Lately, everyone seems to be starting some new hobbies. The one that has brought me the most joy this year is gardening. This spring, I tilled our old raised bed and planted many different types of tomatoes along with carrots, cucumbers and herbs. I find a sense of pride as I water my patch and watch my tomatoes turn a bright, ruby red.
Any gardener knows how a drought can affect her plants. This year, I can't help but think of my investments as I look at my garden bed. February and March of this year sure seemed like a drought that would last forever. But it didn't. On March 23rd, the S&P 500 started its climb and reached new peaks at the end of August. This cycle is not a new phenomenon. It has been repeated many times before. Let's look at some ways investors and the great companies of the U.S and the world "tend their garden" in times of drought.
A gut-wrenching drop of 57% between October of 2007 and March of 2009 was followed by 11 years of growth and expansion. The S&P 500 churned out a remarkable compounded annual rate of return of 16.7%. How did companies achieve this after such a drought? They practiced the age-old technique of pruning. In Nick Murray's August newsletter, he stated, "Just as rational profit-seeking companies always do in adverse times. They wrote off inventory. They cut dividends. They sold or closed unprofitable plants and product lines, in the process, reducing employee headcounts." No one likes to see this part of the economic cycle, as it mostly takes the form of layoffs. But layoffs are essential for the future expansion of companies and enables them to hire more in the future.
Today, companies all over the world follow this process as they navigate through the pandemic. For a list of real-life examples of pruning at work, I invite you to read the article below.
After the pruning process, companies are able to reinvest in themselves. Nick Murray goes on to say, "They used the freed up capital to innovate, to expand their more profitable lines, to invest in new technology, to get more efficient." This puts businesses in the prime position to leap into the next economic phase – expansion.
How can an investor put some of these practices in their portfolio? It is simple. If you have the fertilizer, add to your garden! Market downturns are some of the best times to add to your portfolio. Shares can be bought at a remarkable discount. For those on the other side of retirement, this can still be done by reinvesting any extra portfolio income.
Rain Bucket Strategy
Just as farmers collect and store water for use during dry seasons, wise investors apply the same strategy to their portfolio's income plan. They set aside two to three years worth of income in cash or short-term bonds to use while their equities repair and grow. This method is called a bucket strategy and is employed by many of our clients.
As financial advisors, our firm is continuously tending to our clients' "gardens." If you have any questions about any of the topics above, please do not hesitate to contact us. We hope you are enjoying your last few weeks of summer and have found little joys that will make 2020 the most "fruitful" year ever.