Should you invest in solid firms with ample cash?

(MoneyWatch) A regular reader of my blog recently sent me an email in which he pointed out that virtually every analyst on radio or TV is recommending that investors should only buy the stocks of high-quality firms with big cash positions -- "fortress" balance sheets that create wide "defensive moats" -- and pay large dividends. The defensive moat is created by both the large cash position and a very strong product brand. A classic example is Coca-Cola (COKE). These investments are being touted as substitutes for safe fixed-income investments, which are now offering yields we haven't seen since the Great Depression.

The reader then went on to state that nobody acknowledges that the information that leads to this conclusion is already priced in. What he could have added is that the research shows that whenever investor sentiment is high in an asset class, sector, or country, investment returns tend to be poor because the herd has pushed prices to levels that lead to low future returns. He concluded his comments with the following: If you're going to let the noise of the financial media influence your decisions, you would be better served to be a contrarian investor! In other words, most investors would be better off doing the opposite of what their instincts told them -- as George Costanza decided to do in the famous Seinfeld episode after realizing that his instincts always led him to the wrong decision.

That email made my day as it showed that my efforts to educate individuals about the prudent way to invest haven't been in vain. In fact, they are paying off. We have discussed many times the evidence demonstrating that high-yielding stocks should never be considered substitutes for safe fixed-income investments. The reason is simple -- their risks tend to show up at the same time as does the risk to stocks in general.

What's amazing is that it was only four years ago, in the financial crisis of 2008, that investors were reminded of this lesson. Are investors' memories really that short? It appears so. That's another reason why the winning strategy is to have a well-developed investment plan that includes a policy statement and asset allocation table. That's only a start, of course -- investors also must have the discipline to stick to that plan, ignoring media noise.

Photo courtesy of Flickr user 401K

[yourPFpro]

This is a good point you bring up. I think a lot of people are turning away from low yielding fixed investments and replacing with these high yield dividend stocks/funds. I wonder how they felt after the market dropped 10% and wiped out 3 years of gains..

[R9619]

Cdpete, thanks for writing in and wasting our time with your silly, petty comments. Amazing.

[banff50]

I have personally emailed Larry before and received a thorough reply each time. I know he spends one hour per day responding to emails.

He has written several books, answers personal emails and participates in message boards.

His education has greatly helped me to better understand investing and I'm really grateful for this.

[LarryswedroeCBS]

cdpete-1
What is amazing is that people make such comments when they have no clue what they are talking about

Here is the email I received from the person who was referenced, after reading your comment.

"you may wish to say that I (the reader) made that email to you specifically because you have been—due to years of following your work—instrumental in my understanding of how markets price-in various factors, among those must include even the Big Balance sheet sub-set (which I did research in detail but inferred under the same category as many of the big name Growth stocks you have long since discussed as being "priced-in"). And that you simply did not mention this, initially, in your blog in the interest of saving space and sticking to the point. After all, why was I emailing it to YOU in the first place?!"

Perhaps you should stop guessing at thing you know nothing about?

Best wishes
Larry

[cdpete_1]

Nice to see Larry Swedroe taking credit for the emailer's financial education. My guess? The reader probably learned that basic lesson somewhere else.

Don't get me wrong. I think financial education is critical and severly lacking. But for Larry to say, "That email made my day as it showed that my efforts to educate individuals about the prudent way to invest haven't been in vain. In fact, they are paying off..." is absurd.