When you buy more dividend stocks, you are thinking long term and the magic of compound interest. Dividends and stock buybacks invariable help push up the P/E ratio which implies a high stock price. In the long run, the stocks will rise in value and dividends paid which increases the total returns.

In an article by Kevin Foley, there is a reason why foundations, family offices and long-term institutional investors continue to anchor their portfolios to returns in the 6.5% to 7.5% range. Do they lack ambition, given the stock market was up 12% plus? Target returns are not annual promises. They are long-run averages across full market cycles.

When long-term money managers set their returns, the first issue is what downside can we tolerate? how much liquidity do we need? what volatility can our spending policy survive?

Why ask those questions? The real enemy of long-term compounding is not a few years of underperformance. It is a deep drawdown that permanently impair capital and takes years to recover from. A portfolio that loses 40% does not need a good year to recover, it needs a 67% recovery just to get back to even. That is why the more capital you accumulate, the more you should worry about downside protection than upside participation.

In good times, it is easy to revise expectations upwards, add imprudent leverage, reach for complexity, tolerate illiquidity because it feels like nothing ever goes wrong. Then economic cycles happen – markets go up and down.

The solution is to continually design your investment program not to be impressed in any calendar year. You try to design the portfolio to be functional across very different regimes. You care less about the headlines and more about the probability of staying solvent, liquid and operational through it.

Good portfolios are not built by ranking strategies by last year’s returns. They are built by assigning different roles to different exposure and allowing each of those roles to its job across full market cycles.

It is very difficult not to chase whatever just worked. The discipline is to preserve the architecture that makes the long-run math work.

The most important number in your portfolio is not what it makes this year. It is what can reliably compound over the next 10, 20 years. And that number is always lower and far more meaningful than anyone wants to admit when markets feel easy.

Linking to dividend paying stocks, we all put money into the stock market expecting for more but there are multiple strategies to ensure wealth compounds over the years and allowing your money to make money, but trying not to lose money is the number one rule. Investing in dividends helps you do this, for it gives you a metric, if the dividend is not paid the market will have sent signals that a cut is coming and you can seek alternatives.

There are more questions than answers, till the next time – to raising questions.