CHRISTMAS WEEK END

Beautiful Day at the Lake. It's another beautiful day here at the lake. I got out of Denver just in time to miss the big snow storm. Lucky me. Tomorrow we're headed to town to spend Christmas with the family. Back to living out of a suitcase for a couple of days.

It's Been A Good Year In the Market. I can't complain about how the markets treated us this year. The S&P index increased almost 11% and most of our portfolios did better than that. Predictions are for another good year next year. Who knows. We will continue our philosophy of emphasizing cash flow rather than appreciation for our return on investment. This concept is well understood by my real estate investment colleagues but it sometimes called to question by financial planners. Perhaps now is a good time to discuss the whole concept of total return.

Total Return is a Simple Concept with Huge Implications. Total return is best described by the following simple equation: Total Return = Cash Flow + Appreciation. If you purchase a stock for $10 which pays an annual dividend of $.40 per year and that stock increases in value to $10.50, you have a total return of $.90 ($.40 cash flow plus $.50 appreciation) or 9% for the year. Sounds simple but there are a number of factors to consider. For one thing, you have to pay tax on the 40 cents per share but the 50 cent appreciation is not taxable unless you sell the stock If your objective is to build wealth and you have sufficient income from other sources, you can build more wealth by buying investments with less cash flow and large appreciation potential. If you need income to buy groceries, you buy investments with high current income and less appreciation potential. Can you have both high income and appreciation potential? Maybe, but it requires considerable skill or, better yet, luck to locate those investments. This still sounds relatively simple. Choose high cash flow investments for clients who need income and high appreciation potential investments for clients who want to build long-term wealth. In reality, what we do is construct a portfolio with a mix of cash flow and appreciation investments and tailor that mix to fit the needs of the client.

There are Other Factors to Consider. We can't neglect risk in our investment decisions. In the previous example, the 40 cent dividend is yours to spend or re-invest as you wish but the 50 cents appreciation can disappear. Enron is a notable example of evaporating wealth. Investors who intended to sell a bit of their stock periodically to fund their retirement found that they had no value to sell. Aside from a tax deduction, the only benefits they received from their investment were the quarterly dividends during the holding period. This leads to the conclusion that, as a rule, investments with high cash flow are lower risk than those that depend on appreciation for return on investment. Of course, there are many exceptions to this rule and high cash flow investments can carry considerable risk as well. In constructing your portfolio, you have to pay attention to all these factors. Today's good deal might be tomorrow's trash heap.