The Opportunity Cost of Every Investment
Imagine a scenario where you’re presented with two investment choices:
Company A is the more predictable of the two with revenue, earnings, and free cash flow (and subsequently, dividend growth) that can be estimated with fair precision. Think of it as being comparable to something like Proctor and Gamble (PG) or Walmart (WMT).
Company B is less predictable with less certain prospects, but is a more exciting investment opportunity that comes with the potential of greater total returns than Company A.
So which one do you choose?
Obviously, the answer isn't one-size-fits-all. It depends on your unique investment goals and your intuitive prediction based on the limited information at hand. After all, what you see is all you have, so you’re forced to craft the best possible prediction from that information.
In this scenario, all we know is that Company A is more predictable, but may come with less exciting returns, and Company B is the opposite: less certain with the potential for greater returns.
Essentially, you’re choosing between a bird in the hand and two in the bush, and there's an opportunity cost associated with each.
The opportunity cost here is the trade-off between the degree of predictability and potential returns. Company A, being more predictable, comes with the drawback of potentially lower returns. On the other hand, Company B, with its potential for greater returns, carries the risk that your prediction might be wrong.
So, again, which one do you choose?
One approach is to consider your investment goals and risk tolerance. Are you comfortable with more risk for the chance of greater reward, or do you prefer steadier and more reliable growth?
Another consideration you need to make is how confident you are in your intuitive predictions. Based on the information at hand (remember, what you see is all you have), how certain are you about Company B’s future prospects?
This is where investing gets tricky and becomes both an art and a science.
As it pertains to dividend investing specifically, predictability (which is associated with reliability) is a highly desired quality.
While share price volatility is sometimes unpredictable and can work in your favor, fundamental risk and uncertainty should be approached with caution. Why? Because risk can lead to poor fundamentals, and consistently poor fundamentals can result in disappointing returns and, eventually, dividend cuts.
This is why many investors hold dividend aristocrats (like the two I’m buying more of in this video here) and dividend kings in such high regard. There’s a certain level of comfort and sense of reliability that comes with an extensive dividend growth history.
Do you have any dividend aristocrats or dividend kings in your portfolio? Write to me here and let me know.
And a big thank you to the 15 readers who responded last week. You rock! 🙌
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ICYMI
REITs have been getting crushed this year, and in this video, I'm sharing two discounted REITs that I've been picking up more shares of lately.
We've all heard of the almighty dividend snowball effect. In this video, I'm going to talk about why it's so powerful and why the pursuit of an ever-growing dividend snowball is a great way to invest over a long period of time.
Recently, I was asked whether or not you should DRIP your dividends. In this recent Dividend Happy Hour I'll be talking about when it may make sense to do so and why I personally stopped partaking in the DRIP.
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WHAT I’M WATCHING
How a welder went from chasing penny stocks to making over $550/month in dividends
How Warren Buffett calculates the intrinsic value of a stock
WHAT I’M LISTENING TO
The ONE quality you need to be successful with dividend investing
The math, the Shakespeare, and the four pillars of investing
WHAT I’M READING
SINCE YOU ASKED
"As a parent, my number one goal is for my kids to have a better life then I do. I would love to know how we can not only build our own portfolio but one for our children."
- Andrew | Email Submission
I think it's awesome that you want to get a head start on the next generation's financial future. Luckily, it's not too hard to do. You just need to make a special account for your kids, called a Custodial Account, which is actually how I got my first exposure to investing.
I tell this story from time to time, so I apologize if you've heard this before, but when I was younger, my dad created custodial accounts for me and all of my siblings. From that point on (and still to this day), every Christmas, every birthday; whenever there was a gift to be given, we got money for our Charles Schwab accounts.
We used to watch our dad as he sat at the computer, picking stocks and explaining why he thought they were good investments. As I'm sure you can imagine, being kids at the time, we weren't entirely interested in any of that, and it all just went in one ear and out the other.
It became kind of a running joke in the family, to which he'd always say, "You'll thank me someday," and we'd roll our eyes, not really believing him. It didn't hit me until I was about 26 years old, but I most definitely have the investing bug today, and there's a big chance that you probably wouldn't be reading this if the seeds hadn't been planted when I was growing up.
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