often no simple answers, but you will typically be better off having thought through these issues rather than ignoring them.

What should you include in your spreadsheet?

If you ignore my offer to build a spreadsheet along with me on my YouTube channel and instead decide to build your own alone, please at least include the following:

  • What is the annual contribution / use of capital?
  • What are you invested in?
  • What is the expected compound annual return (CAGR).
  • What is the average annual return? (And do you understand the difference?)
  • What is the risk of the returns? How do you best model that? (The standard deviation is a good start, but it has some issues.)
  • Incorporate inflation (or perhaps make returns ‘real’, which is to say inflation-adjusted).
  • You can also include fees, transaction costs, and potentially taxes.

Understand the challenge of adding many asset classes. Doing so introduces correlation between all the different asset classes, which is hard to predict and constantly changing, sometimes as a result of market changes.

Thinking through these issues will lead to you appreciating some of the biggest challenges in predicting portfolio return ranges (and in trying to model events like the banking crisis, if you’re feeling ambitious).

Simpler than it looks

Please don’t be overwhelmed. If you build your spreadsheet slowly and methodically you might be surprised by what a flexible and useful tool you can create.

And at the end of the day, I think there is a big advantage to appreciating how simple a lot of the financial software packages you might otherwise use really are.

When you are done building your spreadsheet, I believe you’ll understand much more about your risk and what you can expect in the future than you would by studying the outputs page from an online broker, or a summary sheet from a financial planner.

That knowledge should serve you well.

Video on building your own financial spreadsheet

Below is the first video in a series that should help you get started with building your own model spreadsheet. You will also find other relevant videos on my YouTube channel.

As ever with my Monevator articles, I’d really like to hear your views. Please comment below on what you’d like to see me add to the model or explain better. I’d like to try to make the model as accessible and useful as possible. Your feedback here would be very helpful!

Lars Kroijer’s book Investing Demystified is available from Amazon. He is donating any money earned to medical research. He also wrote Confessions of a Hedge Fund Manager.

from Monevator http://monevator.com/why-you-should-build-your-own-financial-spreadsheet/

Comments temporarily not working

Comments temporarily not working post image

Hi everyone, thanks for all the comments and emails – and the letters in bottles that I expect to find in 5-10 years – letting us know that comments aren’t working.

We’re now aware, and should have a fix by the end of today.

Apologies for the kerfuffle!

The Management

p.s. I will delete this post when comments are working again!

from Monevator http://monevator.com/comments-temporarily-not-working/

Weekend reading: Millennials toasted

Weekend reading: Millennials toasted post image

What caught my eye this week.

I have a soft spot for Baby Boomers who appreciate that the younger generation really does have it much harder than they did, financially speaking.

Boomers like Jim, who writes on his blog SexHealthMoneyDeath that:

…if I was a youth today, I’d be damn angry about it. Especially if I read blogs like mine where Baby Boomers in their fifties ponder early retirement and the most tax efficient ways to drawdown their pensions while wondering if they can be bothered taking two long haul holidays a year?

A Baby Boomer, that is, like me who was given a fantastic free education, who took out a mortgage as soon as he started working (required deposit, fifteen hundred quid and a 95% loan) and sat back to watch property rocket over his working lifetime.

Nice work, if you can get it. Which you no longer can.

But while there’s a little bit more inter-generational understanding these days – at least in terms of words, if not actions – Millennials are still regularly hearing guff like the reason they can’t buy a house is because they eat too much smashed avocado on toast. Seriously.

The LA Times notes that the Australian millionaire who doled out that advice actually started his own business with a $34,000 handout from his grandfather.

Good on him for making a success of it, but equally $34,000 buys a lot of avocado on toast – even at the $19 a pop he seems to find it selling for.

At least the youth have Buzzfeed, which collected a super set of Tweets to cheer them up, such as:


From Monevator

Vanguard goes direct to UK consumers [Read the comments, too]Monevator

Out of the archive-ator: Coping with the guilt of losing money – Monevator


Note: Some links are Google search results – in PC/desktop view these enable you to click through to read the piece without being a paid subscriber.1

Bye Bye buy-to-let? Amount lent to UK landlords falls 80% in a year – ThisIsMoney

Rich US retirees are hoarding cash out of fear – Bloomberg

What the election promises mean for your money [Not a search result, something is going wrong with it]FT

£1 tops $1.30 for the first time in eight months – Telegraph

One good thing to come from our imminent one-party state: Tories to downgrade triple-lock pension to a double-lock, since their base is hardly going to switch to a ’70s-styled Labour – ThisIsMoney

Cautious fund manager Neil Woodford spends £200m on Lloyds shares – ThisIsMoney

US company profits have moved to a higher plateau, killing mean reversion strategies – Morningstar

Products and services

Kingdom Bank – established to fund church expansion – now offers the top cash ISA rate, paying 1.2%. Yes, it’s covered by the FSCS. The answer to your prayers, etc? – Telegraph

Meanwhile a new one-year ‘bond’ from Charter Savings Bank pays 1.55% a year interest (but that’ll still lag inflation) – ThisIsMoney

Ford has launched a new regular savings account paying 4% (with the usual restrictions and caveats) as well as some new cash ISA options – Telegraph

Lloyds and Metro bank are bringing back safes and safety deposit boxes – ThisIsMoney

Not only will you get £10 off your first Thriva blood test kit with the following link, you can use the code ITSMAY at checkout to get a further 50% deduction – Thriva

Comment and opinion

Swedroe: It’s so hard to tell investing skill from luck, you may as well presume there’s no skill – ETF.com

The Snapchat IPO has been a good lesson for young investors – A Wealth of Common Sense

Try to be a little underemployed, says Morgan Housel – Collaborative Funds

How to plan for a future stock market crash [Search result]FT

“A study of consultants by a professor at Boston University found that managers could not tell the difference between employees who worked 80 hours a week and those who just pretended to.”Guardian

Dealing with the ‘unknown unknowns’ of investing – Of Dollars and Data

Doomsters be damned: The US stock market tripled because profits tripled – Investing Caffeine

Profit opportunities exist only until researchers publish inefficiencies – Bloomberg

American Gods: The tech firms the market trusts to trump Trump – Reformed Broker

Michael Mauboussin sits down with Patrick O’Shaughnessy [Podcast]Investor’s Field Guide

Regulation is turning the sell-side business model into an honesty box – Bloomberg

Why VC-funded start-ups – especially ‘Unicorns’ – are often overvalued [Research]SSRN

When Norway struck oil in the 1960s, one savvy investor bet different – The Macro Tourist

Off our beat

Today’s big tech companies might be even bigger than you think – The Atlantic

Want higher-quality Internet content? Maybe we should pay for it – Wired

And finally

“Skyrocketing markets that depend purely on psychic support have invariably succumbed the financial law of gravitation. Unsustainable prices may persist for years, but eventually they reverse themselves. Such reversals come with the suddenness of an earthquake; and the bigger the binge, the greater the resulting hangover.”
– Burton Malkiel, A Random Walk Down Wall Street

Like these links? Subscribe to get them every Friday!

  1. Note some articles can only be accessed through the search results if you’re using PC/desktop view (from mobile/tablet view they bring up the firewall/subscription page). To circumvent, switch your mobile browser to use the desktop view. On Chrome for Android: press the menu button followed by “Request Desktop Site”.

from Monevator http://monevator.com/weekend-reading-millennials-toasted/

Vanguard enables UK investors to invest directly in its funds

Vanguard enables UK investors to invest directly in its funds post image

Should you see a worker in the financial services sector kicking a wall today, or muttering slowly whilst tearing up a newspaper, or taking off their shoes and walking into the sea, Reggie Perrin style, then spare a thought (and perhaps a few coppers) for the poor dabs.

Because fund giant Vanguard – famed for its cheap trackers and its all-in-one LifeStrategy products – is now enabling UK investors to invest in its own funds directly.

This means we can now put money into its funds without having to use a third-party platform such as Hargreaves Lansdown.

And with Hargreaves’ shares having fallen as much as 5% on the news, City traders seem to believe Vanguard’s launch will spark a renewed price war.

Which is nice – for us investors, anyway. Not so good for rivals.

  • Vanguard says it will levy an annual fee of 0.15% on up to £250,000 invested with it.
  • There will be no account fee on the excess above £250,000.
  • The platform fee is thus capped at £375 a year for even the largest portfolios.
  • The minimum lump sum investment is £500. Monthly savings start at £100 a month.
  • There are no initial or dealing charges, and no cost levied by Vanguard for transfers in.

Vanguard’s 0.15% platform fee will levied be on top of the ongoing charges that you pay for whatever Vanguard funds you own.

For example, if you opened your Vanguard account by investing £20,000 into its 60% LifeStrategy fund, you’ll pay:

Fund charge of 0.22% x £20,000 = £44

Account fee of 0.15% x £20,000 = £30

Total annual fee = £74

Some Vanguard funds boast even lower fees. For instance, its FTSE 100 Index Unit Trust charges just 0.06%. So £20,000 invested into that fund on the Vanguard platform would cost a total annual levy of 0.21%, or £42 a year.

Vanguard is currently offering ISAs and non-ISA accounts, but no SIPP. It plans to add a SIPP option to the platform “within the next year”.

The new Vanguard site has the website address www.vanguardinvestor.co.uk. (Vanguard says it will eventually retire its existing UK website).

The FAQ is pretty comprehensive, if you have any particular questions.

The Vanguard platform looks hard-to-beat cheap

Vanguard is not the first fund provider to enable us to invest directly into its funds without using a platform.

For instance, I’ve held a small proportion of my portfolio directly in Legal & General tracker funds for many years. (And no, it’s not cheapest! Even us investment bloggers have our foibles. Besides, I favour platform diversification).

But Vanguard’s offering is more transparent (and cheaper) than Legal & General’s, as fans of the US group would expect.

With Legal & General you pay much higher ongoing charges than some competitor trackers, but there’s no platform fee. In contrast, Vanguard is explicitly breaking out the platform fee. This enables you to compare costs more directly.

The big question then: How do those costs compare with the others you’ll find in our comparison table?

Well, I’m not the Monevator expert on platform charges. Also, anyone who has tried to navigate the nightmare of comparing one particular portfolio invested on a particular platform with another platform knows there can be more quirks, hidden corners, and labyrinthine passages than you’d find in a medieval city.

Caveats and costs lurk around every corner!

That said, I believe Vanguard’s new offer looks pretty darn compelling.

For those wanting to hold Vanguard funds it looks substantially cheaper to do directly via its new investment platform than via a percentage-fee charging rival.

For fixed-fee brokers, it could still be cheaper to go with one of the alternatives if you have a large portfolio. You’ll have to run your own numbers.

But for small portfolios of Vanguard funds, going direct again looks cheapest.

Holding Vanguard ETFs with rivals instead of Vanguard funds1 with Vanguard could also be cheaper for some investors with large portfolios.

For instance, our table notes that AJ Bell caps its quarterly platform fee for shares (including ETFs) at a maximum of £7.50 for an ISA, or £25 for a SIPP. That means platform charges are capped at £30 and £100 a year respectively.

Do remember that’s before ETF dealing fees and the ongoing charges on your Vanguard ETFs. Still, there could be savings to be had on larger portfolios.

Low cost barbarians at the gate

To be honest it’d be nice to find some bigger holes to poke in this new Vanguard platform.

You see, for our lauding its cheap funds – and for celebrating the pressure it puts on the wider industry to drive down costs – we’ve been accused in the past of being a sneaky Vanguard promotional site.

In reality, Vanguard has never even advertised with us. And it didn’t care to send us a press release to announce its new service.

Ho hum.

Fact is though, with this very competitively priced platform, Vanguard is likely to provide massive disruption to the incumbents.

While we like to argue the toss between this and that tracker fund, the average person would do fine just investing in Vanguard’s cheap passive offerings, or even its all-in-one options such as LifeStrategy and its target date funds.

Heck, it even has (low cost) active funds if you really must.

Rivals have some thinking to do. The lack of a Vanguard SIPP account at launch gives them some breathing space there. Some may be able to find a niche serving harder-to-please clients, such as expat investors.

But most are probably going to fall back on star active fund managers and heavy advertising to try to keep the Vanguard threat at bay. They should be aided by this rival fund groups, who have just as much to lose from Vanguard gobbling up yet more of the market.

Low-cost rival platforms are in trouble because they’re not cheap enough. Higher-cost offerings touting wunderkind active funds have the flow of history against them. Only a handful of these platforms were making good profits to begin with.

Monevator readers are in clover!

Finally, one of my spies in The City has sent in this documentary footage of the kerfuffle the launch has already kicked off. (Sensitive readers should look away now).

  1. That is, unit trusts aka mutual funds aka OEICS.

from Monevator http://monevator.com/vanguard-direct-uk/

Weekend reading: Just the links, ma’am

Weekend reading: Just the links, ma’am post image

Articles and ideas that caught my eye this week.

The big mistake is thinking they know when to buy and sell stocks,” Buffett says with a chuckle. “That there are times to buy ’em and times to sell ’em. There’s times to buy ’em. And eventually maybe, when you decide to start dis-saving when you’re 70 or 80 years of age or something of the sort, at that time you may sell ’em. But basically any attempts to pick the times to buy or sell, I think, are a mistake for 99% of the population. And I think that even attempts to pick individual securities is a mistake for people.” – Yahoo

From Monevator

Don’t forget your can opener [On prepping for financial freedom]Monevator

Dividends are not guaranteed – Monevator

From the archivator: Rich friends, poor friends – Monevator


Note: Some links are Google search results – in PC/desktop view these enable you to click through to read the piece without being a subscriber.1

House prices see first quarterly fall for five years – ThisIsMoney

Revealed: The cheapest and most expensive places to die – Guardian

Help! My house has been hijacked [New fraud alert, search result]FT

Emerging market valuations look more appealing than most today – Twitter

Products and services

Crowdfunding platform Seedrs is launching a secondary market – Business Insider

Best fixed-rate ISA returns drop 25% in a month – Telegraph

Zopa has been given full FCA authorisation and aims to launch innovative ISA soon – Zopa

Comment and opinion

Bad investment returns? Your birth year may be to blame – Of Dollars and Data

Waiting for higher bond yields is irrational if you’re passive, and risky – Canadian Couch Potato

How can I minimize tax on my pension? [On the £1m lifetime allowance, search result]FT

Academics argue the return factors justifying Smart Beta strategies and the like are flawed because the initial research gave too much weight to tiny companies – Bloomberg

Closing the self-awareness gap – Abnormal Returns

The fallacy behind populism and automation fears – Investing Caffeine

Should you use a trailing stop loss to reduce risk? – Oblivious Investor

Will Thorndike on how skilled capital allocators compound capital [Podcast]IFG

The most interesting thing about the Buffett / Seides hedge fund bet – The Big Picture

Buffett predicts Berkshire shares will rise the morning after he dies – Bloomberg

One theory why the stock market is so weirdly calm… – New York Times

…and the varied ways people are trying to protect their portfolios in response – Bloomberg

Hedge funds are out of ideas […and lagging the market in 2017]Bloomberg

Dalbar’s famous numbers showing how poorly individual investors time their fund investments are dead wrong, says another researcher… – Advisor Perspectives

…but Dalbar replies people have the wrong notion about what its data shows – Advisor Perspectives

Off our beat

“Mrs. May’s idea that her opponents are merely playing self-interested political “games” is a classic populist trope, one that suggests that constitutional democracy is really an obstacle standing between people and leader. The prime minister’s rhetoric since calling the general election has implied that the best outcome for “the national interest” would be to eradicate opposition altogether, whether that be in the news media, Parliament or the judiciary.” – New York Times

Simple maths explains why Elon Musk’s companies keep doing the barely possible – Quartz

Why first-born children are better leaders – The Atlantic

Give your kids an elite private school education (without the cost) – The Escape Artist

The Great British Brexit robbery: How our democracy was hijacked… – Guardian

…and discover what the psychometrics software makes of YOU – Apply Magic Sauce

Oldsters in their graves could swing a second EU referendum vote – Guardian

Meanwhile, Western civilization could collapse – BBC

And finally

“The traders who did badly were hopelessly emotional about the whole thing. They spent hours trying to get it right – and got caught up in lots of different strategies, confused themselves, took wild gambles. Refused to sell losers. They lied to themselves and others about their losses. They got into terrible states.”
– Robbie Burns, Trade Like A Shark

Like these links? Subscribe to get them every Friday!

  1. Note some articles can only be accessed through the search results if you’re using PC/desktop view (from mobile/tablet view they bring up the firewall/subscription page). To circumvent, switch your mobile browser to use the desktop view. On Chrome for Android: press the menu button followed by “Request Desktop Site”.

from Monevator http://monevator.com/weekend-reading-just-the-links-maam/

Dividends are not guaranteed

Dividends are not guaranteed post image

I recently spent some time teaching corporate finance to MBA students at a local university. I found it an invaluable experience (my students may disagree!) as it required me to review the finance basics I learned years ago and then figure out ways to teach them to others.

During our class discussion on equities, we compared and contrasted dividends with bond interest.

One advantage of dividends versus bond interest is that dividends can increase over time, providing an inflation hedge to your income stream.

As the legendary fund manager, Peter Lynch put it in his book Beating the Street:

Whereas companies routinely reward their shareholders with higher dividends, no company in the history of finance, going back as far as the Medicis, has rewarded its bondholders by raising the interest rate on a bond…

The most a bondholder can expect is to get his or her principal back, after its value has been shrunk by inflation.

On the other hand, dividends, unlike interest, are not a contractual obligation and investors have no recourse if a dividend is cut.

The company’s board of directors and executives periodically decide on how much of a payout the business can sustain. If the company needs cash or is concerned it can’t afford the payout, a dividend cut can occur.

Out of the blue

To illustrate, I bought shares of Pfizer in July 2008 when it had a dividend yield of 6.9%.

Sure, I conceded, there were concerns about patent cliffs, but it had increased its payout for 40 consecutive years, had recently boosted its payout by 10%, and had an AAA credit rating. As far as dividend pedigree goes, Pfizer was near the top of the charts. It seemed like a classic value play.

In January 2009, however, Pfizer halved its dividend to help finance its mega-acquisition of rival Wyeth. In one foul swoop, Pfizer’s board erased four decades of its stellar dividend track record and was no longer a so-called dividend aristocrat.

Thankfully, the amount lost was manageable, and the experience served as a lesson that no matter the track record, balance sheet, or even management’s reassurances, no dividend is guaranteed. Each company has a breaking point.

Past and future

It’s easy to forget the pain of dividend cuts when the markets are sanguine. The cuts we endured during the financial crisis have since drifted further in the rear view mirror. But eventually we’ll run into them again.

What will bring about the next round of mass dividend cuts is impossible to predict, but the rapid pace of innovation and competitive disruption is a trend that I believe will not go away anytime soon:

  • Traditionally ‘safe’ low beta consumer staples firms are facing volume pressure as consumers increase online spending.
  • Private label brands have become more comparable in product quality and undercut branded names on price.
  • Integrated energy companies will need to reckon with dramatically lower costs for renewable energy and innovations in electric vehicles.

It’s difficult to conclude that any broad industry is as defensive as it once was. And, by extension, there are probably no industries where cash flows and therefore dividends are automatically well-protected today.

Tall order

So, what can you do as an individual investor to reduce the risk of a shocking dividend cut?

Here are three strategies to consider.

Mind the pace of industry change: Imagine trying to become a chess master if the rules changed every year. Instead of an 8×8 board, now it’s a 16×16 board. Now the king can move like a queen. And so on. It would be very difficult to build skill in such a setting.

Similarly, CEOs and CFOs in rapidly-changing industries can struggle to create enduring value when the competitive landscape is always morphing. Such companies must invest increasing amounts in capital expenditures and research and development just to keep pace. Few executives are suited for this challenge, and the growth furnace is fed with cash flow that would otherwise have been earmarked for dividends.

Instead, dividend investors are best served researching companies in industries with low asset growth, tiny shifts in market share, and where technological innovations are either a small issue or, better yet, can be used to the industry’s advantage via productivity growth.

Keep an eye on free cash flow: Over time, dividends must be funded by free cash flow1. Sure, companies can temporarily finance dividends with debt or asset sales, but eventually the bill comes due.

If you notice a company’s free cash flow cover2 trending below 1.5 times, it is time to ask some questions. Is the company running out of growth opportunities? Is the diminished cover due to revenue or margin pressure? If so, what’s causing it to occur?

Slowing dividend growth can be another sign that the board is concerned about future cash flow generation. When Tesco slammed the brakes on its dividend growth in 2012, it was a red flag that the board confidence was shaky.

Get some culture: Eastman Kodak is the poster child of fallen blue chip dividend payers. Many people point to the rise of digital photography as Kodak’s downfall, but, in fact, Kodak recognized the trend toward digital in plenty of time.

Kodak’s issue – and what likely sealed its fate – was a culture of complacency that prevented the company from being in the vanguard of the digital photography revolution.3

Are the companies you own culturally able to adapt to new challenges? It’s not an easy answer, particularly if you don’t work at the firm, but it’s one worth investigating.

These days, this is possible with sites like Glassdoor, where you can read employee reviews of the company. Local business newspapers can also be a valuable resource. If a company is a great place to work or is doing something unique, there are good odds that a local business journalist has covered the story.

You can also see if there are YouTube interviews with company leaders. What is their demeanor?

Finally, see how management reacted to changes in the past. Were they defensive on the conference call following a bad quarter or did they admit a mistake and outline plans for fixing it?

Whenever I speak with a company executive, culture is the first topic that I bring up. You’d be amazed how few companies have a good and enthusiastic response to this question. As such, pulling the thread on culture is worth your research time.

If the company can’t adapt to industry changes, the long-term viability of the dividend should be a concern.

Keep your eyes open for dividend cuts

A dividend investor’s job is to be ever vigilant. Even companies with distinguished track records and healthy balance sheets can take a turn for the worse in an increasingly competitive marketplace.

The earlier we identify trouble spots in our research, the more likely we’ll be able to preserve our capital and income.

Todd Wenning, CFA is an equity analyst based in the United States. Opinions shared here are his own and not those of his employer. A full disclaimer can be found here. For compliance purposes, Todd cannot reply to comments below, though he welcomes any correspondence sent by email. You can read Todd’s expanding collection of dividend articles here on Monevator or check out his book, Keeping Your Dividend Edge.

  1. That is, cash flow left over after the company reinvests in the business.
  2. Free cash flow/dividend.
  3. See Barriers To Change: The Real Reason Behind The Kodak Downfall on Forbes.

from Monevator http://monevator.com/dividends-are-not-guaranteed/