Three decades ago Sir John Templeton provided 22 rules for investment success to William Proctor who then shared these rules in his book, The Templeton Touch. Templeton’s first rule was: “For all long-term investors, there is only one objective – maximum total real return after taxes.” Around this same time, another famous investor, Warren Buffett, was developing his own investing rules. Warren made it simple and clear. When asked what his rules were, he replied, “Rule No. 1: Never Lose Money. Rule No. 2: Never Forget Rule No. 1.” This month we are going to share with you how we believe common stock dividends help in meeting both rules, but first I want to share some thoughts on a few major events that have taken place recently.
After the recent election of a new President, many of our fellow citizens reacted with their pocketbook, bidding up the average price of common stocks. Other citizens gathered in the streets of major cities around the country to protest. I have read so many articles telling us that the new President will save the country and set us on a road to greatness. I have also read just as many articles as to why our new President will destroy everything that America stands for. We all know that change will take place, but that change will take time. I believe that whatever course our government takes, we as citizens of this country will create a better America.
I have shared my optimism of the future with you many times. It has very little to do with elections and everything to do with our children and young adults, a few of whom will become our future leaders. In the past few weeks, two other major events took place in the life of the Anderson family. Both of my grandchildren celebrated a birthday, Carter on October 29th and Epiphany on November 9th.
Justin and Robyn’s son Carter turned 2 and celebrated with a party including a horse, a goat, a pig, a sheep, some bunnies and a few other barnyard critters. Carter may or may not remember the occasion, but G-pa and G-ma, members of the G-Force, will for years to come.
Andrea and Paul’s daughter Epiphany spent her 11th birthday with some friends at home in Orlando. It is one of the few times the G-Force was not there to celebrate with her. But with the help of the telephone and UPS, we participated from afar.
Of course, as any proud grandparent I know that my children and grandchildren are special, and I assume that this is probably a universal belief for others in the same position. This is my challenge to all who think that the future will not be wonderful. Take a few moments out of your day and share that time with a child. You will see excitement, love, pain, joy, respect, fear, greed, anger, sharing, and a desire to improve their own lives and everyone else’s around them. Our country is one of the few in the world that gives each of us the freedom to be human and pursue happiness in our own way. As long as that freedom is intact, we have every reason to believe that children will build on the positives and correct the problems of their parents. Because of that, we should take the recent protests on college campuses and the streets as a positive, not as a negative as so many feel. These young adults are taking a stance on what they believe is important. One day they may find their way into politics or business, or pursue another purpose with passion as they reach adulthood. Most will be parents and begin the cycle of life over again, leaving their legacy for future generations. It’s going to be fun watching it all take place.
Now, onto the discussion of the two rules put forth by Sir John Templeton and Mr. Warren Buffett. Sir John’s rule is to “maximize total return after taxes.” Most of us will save money to meet some personal goals. A fiduciary advisor will recommend an investment approach designed in a way that will give you a chance to meet those future needs. The approach used will vary from advisor to advisor and is normally modified around a risk parameter that varies from conservative to aggressive. Depending on your age, your current savings, your income, your tax bracket, your future dollar needs and any unique circumstances you may have, advisors will recommend a portfolio designed under these broad classifications: preservation of principal, income, growth and income, or maximum growth. Seldom do you find an advisor that describes an objective as “maximum total real return after taxes,” yet all objectives are attempting to do just that – maximize the rate of return given your risk parameters and needs.
No matter why you invest, or what investment vehicle you choose to use, the equation for total return is the same:
original capital investment + cash flow from investment – investment cost and taxes
+ the gain or loss of capital upon sale or redemption – original capital investment
Here’s a simple example using a Certificate of Deposit, purchased by a taxable investor in a 15% tax bracket, paying 1% interest held until maturity one year later:
$100,000 (original capital)
+ $1000 interest (cash flow from investment)
– $150 (taxes)
+ $0.00 (gain or loss of original capital)
– $100,000 (original capital)
= $850.00 (total return)
To express that return as a percentage, just divide the total return by the original invested capital. In our example: $850.00 / $100,000 = 0.85%
The same formula can be used for a dividend paying common stock. Let’s see what the results are for the same investor for $100,000 in a common stock purchased at $100 per share with a dividend payment of $2.00 per share annually and sold at $101.00 one year in the future:
$100,000 (original capital)
+ $2,000 (cash flow from investment)
– $1000 (cost of brokerage and management fee)
– $450 (taxes on dividend and share gain)
+ $1000.00 (gain from the sale of the shares)
- $100,000 (original capital)
= $1,550.00 (total return)
As a percentage: $1,550 / $100,000 = 1.55%
Granted, these examples are simple. Because of their simplicity I can almost hear the words of the many sophisticated and experienced investors saying “but what if …?” My purpose is just to make sure you recognize that total return requires an end point, which is the ultimate sale or redemption of every investment. You can calculate it one investment at a time, or on your total portfolio including all of your investments. Throughout Sir John Templeton’s life he used the simplicity of total return to amass great wealth for himself and thousands of others. He believed it was so important that he wrote it down as his “rule number one” for all investors.
Warren Buffett’s very simple rule of “never lose money” shows us that he understands Sir John’s first rule. Buffett has practiced a total return approach to investing for over six decades. It is not a coincidence, since both Sir John and Warren were taught investing by Benjamin Graham. They both understood that you must look at things the way they really are, and not how you hope or think they may be.
Today most investors look at dividends