Inflation spelled in letters with basket and piggy bank on seesaw on dark background
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We have to talk about a mistake almost all made by the investor – and it’s a particularly easy trap to fall into today.
That would be letting the headlines push us into making investment decisions out of fear. Below, we’ll dive into a scenario where this could have resulted in 30% loss and missed profit over the past 12 months. And that’s before even considering the dividends that would have been left on the table.
How letting inflation fears get in the way could cost you dearly
Consider today’s inflation scare, which seems new, but was actually starting to make headlines a year ago. At the time, many people sold (or at least reduced) their exposure to equities, fearing that rising prices would cause the Federal Reserve to get aggressive with rates, cutting the legs under the stock market in the process. .
Imagine at the start of 2021, our hypothetical investor gave in to those fears and went cash. Even with the tough start the market had in 2022, they would have missed out on a nice gain.
And that’s just from the index itself. If our investor was overrepresented in some of the largest companies in the S&P 500, he likely would have missed out more: Apple (AAPL), Amazon (AMZN), Microsoft (MSFT), Alphabet (GOOGL) and Tesla (TSLA), for example, has recorded an average gain of 22% since the start of 2021.
Then you have to take into account real inflation. In February, prices rose 7.9% year over year. So if our panic-seller went to cash in January 2021, his stake would be worth 7% less today due to the price increase. So, in addition to missing out on 15% or 22% in earnings, they also missed out because their money would now be worth more than 7% less than it was a year ago.
This means up to 30% lost money selling due to inflation, not including missed dividends! (Our dividends are a big reason why we CEF Insider members stay invested despite market calamities – equity funds in our portfolio are reporting an outsized return of 9.6%, on average, as of this writing. This allows us to hold our ground and collect our payments until the storm passes.)
So-called ‘inflation hedges’ fall flat
Instead of going in cash, inflation often prompts investors to opt for a popular inflation hedge, TIPS bonds (“TIPS” stands for “Treasury inflation-protected security” and are a type of investment bond. State directly linked to inflation). Essentially, the federal government promises to pay you an interest rate that rises when inflation rises, so if prices rise, your income will also rise.
Investors who exited stocks and moved into TIPS ended up missing $1,071 per $10,000 invested. So switching to TIPS to protect your funds from inflation was better than going all cash, but worse than sticking to stocks.
Your best shot: stocks with stocks, dividends over 7%, with a CEF
As we noted above, the bulk of the S&P 500’s gains have been concentrated in a smaller number of big players that have made strong gains over the past year. And now, due to the recent pullback, those same stocks have pulled back a bit, giving us a good entry point.
And of course, CEF fans that we are, we know we can get these shares at a nice “double discount” when we buy through our favorite funds!
Take, for example, the Adams Diversified Equity Fund (ADX), a long moment CEF Insider holding. Its four largest investments are four of the five largest companies in the S&P 500 (Tesla is the odd one out, but it comes across as the fund’s 18th largest investment). ADX’s other top 10 holdings are blue-chip U.S. companies with strong track records, including UnitedHealth Group (UNH), NVIDIA (NVDA), Bank of America (BAC) and Berkshire Hathaway (BRK.B).
These actions have pushed the ADX into a solid run over the past decade, easily eclipsing the S&P 500 and massively outperforming the TIPS.
ADX is trading at a 14% discount to NAV, which means we can buy all of these big companies for 86 cents on the dollar. And when investors realize that ADX has crushed the market while paying out a dividend yield of over 7% in each of the last five years, that discount is bound to disappear, giving us more profits on top of the already solid performance of this fund’s portfolio.
Michael Foster is the Principal Research Analyst for Opposite perspectives. For more revenue ideas, click here for our latest report »Indestructible income: 5 advantageous funds with safe dividends of 7.5%.”
Disclosure: none
