I have allocated a significant portion of my retirement savings to shares. The reason for this is simply a case of wishing to secure a stream of income that has the potential to rise over time to compensate for the effects of inflation.
As with all investments, it is worth considering the risks involved in investing in shares.
1. Inflation is higher than the rate of increase in dividends: shares should still do better than bonds or deposits but the real value of the dividend income will decline;
2. Deflation: companies generally do not do well in a deflationary environment. Revenues and operating margins tend to contract faster than expenses;
3. Companies may reduce or cancel dividends: stock selection and portfolio monitoring can address this;
4. Difficulty in acquiring shares that pay an adequate dividend yield: there is not much that can be done about this one;
5. Higher taxes: likewise, there is not much that can be done to avoid the impact of higher taxes and, in any case, I am expecting tax rates to rise in the future;
6. Volatility: this can work both for and against the portfolio. Downward movements may affect dividends and valuations in the short term, but also provide buying opportunities;
7. Rising interest rates; obviously a negative for company earnings and valuations, but again may provide buying opportunities;
8. Foreign exchange risks: matching the currency of the dividends against the currency of anticipated expenditure can go a long way to addressing this issue.
At various times, all of the above risks have had an adverse effect on the returns from equities.
Some of these risks can be addresses through diversification both within a share portfolio and accross asset classes. Others can be dealt with by adopting an opportunistic approach to investing. Some events may require the portfolio asset allocation to be reconsidered - if interest rates rose significantly investing in long dated bonds may be a sound strategy. A number of factors which could affect the stream of dividends are not ones to which there is necessarily a good response. However, these risks are an inescapable consequence of seeking higher real returns over the long term than can be obtained by simply leaving money in the bank.
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