We opened Monarch Capital in August, 1994. A customer brought us the proceeds, $5.5 million, from the sale of his company in October 1994. He had sold it to an Employee Stock Ownership Plan (ESOP), so if he invested the proceeds into common stocks within one year, he did not owe any capital gains taxes from the sale of his business. His cost basis on his company’s stock ($0) was transferred to his newly-acquired shares. Our investment philosophy of high-quality companies paying reliable, growing dividends, with a very long holding period, fit quite nicely with his objective.
Since he was giving up his salary from his company, the income from this portfolio took on added significance. He was a relatively young person 23 years ago, and being able to offset inflation with an increasing level of income was important.
On the following page, we show the annual income and year-end market value of the original portfolio which we put together for him. This is not a hypothetical portfolio; it is the actual investments made for him. If he had retained the original securities (a portion of the portfolio, in actuality, was sold), he would have had $726,000 of income in 2017 and a year-end market value of over $34 million. This value assumes that dividends were consumed, not reinvested.
Data presented is for one portfolio for which Monarch Capital Management advised and represents a similar management style but not identical for all accounts managed by Monarch Capital Management. Past performance is not a guarantee of future results. Current performance may be higher or lower than the performance shown. The data presented is hypothetical because our customer, while retaining most of the portfolio, did sell a portion of it.
As we have said many times when we purchase shares of a company, we are buying a piece of that company, not a piece of paper. We hear so often that “buy-and-hold doesn’t work.” The hyper-trading mutual fund managers turn their funds over more than 100% per year. When one is buying a stock, another is selling it. While they both believe they are enhancing their returns, in reality, all they are doing is creating commissions for their brokers. If creating commissions is high on your list of objectives, then buy-and-hold will not work for you.
We are asked frequently, “How much do I need to save so I can live comfortably when I retire?” There are many variables, of course: how long you will live, the future inflation rate, bond yields, among others. We can handicap all of these, and use your best estimates of how much you plan to spend. We can then generate outcomes like how much money you’ll have, how much risk you should take, your probability of outliving your money, etc. Obviously, your best bet is to save more versus less, but just as important is to get your money invested. If it is still sitting idle in a savings account 10 years from now, you will be fumbling around with the same question.
We must make decisions. The person with the $5.5 million 23 years ago decided, with the help of saving some taxes, to put his money to work in the U.S. stock market. He could have decided to have a good time and spend it, instead, or buy bonds, but he was smart and purchased good old American equities.
During that 23-year period, his portfolio took some hits. The market endured two 50%+ drops in 2000-02 and 2007-09. Looking back, we can say those were pretty painful, but look how quickly the portfolio recovered. As you all know, in the middle of these storms, sometimes we do not sleep so well. Knowing your companies are going to keep paying you increasing dividends helps a lot. The dividends increased every year but two. The year 2004 included a special dividend from Microsoft. The only real decrease was in 2009, when the banks were forced by the government to severely cut dividends.
We had a very good year in 2017, and the stock market has been on a tear for nearly 9 years, making it easy to write a newsletter on long-term investing. The 2017 year was one of the least volatile markets we have ever experienced. It seems reasonable to expect that this will be followed, at some point, by a period of above-average volatility. The tax package should create economic growth and better corporate earnings for 2018, so even though the market is a little pricey, price/earnings ratios will be coming down as earnings increase.
We, and everyone else, are watching the yield curve. Short-term rates are being increased by the Fed, flattening the yield curve and making some folks nervous. The graph below shows the yields for the 10-year treasury bond (black) and 3-month treasury bill (red). When short rates (red) surpass long rates (black), the curve is inverted. The last three inversions (in 1989, 2000, and 2006) were followed by recessions (blue shading) and bear markets. We believe we are still in safe territory for the foreseeable future.
We hope you had a good year in 2017. If you have any questions or concerns, please give us a call.
Written by David Meyer