Category Archives: Investing

The Great American Canadian Road Trip – Summer 2016 Edition

city-wall-quebec

I dropped some hints about our big summer plans in my last post, and now it’s time to make it official!  We’re going on an almost month long road trip to Canada by way of Kentucky and Michigan.  For those following along with my early retirement journey for the past few years, you might be experiencing deja vu because doesn’t a month long road trip to Canada sound familiar?

You aren’t experiencing deja vu. In 2014 we did set out on what was supposed to be a month long road trip to Canada that turned into a two and a half week road trip when we came home early.  The exhaustion that comes from superintending a rambunctious two year old combined with a disappointingly dirty Airbnb apartment rental persuaded us that it was time to return back home to Raleigh for some true R and R.

The 2014 Canada trip included visits to Montreal and Quebec City.  After leaving Quebec City we intended to visit Ottawa and Toronto, then stop by Niagara Falls on the return trip south to Raleigh.  We never made it to Ottawa, Toronto, or Niagara Falls.  On this summer’s trip we are headed back to Canada to enjoy the mild summers and hit some of the stops we missed two years ago.

 

The Great Triangle

This road trip evolved from our desire to see Niagara Falls and Nashville.  Students of geography know those two cities aren’t near each other.  They aren’t even in the same direction if you start in Raleigh.  In fact, the straight lines from Raleigh to each of those two cities are approximately perpendicular.  For the record, Mrs. Root of Good chose Niagara Falls and Nashville as our summer destinations (she’s less a fan of maps than I am).

If we want to travel along two perpendicular lines, why not make a triangle spanning the eastern half of the United States (and extending into Canada)?  By combining my clever knowledge of geometry with Mrs. Root of Good’s shotgun approach to destination selection, the Summer 2016 road trip was born.

Instead of taking a 17 hour round trip to Nashville then a 22 hour round trip to Niagara Falls for a total drive of 39 hours, we decided to make a triangular shaped journey from Raleigh to Nashville to Niagara Falls then back to Raleigh that would take 30 hours.  By taking the hypotenuse of the triangle in a northeasterly direction, we shaved nine hours off of our total driving time.

Back in our working days with the constraints of a one or two week vacation upon us, we might be happy with seeing the booming city of Nashville and a natural wonder like Niagara Falls.  But we have all summer and wanted to add some value to this road trip.  If I’m driving 30 hours I’d like the trip to be more epic than “just” Nashville and Niagara Falls.

That’s when Toronto re-entered the picture.  Arguably the most metropolitan city in Canada, Toronto was on our wishlist during our 2014 Canada trip but it didn’t happen.  On Canada trip round #2, we’re going to make it happen.  It’s only two hours north of Niagara Falls.  A very logical addition to our road trip since we’ll already be “way up north”.  It’s also a destination with tons of stuff to see and do, unlike Niagara Falls which is mostly just a waterfall (though admittedly a very very big impressive waterfall with lots of water).  Nothing wrong with a two week layover in Toronto when you aren’t in a hurry, right?  Just another benefit of the slow travel mindset.

Along with Toronto, we decided to add two full days exploring Mammoth Cave in Kentucky.  We’re staying down the road in Bowling Green, Kentucky.  After leaving Kentucky, we will head north toward Toronto with a two night pit stop in Detroit.  On the return trip back to Raleigh from Toronto and Niagara Falls, we will stop for one night in the outskirts of Washington, D.C. to visit the Smithsonian Air and Space Museum near the Dulles Airport (the kids didn’t know what the Space Shuttle was, so we’re going to see one up close).

The trip will cover around 2,100 miles and 34 hours (assuming light traffic).

So far we don’t have anything specific planned in any cities other than visiting Mammoth Cave, Niagara Falls, and the Air and Space Museum in DC.  Eventually we’ll get down to business and find something cool to do in Detroit and Toronto (and feel free to suggest anything worth seeing in the comments!).

The whole trip will last 24 nights with stays in the following cities:

  • Between Charlotte and Asheville, NC – staying with family 3 nights
  • Nashville – 1 night
  • Bowling Green, KY (Mammoth Cave) – 3 nights
  • Detroit, MI – 2 nights
  • Toronto, Canada – 12 nights
  • Niagara Falls (Canadian side) – 2 nights
  • Washington D.C. – 1 night
  • Back home in Raleigh!

 

Trip Budget

We usually put together a rough budget for our big summer trips.  For the 24 days we’ll spend traveling through North Carolina, Tennessee, Kentucky, Ohio, Michigan, Canada, New York, Pennsylvania, Maryland, Washington D.C., and Virginia, we expect to spend around $2,100 after our valiant travel hacking efforts.  Numbers for the curious:

 

Lodging $476 

  • 12 nights Toronto Airbnb rental – $363 (after $220 airbnb referral discounts and $500 Barclay Arrival Card travel rebate/bonus)
  • 3 nights Bowling Green, KY Airbnb rental – $47 (after $250 Airbnb gift card from credit card rewards)
  • 1 night hotel in Nashville from Hotwire – $66
  • 2 nights x 2 rooms Four Points by Sheraton Detroit Metro Airport – $0 (8,000 SPG points from Starwood Amex)
  • 2 nights x 2 rooms Four Points by Sheraton Niagara Falls Fallsview – $0 (12,000 SPG points from Starwood Amex)
  • 1 night x 1 room Aloft Dulles Airport North – $0 (4,000 SPG points from Starwood Amex)

 

Transportation (Gas, Tolls, Parking, Transit) $500

  • 2,400 miles at 22 mpg and $2.50/gal. gas = $275
  • Tolls = $25 (2 international bridges; PA/NY going south toward DC)
  • Parking or Transit – $200 (10 days at $20/day)

 

Food $720

  • Restaurants – Once per day at $30 per meal average = $720
  • Groceries – No more than what we usually spend at home ($125-150/wk) – $0 extra
A grocery run from our last Canada trip

A grocery run during our last Canada trip

 

Entertainment $400

  • 2 days of Mammoth Cave tours – $96 (already booked)
  • Touristy stuff at Niagara Falls – $100
  • Random museums/parks/etc in Toronto and elsewhere – $200

 

Souvenirs $0

  • lots of pictures and memories – $0

 

All of the lodging and $96 of the entertainment expense was paid in March.  The other $1,600 we’ll spend in July and August during the trip.

 

Travel hacking our way to glorious savings

We slashed the lodging expense significantly by careful use of our credit card points.  We redeemed the $500 sign up bonus from our Barclay Arrival card on the Toronto Airbnb rental.

I picked up a $250 Airbnb gift certificate by redeeming 25,000 of the 150,000 American Express Membership Rewards points we earned when we signed up for a pair of Amex Business Gold Rewards cards in December last year.  That slashed the total price for three nights in an Airbnb rental in Bowling Green, Kentucky from $297 to $47.

We booked nine nights at Starwood Hotels (including Four Points by Sheraton and Aloft hotels) using 24,000 Starwood Preferred Guest points from a single Starwood Amex sign up bonus offer.  The most amazing redemption of the bunch was a $400 per night (in Canadian dollars) room in Niagara Falls for 3,000 points per night.

Overall, we slashed what would have been $3,000 in lodging expenses to under $500 using credit card reward points and hotel points.  Not a bad deal at all.

Travel hacking is how we traveled through Mexico for seven and a half weeks for $4,500.  If you like free travel as much as we do and want to get some of these same cards, check out these credit card offers.

Another travel hack of ours is renting apartments for a week or more.  Airbnb is an incredible way to save money while on vacation, particularly if you’re traveling with a family.  We booked decent two bedroom apartments and houses for much less than the cost of a crappy hotel room suite.  The biggest benefit beyond having tons of space is that we get a full kitchen so we don’t have to dine out for a month straight.  If you haven’t tried Airbnb before, check them out for your next vacation and save $35 off your first stay.

 

Hitting the Road

We are leaving in mid-July and returning home in mid-August.  We have our new (to us) minivan which will make for a very comfortable and luxurious touring vehicle for this road trip.  One of the goals of the trip is to skip the typical rush rush rush that accompanies the normal one week American vacation and travel at a slower pace.

Other than the hotels and apartment rentals, our daily routine is very flexible so that we can take a vacation from sightseeing if we’re feeling lazy or exhausted. We’ll have a swimming pool at our hotel or apartment during most of the trip.  The kids promised to make the pool an often used luxury.

The trip budget includes dining out once per day.  We spent an average of $19 per day on restaurants during our last trip to Canada, so $30 per day should let us dine out more than we did last time.  The Canadian dollar is about 20% weaker this time around so our USDs will go farther.  We’ll probably dine out more when we are staying in hotels and less frequently when we’re settled in to our Toronto apartment for almost two weeks (if Toronto’s amazing food scene doesn’t prove overly tempting!).

Maybe we go absolutely crazy and spend way more on dining out than we budgeted.  That’s okay too because we increased our travel budget to $10,000 this year.  Beyond the $2,100 budgeted for this trip and a little under $2,000 budgeted for our December Caribbean cruise, we won’t be spending much on vacations during 2016.  With around $6,000 going unspent in our 2016 travel budget, I think we can afford to live it up a little while on vacation.  Though we’re already talking about a big 2017 trip (Mexico again? Europe?) so any unspent money could be used next year.

 

 

Any tips or hints for the cities we’re visiting?  Any hidden gems?  Free family fun? Any can’t be missed favorites?  

 

 

The Many Faces of the Four Percent Rule

four-percent-rule

If you are a fan of early retirement and financial independence, then you have probably heard of the four percent rule.  And if you haven’t, then welcome to the Club and allow me to explain more.

The four percent rule as developed in the “Trinity Study” way back in 1998 says:

a portfolio of stocks and bonds can support four percent annual withdrawals, adjusted for inflation each year, for a period of thirty years with very little chance of running out of money during that period of time.

The four percent rate of withdrawal is often called the safe withdrawal rate because the retirement portfolio didn’t run out of money in 95% to 98% of overlapping thirty year periods of past investment returns dating back almost a hundred years.

The four percent rule says that in the past, four percent was a safe amount to withdraw in almost every case.  The inference from the Trinity Study is that if the future is no worse than the past, then it’s likely that four percent will continue to be safe going forward.  The Trinity Study didn’t try to predict future returns, but rather came to a conclusion of what would have been safe in the past based on many decades of returns including some horrible periods of twentieth century financial history.

 

The Four Percent Rule – Fixed Withdrawals Plus Inflation Method

In its classical form, the four percent rule provides a level withdrawal amount each year in real terms.  As inflation goes up, your annual withdrawal goes up as well, but only enough to cover inflation.  In other words, you’ll have the same purchasing power in year one of retirement as you will in year thirty (and every year in between).

The good:

  • Consistent withdrawals year after year maintain a steady standard of living
  • No need to cut spending during an economic downturn or consider altering one’s lifestyle to reflect poor market returns

The bad:

  • No feedback mechanism in the spending rule means no upward adjustment when the portfolio value increases significantly and no downward adjustment in down markets to conserve assets
  • Not a realistic reflection of how retirees actually spend money. Who would feel comfortable spending tons in the face of a market crash?  Who wouldn’t spend more after years of sustained portfolio growth?
  • “Success” means having $1 or more left at the end of the 30 year retirement spending period (what happens if you live 31 years?).  Having only $1 to my name at any point in my retirement would be incredibly scary and I wouldn’t consider that a success in practical terms.

I have always viewed this classical statement of the four percent rule as a useful long term planning tool rather than a form of prescriptive withdrawal strategy to be used faithfully and relentlessly during retirement.

Flip the four percent rule upside down and you get a quick and dirty rule of thumb that tells how much to save for retirement.

Portfolio amount x 0.04 = annual spending/withdrawals

Rearrange the equation and solve for portfolio amount and you get:

Portfolio amount = annual spending / 0.04 = 25 x annual spending

Portfolio amount = 25 x annual spending

You need twenty five times your annual spending in your investment portfolio to have “enough” to retire using the four percent rule.  That 25x multiplier is a great way to put the four percent rule to use for planning purposes.  Want to spend $40,000 per year in retirement?  You need 25 x $40,000 = $1,000,000!

 

The Other Four Percent Rules – Percent of Portfolio or Variable Percentage Withdrawal Methods

I look at the classical four percent rule with its fixed annual withdrawals (plus inflation) as being more bad than good.

Look, I’m hard core.  I’ve got the battle hardened skin to weather a massive blizzard of hurt that the market occasionally snows down on us.  In the past year you’ve seen my stoic posts on losing $36,000, $64,000, and even $74,000 in a single month.  I just don’t care.

But if those kinds of losses showed up month after month without reprieve (as they did in the 2007-2009 period), I wouldn’t be blindly following the “spend 4% of your initial portfolio value adjusted for inflation” rule.  I would be looking for ways to cut spending in order to conserve what’s left of my portfolio.  That’s human nature.

The percent of portfolio method and the variable percentage withdrawal method are variations of the traditional 4% rule’s fixed plus inflation withdrawals.

Under the percent of portfolio method, each year you spend a certain percentage of the current value of the portfolio.  A safe percentage is 4% for this method.  A 4.5-5% withdrawal rate is also acceptable in many cases for older early retirees.  For the 4% “percent of portfolio” withdrawal on a portfolio starting at $1,000,000, the annual withdrawal would equal $40,000.  If the portfolio goes up to $1,200,000 next year, the annual withdrawal would be $48,000 ($1,200,000 x 0.04 = $48,000).  If the portfolio drops to $900,000, the annual withdrawal would be $36,000 ($900,000 x 0.04 = $36,000).  It’s simple – the market goes up and you can spend more.  The market goes down and you spend less.  Under the percent of portfolio method, the annual withdrawal is informed by the actual portfolio value each year unlike the fixed withdrawals plus inflation method which keeps the spending constant in real terms (after inflation).

The variable percentage withdrawal method, a variation on the percent of portfolio method, was developed by the geniuses (I mean that in a non-sarcastic sense) at the Bogleheads site.  Instead of using a fixed 4% or 5% withdrawal rate, the percentage withdrawal rate increases each year as you get older to account for a shortened life span (sadly enough, as you get older your life expectancy decreases).  A 35 year old’s withdrawal percentage is 4% whereas a 65 year old’s withdrawal percentage is 5% (based on a 60%/40% stock to bond asset allocation).  In the intervening years, the percentage withdrawal rate creeps up from 4% to 5% by a tenth of a percent every few years.  The variable percentage withdrawal method has the same year to year volatility that comes with the percent of portfolio method, but increases the withdrawal percentage rate over time as the retiree gets older.

There are pros and cons to these portfolio withdrawal methods that reset each year based on the then-current value of the portfolio.

The good:

  • There is a feedback mechanism to increase spending during good years and decrease spending in bad years
  • This change in spending provides psychological comfort.  You’re “doing something” to prevent running out of money in a bad market and you’re enjoying the largesse during good times.
  • Impossible to run out of money (there will always be 4% of whatever is left in your portfolio, but it might be painfully small)
  • You can withdraw a higher starting percentage (at age 35, around 4% versus perhaps 3.25% or so for the fixed plus inflation method)

The bad:

  • As a trade off for being able to spend a higher rate initially, spending may get cut in some years, perhaps drastically
  • Unpredictable.  Say goodbye to that trip around the world next year if the market tanks tomorrow.
  • Annual spending may not keep up with inflation over the intermediate term (in a weak market)

 

Comparing 4% Fixed Plus Inflation Versus 4% of Portfolio Each Year

Here’s a simple illustration of actual withdrawals someone retiring ten years ago in 2006 would have experienced.

For investment returns, I copied the Vanguard Lifestrategy Growth Fund (VASGX) annual returns.  This fund consists of a growth oriented mix of 80% US and international equities and 20% bonds.  It’s representative of a typical asset allocation chosen for those investors focused on long term growth.

The ten year period from 2006 to 2015 is a good representative sample of a typical decade of investing.  There were a couple of bad years with slightly negative returns, one year of horribly negative returns (down 34% in 2008!), with the remaining years ending in the positive.  The market returned an annual average of 5.4% during this ten year period.  Inflation was tame at an average of 1.86% per year.  In other words, not the best ten year period and not the worst ten year period, but pretty typical as far as decades go in the investing world.

We start with an initial portfolio of a million dollars.  Under the fixed plus inflation withdrawal method, the withdrawal in the first year is 4% of one million dollars, or $40,000.  In subsequent years, the withdrawal is increased by inflation each year.  The 2007 withdrawal is 2.5% higher than the 2006 withdrawal due to the 2.5% CPI-U inflation during 2006.  Mathematically, the 2007 withdrawal is $40,000 x (1+ 0.025) = $41,000.  In 2008, the portfolio withdrawal is 4.1% higher than 2007 due to the 4.1% CPI-U inflation during 2007.

It’s worth noting that in real terms (after inflation), the withdrawal remains $40,000 per year while the nominal value increases every year to match inflation, ultimately ending at $47,730 in the tenth year.  That $47,730 withdrawal in 2015 has the same purchasing power as the $40,000 withdrawal in 2006.

Under the percent of portfolio method, there is no guaranteed increase for inflation each year because the withdrawal amount resets each year based on the portfolio value each year.  The initial withdrawal in 2006 is 4% of $1,000,000 or $40,000, leaving $960,000 in the portfolio.  Since the market had a banner year in 2006, the $960,000 remaining in the portfolio generated a 16.13% return bringing the account balance to $1,114,848 at the start of 2007.

The 2007 annual withdrawal is 4% of $1,114,848, which equals $44,594.  In subsequent years, the annual withdrawal amount is 4% of whatever is left in the portfolio each year.  In the early years of 2007 and 2008, the annual withdrawal increases significantly in lock step with the rising value of the portfolio.  However after a horrible 34.39% market crash in 2008, the portfolio balance drops to $724,394 and upon calculating the 2009 annual withdrawal, we see the early retiree can only withdraw $28,976!

For the five years from 2009 to 2013 the retiree following the percent of portfolio method actually withdraws less than the $40,000 initial withdrawal back in 2006.  However, by 2015 the percent of portfolio method results in a $47,360 withdrawal which is within a few hundred dollars of the 4% fixed plus inflation withdrawal.

 

Can You Limbo?

How flexible are you?  Those middle years from 2009 to 2014 might be troubling if you absolutely have to have $40,000 (in real dollars) to survive every year.  However, if you’re okay with the concept of cutting expenses during bad years, possibly even six straight bad years, then you will be okay.

Alternatively, you might not want to cut expenses drastically but instead prefer to earn a little income on the side to support your living expenses.  For example, in the worst year of 2009, $7,000 of income from a part time gig or a hobby business will get you to within 10% of the starting $40,000 withdrawal.  That plus some minor cost cutting or spending deferral would get you through the worst parts of the recession.  I’ve talked about this concept previously when I discussed why I don’t think we’ll ever run out of money in early retirement.

When you limbo, it’s all about how low can you go.  For retirement spending, it’s all about your core expenses which is how low your spending can go.  For our household, I identified around $24,000 per year in core living expenses.  That’s not to say we would prefer to live on $24,000 per year or that we could even do it for many years in a row.  That level of spending means no vacations, no new car purchases, and no major repairs to the house (more DIY?).

When I developed my first early retirement budget, I allocated an extra $8,000 per year mainly to cover discretionary spending above the austere $24,000 per year core expenses.  In other words, I added the fun and the fun costs $8,000 per year.

More recently as our portfolio grew, I increased our 2016 retirement budget to $40,000 which gets us close to a 4% annual withdrawal rate.  Those core $24,000 in expenses are still there, but there’s even more fun in the mix mainly in the form of a fattened travel budget.  We may not spend that much this year, but it’s okay if we do.

For planning purposes, you have to establish what your core expenses are and what your ideal budget would be.  Those two numbers can help you determine how flexible your annual withdrawals can be.  If you aren’t already tracking your expenses, then consider using the free income and expense tracking tools from Personal Capital.  That’s how we keep track of our monthly spending.

february-2016-expenses

If you can cut your spending almost in half like we could, then the percent of portfolio or variable percentage withdrawal methods would probably generate higher average withdrawals over many decades without taking on too much risk of depleting your portfolio.

If, in contrast, you have a lot of fixed expenses or don’t want to cut your standard of living in down market years, then the fixed withdrawal plus inflation method would make more sense for your desired lifestyle.  It might also mean you need to save more money if you’re planning on retiring in your 30’s or 40’s and planning for five or six decades of retirement.  Remember that the classical 4% rule says you can withdraw 4% plus inflation every year for 30 years with a high probability of not running out of money.  Extend the withdrawal period to 50-60 years and you’re looking at a safe withdrawal rate closer to 3.25-3.5%.

So far I’ve presented these withdrawal methods as mutually exclusive options.  The truth about withdrawal strategies is that they are nothing more than general guidelines for what should work in the future based on past history.  In reality, you could choose the fixed plus inflation method to get you through the first five or ten years of early retirement, and then if your portfolio keeps growing, you could switch to a percent of portfolio method to convert some of that portfolio growth into spendable liquid cash and increase your standard of living.

chilling-by-the-lake-with-pizza

Me not stressing over withdrawal rates

 

How Do You Actually Withdraw 4% Per Year?

I get asked this question a lot on the blog and in my Early Retirement Lifestyle Consulting sessions, so it’s probably worth covering the mechanics of actually pulling the 4% per year from your investments.

It’s easy to say 4% of a million dollar portfolio yields $40,000 per year in withdrawals.  But how do you turn a small chunk of your portfolio into spendable cash in your hand (or checking account)?

Here’s how to create a $40,000 annual withdrawal from a $1 million portfolio that consists of $300,000 in a taxable brokerage account and $700,000 in 401k’s and IRAs:

  • $7,500 in dividends/interest from the taxable brokerage account (2.5% dividend/interest yield on the $300,000 account balance).  Have these dividends and interest pay to your cash account or transfer to your checking account.
  • $32,500 sale of investments.  Place an order to sell and transfer the sales proceeds to your checking account.

If you’re under age 59.5 then you should figure out how to access the 401k and IRA funds without paying a penalty.  The Roth IRA Conversion Ladder can help you.   In this example, the $32,500 sale of investments will probably generate somewhere around $5,000 to $20,000 of capital gains.  That amount plus your $7,500 dividend income will put your total income for the year at a level that won’t generate much of a tax bill.  You can convert traditional IRA assets to Roth assets without incurring a huge tax liability (but beware falling off the Affordable Care Act subsidy cliff!).

If you choose the Roth IRA Conversion Ladder strategy, as you spend down your $300,000 taxable brokerage account, you’ll be converting traditional IRA assets to Roth IRA assets.  Once the taxable brokerage account is substantially depleted, you should have a decent balance built up in Roth IRAs.  To fund your future $40,000 annual withdrawals after depleting the taxable brokerage account, you can initiate a withdrawal from your Roth IRA account tax free and penalty free (and keep on converting traditional to Roth).

 

More on withdrawal strategy and retirement calculators

In case I haven’t quenched your thirsty desire for knowledge of the four percent rule, I’ll refer you to Jeremy at Go Curry Cracker, Mr. Money Mustache, Mad FIentist, and JL Collins who have all done a great job exploring the four percent rule and its workings at their own blogs.

In the coming months I hope to review the major retirement calculators popular in the financial independence / retire early community.  Here are those calculators if you can’t wait:

 

 

Have you considered a withdrawal strategy for your retirement?  Are you a fan of fixed plus inflation or one of the methods based on a percentage of the portfolio balance each year?

 

 

Living on Dividends in Early Retirement

dividend-marker-on-glass

Dividends are a popular source of income in retirement.  We rely on them for a part of our annual living expenses.  Dividends provide a relatively steady stream of income regardless of the fluctuations in the stock market.

It’s worth stating that I’m not exclusively a dividend focused investor.  Instead I focus on the total return of my portfolio.  I’m an index fund investor with a fixed asset allocation that I use to periodically rebalance my portfolio.  Right now I’m almost entirely invested in equities through mutual funds and ETFs.  All of those investments pay dividends ranging from 1% to 4% per fund.

In 2015, we received a total of $28,527 in dividends from our portfolio.  This is down slightly from the $29,437 we received in 2014.  This drop was a little unexpected but owes to lower dividend payments from international investments due to the appreciation of the dollar and generally less favorable economic conditions overseas.

Our 2015 dividends were still significantly higher than the $22,000 dividend income we received in 2013.  I’m going out on a limb by guessing that 2015 is a temporary lull in the long term growth of our dividend payments (assuming we don’t eat into the portfolio principal too much).

Here’s a pic from my Personal Capital account showing the total dividends for last year and how much each mutual fund paid (isn’t free automated investment tracking great?).

total-dividends-2015

Around 75% of our investments are tied up in tax advantaged accounts.  Accessing these funds requires some fancy financial footwork (namely, the Roth IRA Conversion Ladder), so we’re only spending the dividends in our taxable brokerage accounts for now.

This year we received $7,767 of dividends in our taxable accounts.  That’s down roughly $1,300 from 2014’s $9,077 in dividends in our taxable accounts.

taxable-dividends-2015

The $21,000 or so of dividends in the tax deferred accounts gets reinvested automatically.

The $7,767 of dividends from our taxable account covered about a third of our $23,802 living expenses in 2015, which goes to show just how important dividends can be to fund a successful early retirement.  We didn’t spend our whole $32,400 early retirement budget in 2015, but our taxable dividends would have covered a quarter of our planned expenses for the year.

Here’s a summary of all our dividend paying investments:

These are the actual dividends we received for the investments in each asset class in 2015.  To calculate the dividend yield, I divided the dividend payments by the value of the investment (as of January 8, 2016).

I have about $63,000 invested in proprietary index funds in my 457 account that don’t pay dividends.  These funds automatically reinvest dividends internally without making a dividend distribution inside my 457 account.  I took those account balances out of the denominator when calculating dividend yields.

I excluded about $40,000 in the kids’ 529 accounts because they are also proprietary funds that automatically reinvest dividends internally.

Taking a look at the chart, you can tell that the value tilted investments tend to pay a higher dividend yield.  The US small cap asset class offered the lowest dividend yield at 1.51%, while the US REIT asset class yielded almost 4%.  The overall portfolio yielded 2.44% in 2015.

For those wondering exactly what funds I invest in, take a peek at that “Representative Holdings” column in the chart.  It’s not every single fund I own but it is a good reflection of what’s in my portfolio.  Some of the funds are Ishares ETFs that trade for free in my Fidelity account, and might not necessarily be better than the Vanguard equivalent ETF’s (so do your due diligence on expense ratios, average bid/ask spread, average volume, and average variance from NAV).

 

The rest of this article is excerpted from my original article on dividends from January 2014 (with some updates), so for the twenty seven loyal readers that remember the original article verbatim, my apologies.  For the other few thousand new readers, here’s what you missed two years ago:

Benefits of Dividends

In addition to being a good source of cash flow, dividends have a lot of other benefits, too.

Tax free income – If you are in the 15% tax bracket or lower, all of your qualified dividend income is tax free.  For US funds, virtually all of your dividends will be qualified.  For international funds, typically around half to two thirds of your dividends will be qualified dividends (with ordinary income tax being due on the non-qualified dividend income).  Dividends can be a pretty sweet way to fund your retirement expenses since you could potentially enjoy a fairly high income yet pay zero federal income tax.

Psychology of automatically receiving dividends – In early retirement, you might worry excessively about selling in a down market and how to fund next month’s expenses.  When markets are in the dumps, dividends can provide pain free cash in your pockets!  They keep arriving (for the most part) in good markets and bad.  Unless your portfolio’s yield is higher than your withdrawal rate, you’ll still have to sell some of your holdings to fund your monthly expenses, but having a large part of your expenses automatically funded by dividends can make it less painful.

Long term growth of dividends – The dividends paid by the stocks and funds you own will increase as the underlying companies grow their profits over time.  The growth in dividends will keep inflation at bay.  Dividends can grow faster than the rate of inflation, thereby providing a real increase in your standard of living.

Emergency funds –  If you hit a bump in the road and need an extra source of cash before you reach financial independence, you can consider your dividends as a source of emergency funds.  At a 2% yield, a “modest” portfolio of $100,000 can produce $2,000 of dividend income per year.  I was lucky to never need the extra cash while working, but when my job suddenly ended and I decided to retire, it felt great to know I had an instant source of about $8,000 per year with a few clicks.

 

Dividend focused portfolios

If you want to become a dividend investor, you could copy my asset allocation and get a 2.44% yield without trying very hard.

Or if you want to be a hot shot investor, you can try to hand pick the “best” dividend stocks out there and craft a portfolio that pays 3-4% or more.  I’m not particularly good at picking stocks so I wouldn’t personally choose this route.

I like easy solutions that don’t take a lot of work.  Vanguard has a few excellent offerings that are dirt cheap (which is a good thing when you are shopping for an investment).

The Vanguard High Dividend Yield Fund is available in mutual fund or ETF format (ticker: VHDYX or VYM respectively).  The ETF version (VYM) has a nice low expense ratio of 0.10% (which is great!).  This fund invests in stocks that consistently pay higher than average yields today.  The fund yields about 3.4% currently.

You can sacrifice a bit of yield today in exchange for higher dividend growth in the future with two different Vanguard funds.  The Vanguard Dividend Appreciation Index Fund (ticker: VDADX for mutual fund or VIG for ETF) is the better choice since it has a low 0.10% expense ratio and a current yield around 2.3%.  The other option, the Vanguard Dividend Growth Fund (ticker: VDIGX) comes with a higher expense ratio (0.29%) and a 2% yield.

Another great way to put together a dividend focused portfolio is by purchasing a basket of solid dividend paying stocks through Motif Infesting (full review here).  For $9.95, you can buy a slate of up to 30 stocks.  You can choose your own 30 stocks based on your own dividend screens.  For example, you can set a filter that shows only those stocks with yield over 4% with a history of stable and growing dividends.  Or you can pick from one of Motif Investing’s many pre-selected “motifs” (basket of stocks) centered around high dividend yield or dividend growth.  Buying motifs is slightly more complicated than buying a dividend mutual fund, however you can skip the 0.10% to 0.29% expense ratios by owning the stocks directly.  That means a 3% yield after expenses would become 3.1% to 3.29% without the expenses.  Definitely worth checking out Motif Investing if you want to maximize your yield.

 

Parting Thoughts

Dividend yields can be a great way to generate cash to fund an early retirement.  I personally don’t put too much emphasis on dividends in my own portfolio, since I’m expecting long term appreciation of my investments to keep me flush with cash as I continue to enjoy my early retirement.  But a 2-3% dividend yield can fund the majority of your budgeted retirement expenses if you don’t exceed a 4% annual withdrawal rate from your portfolio.

I came of age and started buying my first investments during the roaring 1990’s tech bubble when everyone was making easy double digit returns and no one cared about a few percent yield.  The focus was all growth growth growth, and sometimes profit profit profit was ignored.  After the tech bubble burst and double digit losses replaced double digit gains, the dividend investors sat back and smiled since their dividend focused portfolios sailed through the crash relatively unscathed.

A decade later, the old high growth tech bellwethers like Apple, Microsoft, and Intel have become somewhat boring dividend payers (yes, Apple is boring).

Some companies are good at consistently earning money but still don’t pay any dividends at all.  Warren Buffett’s Berkshire Hathaway is one of those companies.  Mr. Buffett thinks it more efficient to reinvest all the corporate earnings from Berkshire’s holdings instead of giving part of the earnings to shareholders in the form of dividends.  Berkshire Hathaway’s impressive track record of outperforming the S&P 500 by 4-5% annually for a few decades means Mr. Buffett knows what he’s doing.

I mention Berkshire Hathaway’s solid investment performance to highlight a company you would completely miss if you were strictly a dividend investor.

Dividend focused strategies can pay off, but so can investment strategies that are spread across many asset classes.

 

 

What is your take on the dividend investment strategy?  Do you manage your portfolio with a focus on generating current dividends growing your dividend stream in the future?  Or do you rely on the overall growth of your investment portfolio?  

 

 

The Mini Flash Crash of 2015, or, How I Made $5,000 in 30 Minutes

stock-market-crash

“Be fearful when others are greedy and greedy when others are fearful” says Warren Buffett.  At the opening of the stock market last Monday on August 24, 2015, we saw a ton of fear.  Following Buffett’s advice, I got greedy.

Out of sheer luck I happened to be sitting in front of the computer at the opening bell.  I was looking at my index fund tracker at Yahoo Finance when I saw one of my recent purchases plummet over 30% for no reason at all.  Sure, the entire market was down 5-6%, but that didn’t explain the drastic drop I saw.  Then I checked a few other ETFs in my portfolio and noticed they were also down by ridiculous amounts of 30% or more.

After scratching my head for a few minutes, I realized what a galactic treat the cosmos just dropped in my lap.  Index fund ETFs at 25% off their intrinsic value!  Guns ablazin’, I fired off two trades in my Fidelity account as quickly as I could.  I placed an order to buy 100 shares of IJS (iShares Small Cap Value ETF) at $82 and another order to buy 100 shares of IUSV (iShares Large Cap Core ETF) at $92.

The $82 purchase of IJS didn’t execute immediately even though the price was quoted in real time below $82.  Strange.

I checked the IUSV order and realized the price shot up to $100 or so with a bid price of $98 and an ask of $101.  I immediately replaced my $92 buy order with a buy order at $102.  Yes, a buck above the best asking price which should guarantee immediate execution.  It didn’t.

Oh crap, I can’t access my order screen at Fidelity!  Then began an intense waiting game hoping that my trades were actually in Fidelity’s system and that those trades would be executed before the price recovered beyond my limit prices.  Tick tock tick tock.

After what felt like hours but was probably no more than ten or fifteen minutes (just about the right amount of time to go cook a bowl of oatmeal), the order screen at Fidelity came back to life.

First the IJS trade confirmation appeared.  100 shares bought at $82 per share.  Then the IUSV trade confirmation appeared.  I was the proud new owner of 100 shares of IUSV at $100.85 per share (right at the asking price when I submitted my order and more than $1 below my bid price).  Ca-ching!

ijs-mini-flash-crash-profit

That’s a 29% profit in 30 minutes, folks.

While I enjoyed the glutinous texture of my slow-cooked oatmeal, I sated my gluttonous appetite for wealth with a nearly instant profit of almost $5,000.  I refreshed the quotes on IJS and IUSV a few times and watched them climb up, up, and up just as swiftly and linearly as they dropped thirty minutes earlier.

And that is how I spent the Mini Flash Crash of 2015.  Eating a $0.10 bowl of oatmeal (the bulk, slow cooked kind with added cinnamon, raisins, and brown sugar) and making $5,000 from a few well timed trades.

 

What caused the Mini Flash Crash of 2015?

During the first 30 minutes after the opening bell I noticed a lot of weird stuff going on.  The bid/ask spreads on the ETFs I followed went bananas.  At times, there was a $20 or $30 spread between the bid price (what buyers are willing to pay) and the ask price (what sellers ask for the shares they want to sell).  Typically bid/ask spreads are no more than a few pennies in heavily traded ETFs and perhaps $0.20-0.30 in thinly traded ETFs.  Something was definitely wrong.

Being the generous but greedy person that I am, I stepped in to narrow those bid/ask spreads and provide a little liquidity to the market.

But what caused the insanity of the Mini Flash Crash?

  • market makers stepped away from the market due to risk
  • HFT and algo traders walked away, also due to risk
  • Arbitrage traders that swap back and forth between owning an ETF and the basket of stocks within the ETF (that’s why they’re called arbitrage) abandoned the market, too.

The arbitrage guys couldn’t get quotes on the basket of stocks owned within the ETF since some stocks didn’t open for trading for 30 minutes or more.  Without stock quotes across the market, the arbitrageurs couldn’t mathematically determine the Net Asset Value (NAV) of the ETF and therefore they couldn’t stomach the risk of buying the ETF and selling the basket of stocks within at unknown prices.  The arbitrageurs walked away, too.

In general terms, take away all of the huge market participants and you get severely limited liquidity and horrible bid/ask spreads.

For a more in depth read, check out ETF.com’s commentary on the Mini Flash Crash of 2015.

Lessons learned

Even financial advisers get bungled up in temporary market craziness like last Monday’s Mini Flash Crash.  From the Wall Street Journal:

Lansing, Mich.-based financial adviser Theodore Feight had set up an automatic sale [a.k.a. a stop loss order] for iShares Core U.S. Value ETF [IUSV] if it were to fall a certain amount. The ETF tumbled 34% in early trading, and instead of Mr. Feight’s position selling at his target price of $108.69, down 14%, it sold at $87.32, off 31%. By noon, the ETF had bounced back, and it ended the day down 4.3% at $121.18.

“I’m really disappointed,” said Mr. Feight, who invested in ETFs for more than a decade. “They weren’t as liquid as they should have been.”

Ouch.  Mr. Feight used a stop loss order hoping it would limit losses in his IUSV position.  Instead, when the stop loss target of $108.69 was reached on the plunge down, it became a market order, ready for execution at any price.  The next price available in the market was $87.32, a full 20% lower than his stop loss target price.  A market beset with a lack of liquidity and frozen by intermittent circuit breakers does not mix well with stop loss orders.

Moral of the story: don’t use stop loss orders unless you really really want to sell at any cost and you really really don’t care how much you lose.  Limit orders would have prevented the presumably unintended sale of Mr. Feight’s IUSV shares at 31% below the previous closing value.  Mr. Feight didn’t respond to the questions I asked him by email four days ago, so I can only make assumptions about his intentions at this point.

Stop loss orders are dangerous because they do not come with a limit on the sale price.  They are essentially market orders that get executed once a security drops to a certain target.  Save yourself from a big mistake and don’t use stop loss orders or market orders.

Stick with limit orders.  It’ll guarantee future market weirdness won’t snatch your shares at an unconscionable price.  If you absolutely have to sell something, set the limit price low enough to guarantee it’ll execute (somewhere just below the current bid price) and you should get the same price as a market order coupled with the security of a minimum price limit.

Same advice on the buy side of a trade.  If you really really really have to buy something, set the limit price a bit above the current ask price (as I did with the IUSV trade with limit at $102 when the ask was around $101).  You won’t get stuck with a wonky trade if the market moves wildly before your trade is executed.

Some other routine trading advice bears mentioning.  If you’re buying or selling ETFs and want a decent price without a lot of uncertainty in the markets, avoid the first 30 minutes and the last 30 minutes of the trading day.  Those time periods are typically the most volatile and wild price swings right at the open or close can be problematic if you aren’t really careful with limit order prices.

 

The future of the market

It also bears mentioning that the opportunities I found last Monday rarely present themselves.  The markets have traded with decent liquidity since the last Flash Crash five years ago.  That’s over 8,000 hours of highly reliable market operations punctuated by a half hour of a big chunk of the market temporarily falling apart.  In percentage terms, the market functioned properly 99.994% of the time since the 2010 Flash Crash.

99.994% is so close to perfect that it doesn’t bother me the slightest to continue owning ETF’s and occasionally placing limit orders in the stock market when I need to invest new money, raise cash for living expenses, or rebalance my portfolio to my target asset allocation.

Some critics say the HFT’s, algo traders, opportunist arbitrageurs, and the faceless boogeymen of hi tech capitalism have ruined the integrity of the stock market forever.  Except they haven’t.  99.994% of the time they provide liquidity to the markets, improve bid/ask spreads, and make it easier to complete trades in the market by serving as a willing counterparty.

 

 

Where were you during the Great Mini Flash Crash of 2015?  Did you snap up any winners?

 

 

photo credit: Stock Market Crash by zemistor at flickr under creative commons license BY-ND 2.0

Cost Effective Investing With Motif

city-lights-boston

It’s hard to get excited about a brokerage firm.  In fact, I like boring brokerage firms.  Other than low costs and fees, an excellent web interface, and great customer service, there’s not a lot I want from my broker.  Check out my recommendations page, and you’ll see Vanguard and Fidelity as my top choices.

But there’s another brokerage firm that piqued my interest recently: Motif Investing.  They offer something that I haven’t seen at any other brokerage firm.  The ability to trade a basket of stocks with one click and for only one low $9.95 brokerage commission.  And they are offering $150 to entice you to give them a try (read on for more details).

 

What’s a “Motif”?

A motif is a basket of stocks or ETFs centered around a common theme.  You can find a motif to cover just about any idea imaginable.  And if you don’t find it, create a new motif yourself and earn a royalty every time someone else completes a trade using your custom motif.

Motif Investing offers over 150 professionally created motifs while the clients of Motif have created another 75,000 motifs.  A few motifs that caught my eye:

  • “Permanent Strategy” – Harry Browne’s classic asset allocation to equal parts short term bonds, long term bonds, equities, and gold.
  • “Seven Deadly Sins” – Cigarettes, fast food, porn, and other social no-no’s.
  • “Socially Responsible” – The opposite of the previous motif.
  • “For-Profit Colleges” – Might be worse than “Seven Deadly Sins”
  • “Rising Food Prices” – Stop complaining about prices at the grocery store and buy this instead
  • “Ivy League” – Invest like Yale’s David Swensen (he runs a megabillion dollar endowment fund)

For those that want to skip certain kinds of companies for religious or personal reasons, Motif has a lot to offer.  If you’re big on the environment and not so much on Big Oil, you can find or craft a motif to skip the oil and gas companies altogether.  There’s even Jewish, Christian, Mormon, and Islamic/halal motifs (for those concerned that God is closely scrutinizing their 1099’s).

 

Trading with Motif

They are a real, legitimate brokerage firm just like Vanguard, Fidelity, Schwab, Etrade, or TD Ameritrade.  A few more details:

  • You get instant order execution (and not pricing as of close of business like mutual funds).
  • Trading up to 30 stocks is only $9.95 (almost as much as most discount brokerages charge for one stock trade).
  • The minimum order size is $250 (which means you’ll get some fractional shares of stocks).
  • Commission free trades with their “Horizon” asset allocation motifs (which look awesome!)

For those that have seen my asset allocation, it is moderately complex with eleven different asset classes.  Motif’s platform would make implementing this asset allocation pretty straight forward and easy to manage while saving a lot of money on trading commissions for all those ETF purchases.

If you want to avoid potentially high management fees on some ETFs, you can create your own ETF by picking one of the available motifs.  Let’s consider a $5,000 true ETF purchase that comes with a 0.25% expense ratio.  That works out to $12.50 in management fees every year that come right out of the ETF’s investment returns.  You could skip the management fees altogether if you can find an appropriate motif with holdings that parallel the ETF.  After one year, you’ll save enough to pay the $9.95 commission at Motif and then some.  And in year two, there are zero management fees on your motif (and no account inactivity fees at Motif, either).  Change $5,000 to $50,000 in this example and you’re starting to talk real savings year after year.

 

Dividend Portfolios

I mentioned a few ETF options for dividend plays in this article.  There are dozens of motifs centered around different variations of the dividend theme.  Or you can craft your own 30 stock dividend portfolio and execute it with one click for $9.95.

As far as I can tell, there’s no maximum dollar limit for trades at Motif, so you could potentially invest $100,000 or more into a dividend portfolio this way and have an instant source of $3,000 to $5,000 income per year (depending on your choice of dividend strategy).

 

Possible Pitfalls

The two downsides I see with Motif are:

  1. Playing at investing instead of actually investing, and
  2. Tax reporting

First and foremost, I don’t think anyone should browse the listing of popular motifs and shop only for what’s trendy and cool when it comes time to invest for the long term.  That’s what a proper asset allocation is for (and Motif actually has a great selection of asset allocation models as off-the-shelf motifs).

But lots of investors, including me, want to take a gamble on a hunch on occasion.  As long as you aren’t putting a large chunk of your portfolio at risk, I say it’s okay to try to outsmart the market.  In small doses.  Motif looks like a good tool to spread your crazy guesses across many stocks centered around one idea instead of selecting only one or two stocks.  You won’t be as likely to make 1000% on a long shot, but you also won’t lose everything if you’re invested in a basket of a couple dozen stocks.

The second potential pitfall of Motif comes down to tax reporting.  If you buy and sell a lot of motifs throughout the year then you’re going to have a very long Schedule D listing all of those transactions.  I use pen and paper to prepare my taxes (and do a pretty good job at dodging those taxes), so this would be a paperwork nightmare for me if I traded a lot of motifs.  For long term buy and holders or those that use tax software like Turbotax, this tax reporting issue isn’t a big concern.  Those trading within an IRA don’t have to worry about keeping track of purchases and sales and tax lots.

 

Summary

This service looks very promising for different types of investors.  The buy and hold type can pick one motif for their whole portfolio and pay a single fee of $9.95 (or $0 for fee free Horizon asset allocation motifs) and take care of setting up all the investments in their account.

Those wanting to “play the market” with a small percentage of their investment account can get easy and cheap access to a basket of stocks to implement a particular finely targeted strategy (gold bug?  oil bull?  solar power/green energy?).

The platform looks innovative and I’m impressed with the flexibility to choose from thousands of off the shelf pre-made motifs or to craft your own motif to fit your particular strategy or asset allocation.

Investment management fees are one of the killers of long term returns.  Motif offers a middle ground of off the shelf asset allocation models that are free or cheap to implement in your portfolio.  It’s another great tool to help you skip a high fee financial adviser and keep more of your investment dollars in your own account and out of the hands of a greedy money manager.

 

$150 Promotion for New Motif Accounts

Motif is offering a $150 sign up bonus when you open an account and make at least five trades within the first 45 days.  Check out the full details on the offer page.

 

 

Note: I may receive a commission if you sign up for a Motif account through the links on this page, however I only recommend services I personally believe in.

// photo credit: Eric Kilby @ flickr  //

Starve The Army Of Hungry Money Managers

hungry-army-1

Hide your cash!  The money managers are coming.  There’s a huge lusty hungry army of financial advisers marauding about looking to latch on to your early retirement war chest and clandestinely drain it’s lifeblood while telling you it’ll all be okay and you’re in good hands.

Of course the conquerors will try to pacify you with soothing words!  Of course they will try to take away any worries of losing money.  How else could they justify outsized fees?  How else can they scare you away from low cost DIY investing?

The truth is that you can manage your own investments and do better than the professionals (after fees) as long as you keep the long game in mind.  Investing isn’t full of secrets that only seasoned professionals know.  There are plenty of different ways of investing on your own, but here’s the way I do it:

Invest in an adequately diversified portfolio of low cost passive investments and hold for the long term.

That’s it.  No secrets.  No fancy sales words, charts, or graphs to persuade you to fork over a few percent of your investments to me every year (unless you’re feeling generous!).

I have a fairly complicated asset allocation that includes ten different asset classes, but you can do well with just one fund (like the Vanguard Lifestrategy Growth Fund VASGX).  Or if you want to feel like you’re a real investor, two or three funds like Vanguard Total Stock Market ETF (VTI) plus Vanguard Total International Stock ETF (VXUS), plus Vanguard Total Bond Market ETF (BND).

 

Appetite for risk

The biggest challenge in investing is determining your risk tolerance.  To get more specific, how comfortable are you risking the loss of money in order to achieve higher returns long term?  More appetite for risk equals a larger proportion of equities in your portfolio.  Inversely, less appetite for risk equals a smaller serving of equities and a larger serving of less volatile fixed income investments like stocks or bonds.

My investment company of choice, Vanguard, can help you out.  They have an online Investor Questionnaire that does a great job of making you spill all your secrets and share your fears of losing money in the market while also figuring out other important financial considerations that impact your risk tolerance and ideal asset allocation.  All in eleven questions.  Give it a shot.  Or if you want a customized recommendation of funds based on your risk tolerance, check out their Fund Recommendations questionnaire.

I plugged in my current situation as an early retiree starting to pull from investments soon and received a suggestion to invest in 70% stocks and 30% bonds.  I’ve decided to get way more aggressive and hold almost 100% stocks with the exception of one to two year’s expenses in cash.  I do this knowing that holding more stocks increases my risk of volatility year to year.  In the long term, I expect to make about a percent higher return each year by holding more stocks.

If you’re curious about how different mixes of stocks and bonds have performed historically, Vanguard has that info too.  I can see that a mix of 70% stocks/30% bonds generated a 9.2% return on average versus a 10.2% return for 100% stocks.  How often did these two portfolios lose money?  The 70% stock portfolio lost money in 22 out of 88 years they studied compared to losses in 25 out of 88 years for a 100% stock portfolio.  And losses were steeper with the all stock portfolio.

In exchange for more volatility, I’m banking on the 1% higher returns generating me a 17 fold increase in my portfolio over 30 years instead of “only” a 13 fold increase if I were to choose a 70% stock allocation.  This is my personal appetite for risk, and if you aren’t one to take calculated risks, don’t get too aggressive.

 

You aren’t alone

Some folks take pride in how awesome their financial adviser is.  They hold the adviser up like it’s some badge of honor, some tangible proof that they have arrived.  That they are successful enough to need to employ a paid professional adviser (to manage all their thousands of dollars!).

It’s really not necessary since plenty of wealthy individuals with million dollar portfolios manage to make great returns without a paid adviser.  You just don’t see them boasting around the water cooler about how awesome their financial adviser is because they already retired early.  That’s what saving hundreds of thousands of dollars in fees over a lifetime can do for you, too.

There are tons of online groups that are fans of low cost investing.  The Bogleheads (40,000+ members), the Early Retirement Forum (27,000+ members), and the Mr. Money Mustache Forum (14,000+ members) to name a few groups.  There are tens of thousands of people just in those three forums, virtually none of whom have MBA’s or professional training as financial advisers.  They did a little research and legwork and figured out they can reach financial independence a lot sooner if they take care of their own investments and keep for themselves the 1-2% fees most advisers take.  To be fair, not all the members manage their own investments, but the great majority do.

 

Resources to help you invest on your own

The forums I mentioned are great tools.  But if you want to get a solid foundation in investing and how the stock market works, I’ll suggest a few books that taught me a lot.  The Boglehead’s Guide to Investing.  A Random Walk Down Wall Street by Burton Malkiel.  The Four Pillars of Investing by William Bernstein.  The Bogleheads book is a perfect introduction to DIY investing, and the other books provide more depth to investing and how the stock market works.

Once you start investing on your own, you’ll want to track your investments.  The best online tool I know of (that also happens to be free!) is Personal Capital (review here).

Let Personal Capital track your asset allocation for you!

Let Personal Capital track your asset allocation for you!

Even though a simple approach of just a few funds is perfectly adequate, you often end up with more funds than that if you have more than one investment account.  By the time you add in a his and hers 401k and a set of IRAs plus possibly a health savings account, you might have more than a dozen funds and need some way to keep track of the resulting jumble.  I personally use a spreadsheet that is fed by the aggregated investment tracking from Personal Capital.

If you really can’t invest on your own and have to have a financial adviser, make sure it’s a fee only adviser.  The best place to find one is NAPFA, the National Association of Professional Financial Advisors.  All members are fee only advisors and will put your interests before their own.  They don’t work on commission, instead relying on a fee you pay them for their services.  Vanguard also has financial advisers for a very reasonable fee (who also don’t work on commission).

 

Online money managers

There are online investment services that will manage your money for you for a low to moderate fee that is usually a fraction of a full service brokerage firm.  Personal Capital will manage your money for under 1% (with minimum accounts of 100,000).  Another option with even lower fees than Personal Capital is Betterment.  For 0.15% to 0.35% (depending on how much you invest with them), they will automatically invest any amount of your funds (even as little as $100) into a globally diversified investment portfolio that would look pretty similar to my own portfolio.  They use mostly Vanguard ETFs which means rock bottom fees for the investments themselves.  At $150 in annual fees for a $100,000 portfolio, it isn’t a horrible deal if you don’t want to deal with learning about investing on your own or want to let someone else manage a portion of your funds.

But you’ll be best off if you learn to invest on your own.  For a moderate investment in time, you’ll save on investment fees and have more personalized control over your investments.  Even a 0.15% management fee adds $1,500 in investment expenses to a $1 million portfolio.  That’s a lot of money to pay someone else.

 

 

Do you have a financial adviser or are you a DIY investor?  I’m guessing most readers manage their own money!  

 

 

photo courtesy of flickr / Ken Eden

Root of Good Interview On The Voluntary Life Podcast

Sharks

A few weeks ago I had the opportunity to sit down (virtually) with Jake Desyllas and discuss the financial moves and life decisions that put me in a position to retire by age 33.  Jake runs The Voluntary Life podcast, which features over 160 podcasts recorded to date that cover entrepreneurship, financial independence, and freedom among other topics.

A few of the topics discussed in my interview are:

  • Saving all salary increases and avoiding lifestyle inflation
  • Cost-effective housing, transport and food choices
  • The importance of having agreement with your spouse towards your financial goals
  • Children and financial independence

Here’s the landing page for the full podcast.  Or go straight to the audio link here.

 

The Voluntary Life

Jake’s a cool guy.  Like me, he also managed to pull off a successful early retirement in his thirties and has moved on from full time work to living the good life.  A voluntary life where he chooses what he does because he wants to (and because he can). In his words:

I wanted maximum freedom and the chance to spend every day doing only things that I love. So far, that has included playing in a jazz band, doing improv comedy, long term travelgoing minimalist, and publishing a book.”

Jake’s book is “Becoming an Entrepreneur: How to Find Freedom and Fulfillment as a Business Owner” and you can get your own copy at Amazon.  I’ve read the free parts available at Amazon and it looks like an interesting read to get entrepreneurs in the right frame of mind to successfully establish and operate a business.  The average five star rating (out of five) at Amazon means I’m not the only one digging this book (and those reviewers probably read the whole thing!).

 

I hope you all enjoyed the podcast!  It’s always a blast to talk to another person about something you’re both passionate about.  I don’t know how others feel, but I appreciate the deeper experience of listening to an author’s voice instead of only reading what that person writes.

 

Thoughts?

 

 

 

Eavesdropping On Economic Lessons From a Tradesman

construction

This morning I was relaxing in my hammock while enjoying the mild spring weather.  With coffee in the mug next to me and two year old Mr. Root of Good Jr. playing on the deck not far from me, I was planning on a morning of peace and quiet.  I set the lofty goal of finishing the last hundred pages of Nanjing Requiem, a work of historical fiction set in the 1930’s in Japanese-occupied Nanjing, China.  I managed to finish the book this morning, but not entirely in peace.

My neighbor has a contractor installing hardwood flooring for her.  The occasional sound of hammering and sawing broke the solitude I’m accustomed to in my mid-morning layabout sessions in my hammock.  Lucky for me, I was able to eavesdrop on a conversation between an older gentleman (presumably the general contractor overseeing the larger remodeling project) and a younger guy in his late twenties.  I took the younger guy to be the foreman or supervisor of the hardwood flooring crew dropping by to check on their progress and work out the next few days’ schedule with the general contractor.

I’ll paraphrase the first part of the conversation between the two tradesmen, probably embellishing it at points where I can’t remember the details.  The general contractor did most of the speaking, and did his best to recount the inflation of the housing bubble and the eventual popping of the bubble from his perspective here in North Carolina (a relatively non-bubbly area compared to California, Florida, Nevada, and Arizona).

Back before the housing market crashed, things were a lot different in the building industry.  Everything was booming, and we worked long hours six or seven days a week to meet the demand of new home buyers and those wanting to remodel with their new found wealth from home equity loans.  Back then, you knew some of these customers couldn’t really afford to buy all the house they were buying or all the remodeling they “paid” for.

But times were good and we didn’t worry too much as long as we were making good money.  The banks were so eager to hand out money to anyone who asked for it.  Homeowners could cash out every penny of equity (and then some) to pay any price we asked for remodels.  Developers and home builders had no problem getting seemingly unlimited credit lines and loans from the banks to build homes and whole neighborhoods “on spec” [on speculation; without buyers].

 

Times were very good.  I know one developer that had over $120 million of single family houses under construction at one point before the crash.  Man, was he rolling in the money!  I never had more than a couple of houses under construction at once plus a few crews doing remodels.  We felt invincible when the money kept rolling in but had the feeling that this can’t go on forever.

When all the foreclosures and trouble started in California, that was the first sign that something wasn’t right.  Not long after that, things started to slow down here.  I made sure to pay all my suppliers and subs because I didn’t want to owe anybody money and I wanted to keep operating as long as I could.  I still lost it all during the crash!  That guy with the $120 million of projects did way worse though!  He still owes me money, but I don’t hold that against him.

The banks got really tight with their lending, you see.  The builders and developers had their credit lines shut off and simply didn’t have the cash to keep building new houses on their empty lots, and couldn’t even finish up the houses that were close to completion!  Nobody could borrow money from anywhere to do anything.  And home buyers couldn’t get financing as easy as the old days.

 

The housing market turned into a strong buyer’s market overnight.  If you had cash or financing in hand, that is.  Prices went down so low but it was hard to get financing.  So many good, reputable builders went bust because they couldn’t clear our their inventory fast enough (even at lower prices) to repay the financing.  Lots that used to sell for $100,000 to $200,000 were almost worthless if you tried to offload them wholesale.

I don’t mean to scare you, but it was ugly back then.  Nobody knew what was coming next as we went into 2008 and 2009.  Today, everything is going great again and people are remodeling and new construction is making a good comeback.  The slower pace today is a lot better than the craziness of 2006, 2007 and earlier.  You can hire a new crew one at a time as you need them, and buy a new truck and equipment slowly as you get more jobs.  You don’t want to stretch yourself too far because you never know when you will hit a soft spell when work dries up.  The last thing you want is to owe too many people too much and then lose it all.

This guy didn’t have a PhD from the London School of Economics or U. of Chicago, but somehow I felt like his five minutes worth of advice to the twenty-something guy was worth as much as an MBA.  The older guy gave a concise economic history of the housing bubble and the crash, highlighting the key elements of risk and ways to mitigate the risk today.

I’ve studied finance as a hobby (and for personal gain through my investments!) my whole adult life, but for the uninitiated, it’s hard to wrap your head around the booms and busts of economic cycles.  The younger guy I eavesdropped on this morning might be 28 today which means he was 21 as the housing bubble began it’s implosion.  I would wager he wasn’t paying attention to national trends in housing supply and demand and the intricacies of collateralized debt obligations and mortgage backed securities.  He was probably on his hands and knees learning to install hardwood flooring.  Maybe he was getting into quantity estimation, pricing, and quoting jobs.

I’m sure the younger guy knew something was wrong in the housing market but not really why.  The older gentleman’s anecdotal explanation is pretty awesome to fill in the younger guy on what went wrong and what to watch out for in the future.  Without some perspective of the past, it’s hard to know you’re riding on a wave of excess until after that wave has crested and you are headed for a painful wipe out.

 

Predicting the future

At this point in a blog article, more prescient writers than me might suggest that our stock market, up almost 200% since the lows of March 2009, has crested and is set for a painful crash onto the beaches of a bear market.  I’ll be honest and say I have no idea how long the bull market will last or if today marks the end of it.  I know economic expansions tend to be stronger after really bad recessions.  I also know, like the older gentleman I eavesdropped on this morning, that eventually booming markets decline.  Sometimes painfully.

I don’t mean to scare you, but it was ugly back then (to quote the older gentleman).  I doubt the next market correction will be nearly as painful as the one in 2007 and 2008, but it will still hurt.

What’s a prudent investor to do?  Now is probably a good time to check on your asset allocation and make sure you are comfortable with the percentage of your portfolio you have in stocks, bonds, and cash.  After you review your asset allocation itself, make sure you rebalance to your target asset allocation.  I like to use Personal Capital (review here), but a simple spreadsheet with your current and target asset allocations will also work.

You might find that your stock allocation has creeped up well beyond your target allocation, and it’s time to rebalance.  The market might keep on going on it’s bull run, and you might sell too soon.  But hey, that’s the price you pay when you stick to your asset allocation.  If we see a downturn, you’ll look like a genius!

When we do (eventually) enter the next bear market, you can rest a little easier knowing that your asset allocation is exactly where you want it.  The worst thing you can do a few years into a bull market is to get overly confident and extend yourself too far (options? margin investing? high-flying penny stocks?).  Make sure you are where you want to be today with your investments.  That way, you won’t be as tempted to sell it all and go to cash if we do see a sharp market correction.  The market will switch direction without warning in spite of what market prognosticators will lead you to believe they can foretell.  They really don’t know when the market will switch directions (just like me!).

When the housing or stock market goes up, up, and up for a long time, it’s hard to remember how ugly things are when it goes down, down, down month after month.  But once you live through a severe market downturn, all you have to do is reflect back on your own experience.  And like the older gentleman I eavesdropped on, you can pass your wisdom on to the younger generation who has yet to learn the painful lessons taught by a sharply declining market.

 

Has it been easy forgetting your investment losses from 2007 and 2008?  For young people that started investing since 2009, can you still appreciate risk in spite of the last five years of solid stock market returns?

 

January 2014 Financial Update

money-january-2014

Let’s go over the Root of Good household’s financial activity in January 2014.

I’ll start off with income.  This month’s income of $4,291 was much lower than December’s income of almost $20,000.  We only received around $50 in investment income this month, which was much less than December’s massive $13,100 year-end dividend payments.  March will be the next moderately big month for dividends (but not “December” big!).

The Root of Good earnings from November 2013 finally appeared in my checking account in January.  That’s the $1,515 in “other income” shown on my income report.  December and January Root of Good earnings weren’t quite as high, but at least I know I’ll be seeing that revenue flow in over the next few months.

The biggest source of income in January was “deposits” which were Mrs. Root of Good’s earnings from her job and a small repayment of the business loan we made to family back in October.

February is stacking up to be a very nice month for income.  Mrs. Root of Good just received a sweet bonus.  As expected, the majority of it was siphoned off to fund her 401k and pay ridiculous taxes that we’ll mostly get back in April 2015.

I’ve also been busy selling crap on eBay.  I’ll have a better update on what I sold and what I made in next month’s financial update.  So far I’ve made a few hundred dollars, but I’m not booking that as earnings yet until the buyers have a few weeks to defraud me or dispute charges.  I’m new to the ebaying hustle so I’m hoping for the best but expecting the worst.  So far, so good.

 

January 2014 Income

 

A quick note on the expense tracking and income tracking tools I use.  If you like these pretty graphics, that’s exactly what you get from Personal Capital.  With Personal Capital, it is really easy to take a quick look at my income and expenses, and then drill down to areas of spending that I want to take a closer look at.  But they really go beyond pretty pictures.  All of our savings and spending accounts (including checking, money market, and five credit cards) are all linked and updated in real time through Personal Capital.  It’s my first stop when I have a quick finance question like “how much cash do we have?” or “what do we owe on credit cards right now?”.

Personal Capital is also a solid tool for investment management.  Keeping track of our investment portfolio takes two clicks and is incredibly easy with Personal Capital.  If you haven’t signed up for the free Personal Capital service, check it out today.

 

Now let’s look at expenses:

January 2014 Expense

 

January wasn’t as spendy as I expected.  We paid the annual property tax bill of $1,431 and the twice per year auto insurance of $235.  That was about half of our monthly expenditures.  I actually saved about $10 per year on auto insurance by changing the main purpose of my driving from “commuter” to “pleasure/recreational”.

The expense summary shows we spent $200 on “travel” but we’ll be getting all of that back.  We booked a $600 cruise that was supposed to take the four of us (excluding the toddler) on a week-long journey through a bunch of island destinations in the Caribbean.  The seven night cruise was unilaterally changed to a two night cruise (for the same $600), so I canceled.  I’m still waiting on the refund.  Preparing this post on our expenses motivated me to collect on this debt.  Travelocity “filled out a form to escalate my issue with accounting”, so I assume that means I can expect a full refund of my $200 deposit within the next month or so.

In some areas we spent a lot – thrift shopping for clothes and shoes ain’t cheap after all ($75, but that includes a few brand new toys, too).  In other areas, like “restaurants”, we spent very little ($46 in January compared to the $80 per month we have in our budget).  Too much awesome home cooking I guess.

The “home maintenance” expense of $124 has been mostly refunded (but it showed up as “income”).  That was for the replacement microwave I bought when our old one died.  I borrowed a working microwave from family, so I returned the unopened microwave I bought.  We also replaced the kitchen cabinet handles in January.

We spent almost $100 on electronics in January, which is higher than our average electronics spending of $50 per month.  Those expenses were the replacement laptop screen ($45 from eBay) and a brand new (to me) phone ($54 from eBay).  I bought the phone in order to try out Freedompop’s “bring your own device” phone service.  I rarely use my cell phone for voice, so the monthly fee of free is pretty enticing.  So far, the voice quality is fair to poor, but I think it’s because I don’t have the 4G service configured correctly (freedompop uses VOIP over data to carry the voice signal).  The data works perfectly though.  I’ll give it another month or two before deciding whether to dump it for a better but more expensive service provider.

I was using Virgin Mobile’s grandfathered $25/month unlimited data plan, although the best they offer these days is $30-35 per month.  I liked them a lot and would recommend them if you need an inexpensive prepaid option. In fact, I’ll sell you my old Virgin Mobile phone with the grandfathered $25/month plan if you’re nice to me (and pay me).  Although I might go back to Virgin Mobile before my grandfathered plan expires in a few months.

Overall we are doing great on our expenses.  Since we budgeted around $2,700 per month for retirement, we are well on our way to staying within our targeted budget.  January was certainly a more expensive month than usual with the annual property tax bill and the six month auto insurance bill coming due at the same time.

February will probably be a low-spending month.  It’s 10% shorter than January, which helps.  The kids’ summer camp just hit the credit card, but that’s about the only big expense I expect in February.  Unless we start blowing some money on the big summer travel we are planning.

 

Net worth

I don’t normally say much about our net worth.  But I figured I’d give a general update.  Someone mentioned to me that they thought I was crazy for remaining heavily invested in equities “during these crazy times”.  I assume they were talking about the barely noticeable mild volatility we experienced in January and early February.

By the third of February, our net worth declined over $60,000 from where it was just a few weeks earlier.  That’s about two year’s worth of expenses.  I guess to some people that would be a cause for panic.  Since I think it’s unlikely we’ll run out of money in early retirement, I’m not panicked at all.  We still have over 30 years of annual expenses in our investment portfolio!  Maybe I’ll panic if the portfolio drops to 15 year’s worth of expenses.

 

The crash

To put that $60,000  loss in perspective, it made us as poor as we were on December 17, 2013.  I didn’t feel particularly poor back on that particular day in December (quite the opposite actually!).  Since the third of February, the stock market has switched directions and started marching upwards once again.  As of today (February 15th), we are once again within $4,000 of our all time high net worth.

Over the next few years, I wouldn’t be surprised to see our net worth drop by 20% in a relatively short period of time.  We’ve seen much worse in the ugly financial markets of 2008-2009.  While I don’t expect it to be quite as bad as 2008-2009 any time soon, a 20% loss in the stock market isn’t all that uncommon.  Historically, the markets bounce back after a period of time.  The next major correction won’t scare me any more than the mild turbulence of January 2014.  I guess that’s why I’m happy enough holding an equities-heavy investment portfolio.

 

January was a wonderfully blissful month of retirement in spite of the fact that we didn’t spend that much money.  Our cash accounts have been growing over the last five months since I retired, and if the blog income and other sources of income stay constant, we won’t need to dip into the investment portfolio very much.  Here’s to a good February and good remainder of 2014!

 

How was your January?  Is the year off to a good start?

 

photo credit: 401(K) 2013 creative commons

Dividend Investing

beautiful dividends

I love December.  It’s dividend season for my mutual funds.  Like a kid eagerly awaiting Christmas morning, I excitedly anticipate the arrival of my dividend payments.  I don’t even have to unwrap them.  They just show up in my investment accounts!

Dividends are pretty awesome, but I don’t want to overstate my reliance on dividend income in my early retirement financial planning.  I’m a firm “slice and dice” index fund investor with fixed asset allocations I use to periodically rebalance my portfolio.  Right now I’m almost entirely invested in equities through mutual funds.  All those equity mutual funds pay dividends.  This adds up to a lot of dividend income without even trying to be a dividend investor.

What is “a lot” of dividend income?  You may recall from my “four months in retirement” update that we earned $13,134 of dividends in December.  Here’s a snapshot from Personal Capital showing all the December dividends:

December 2013 Dividends

I didn’t sign up for Personal Capital until October, so I don’t have all of 2013’s financial information in their system.  I manually totaled the dividends I received in 2013 from my financial institutions’ websites.  What a pain.  2014’s dividend tracking should be much easier since Personal Capital is now tracking all investment transaction data from all of my accounts.

For all of 2013, we received $22,300 of dividend income (including the $13,134 received in December 2013).  The dividends are concentrated in December because some mutual funds in our investment portfolio only pay dividends once per year, and the payment falls just before the end of the calendar year.

The $22,300 dividend total for 2013 includes dividends paid into our taxable brokerage accounts as well as those paid into our HSA, IRA’s and 401k’s.  The distinction between taxable and tax deferred accounts is important because we can easily use the dividends in the taxable account for living expenses.

In December 2013, we received $4,850 of dividend income in our taxable accounts.  For all of 2013, we received $7,700 dividend income in our taxable accounts.

Taxable Dividends

Our retirement budget is $32,000 per year, which means the $7,700 in dividend income is enough to fund around 25% of our expenses during early retirement.  The other 75% of retirement expenses will be funded by selling appreciated funds in the taxable account (for the first 10-15 years).

 

2014 Dividend Forecast

We have a lot of dividend income, but where does it come from?  Take a look at my forecast of 2014 dividends.  I used the currently reported yields on these funds when available.  In the case of the international investments, I calculated the yields based on 2013’s actual distributions divided by the current share prices of the respective funds or ETF’s.  My assumption is that the funds in my portfolio will pay the same amount in 2014 as they did in 2013.  I actually expect the dividends to go up a small amount as long as the economy remains moderately strong in 2014.  However for simplicity’s sake, I kept the dividends the same in 2014.

This table is an extension of my asset allocation table in this post.

Dividend forecast 2014

 

You’ll notice the projected 2014 dividends of $22,590 are slightly higher than what we actually received in 2013 ($22,300).  There are a few reasons.  We were contributing to our investments all year, so dividends weren’t being paid in the early months of 2013 on some of our investments.  Our portfolio differs from the all-Vanguard portfolio I show above for various reasons, with the result being the dividend yields are a little different where we own other mutual funds outside of Vanguard.

We don’t have exactly $1 million worth of dividend paying investments.  We have a bit more than that.  We also have some investments that don’t pay dividends at all (the crappy proprietary funds in my 457 account, for example).

In the 2014 dividend forecast chart, the yield on the entire portfolio is 2.26%.  The actual 2013 dividend yield on our account was closer to 2.1%.

I provided the forecast chart because those are the funds where I want to be long term with my investments.  I plan to sell some non-Vanguard funds and move to lower cost options at Vanguard (and keep more of the yield for myself!).

I want to point out a few things on the forecast chart.  REIT’s and international funds tend to have the highest dividend yields.  The “value” oriented funds also tend to pay higher dividends than blended or growth funds.  I haven’t picked any of the funds in my asset allocation for their dividend paying ability, but by leaning toward value and international investments, I have inadvertently created a portfolio with a slightly higher dividend yield (at 2.26%) than the 1.95% yield offered by the Vanguard 500 index fund (for example).

The higher yields from the international funds can be deceiving because international companies are more likely to pay variable dividends from year to year.  That is, in good years when the companies are highly profitable, they will reward shareholders by paying out most of the profits.  In years where profits are slim, dividends are likely to be low or nonexistent. In other words, during a recession when profits are lower, an international mutual fund is likely to decrease dividends more than a domestic mutual fund.  In 2009 and 2010, for example, the Vanguard Developed Markets fund paid 20-25% fewer dividends than the years before or after the recession.

 

Benefits of Dividends

In addition to being a good source of cash flow, dividends have a lot of other benefits, too.

Tax free income – If you are in the 15% tax bracket or lower, all of your qualified dividend income is tax free.  For US funds, virtually all of your dividends will be qualified.  For international funds, typically around half to two thirds of your dividends will be qualified dividends (with ordinary income tax being due on the non-qualified dividend income).  Dividends can be a pretty sweet way to fund your retirement expenses since you could potentially enjoy a fairly high income yet pay zero federal income tax.

Psychology of automatically receiving dividends – In early retirement, you might worry excessively about selling in a down market and how to fund next month’s expenses.  When markets are in the dumps, dividends can provide pain free cash in your pockets!  They keep arriving (for the most part) in good markets and bad.  Unless your portfolio’s yield is higher than your withdrawal rate, you’ll still have to sell some of your holdings to fund your monthly expenses, but having a large part of your expenses automatically funded by dividends can make it less painful.

Long term growth of dividends – The dividends paid by the stocks and funds you own will increase as the underlying companies grow their profits over time.  The growth in dividends will keep inflation at bay.  Dividends can grow faster than the rate of inflation, thereby providing a real increase in your standard of living.

Emergency funds –  If you hit a bump in the road and need an extra source of cash before you reach financial independence, you can consider your dividends as a source of emergency funds.  At a 2% yield, a “modest” portfolio of $100,000 can produce $2,000 of dividend income per year.  I was lucky to never need the extra cash while working, but when my job suddenly ended and I decided to retire, it felt great to know I had an instant source of about $8,000 per year with a few clicks.

 

Dividend focused portfolios

If you want to become a dividend investor, you could copy my asset allocation and get a 2.26% yield without trying very hard.

Or if you want to be a hot shot investor, you can try to hand pick the “best” dividend stocks out there and craft a portfolio that pays 3-4% or more.  I’m not particularly good at picking stocks so I wouldn’t personally choose this route.

I like easy solutions that don’t take a lot of work.  Vanguard has a few excellent offerings that are dirt cheap (which is a good thing when you are shopping for an investment).

The Vanguard High Dividend Yield Fund is available in mutual fund or ETF format (ticker: VHDYX or VYM respectively).  The ETF version (VYM) has a nice low expense ratio of 0.10% (which is great!).  This fund invests in stocks that consistently pay higher than average yields today.  The fund yields about 3% currently.

You can sacrifice a bit of yield today in exchange for higher dividend growth in the future with two different Vanguard funds.  The Vanguard Dividend Appreciation Index Fund (ticker: VDADX for mutual fund or VIG for ETF) is the better choice since it has a low 0.10% expense ratio and a current yield around 2%.  The other option, the Vanguard Dividend Growth Fund (ticker: VDIGX) comes with a higher expense ratio (0.29%) and a similar 2% yield.

Another great way to put together a dividend focused portfolio is by purchasing a basket of solid dividend paying stocks through Motif Infesting (full review here).  For $9.95, you can buy a slate of up to 30 stocks.  You can choose your own 30 stocks based on your own dividend screens.  For example, yield over 4% with a history of stable and growing dividends.  Or you can pick from one of Motif Investing’s many pre-selected “motifs” (basket of stocks) centered around high dividend yield or dividend growth.  Buying motifs is slightly more complicated than buying a dividend mutual fund, however you can skip the 0.10% to 0.29% expense ratios by owning the stocks directly.  That means a 3% yield after expenses would become 3.1% to 3.29% without the expenses.  Definitely worth checking out Motif Investing if you want to maximize your yield.

 

Parting Thoughts

Dividend yields can be a great way to generate cash to fund an early retirement.  I personally don’t put too much emphasis on dividends in my own portfolio, since I’m expecting long term appreciation of my investments to keep me flush with cash as I continue to enjoy my early retirement.  But a 2-3% dividend yield can fund the majority of your budgeted retirement expenses if you don’t exceed a 4% annual withdrawal rate from your portfolio.

I came of age and started buying my first investments during the roaring 1990’s tech bubble when everyone was making easy double digit returns and no one cared about a few percent yield.  The focus was all growth growth growth, and sometimes profit profit profit was ignored.  After the tech bubble burst and double digit losses replaced double digit gains, the dividend investors sat back and smiled since their dividend focused portfolios sailed through the crash relatively unscathed.

A decade later, the old high growth tech bellwethers like Apple, Microsoft, and Intel have become somewhat boring dividend payers (yes, Apple is boring).

Some companies are good at consistently earning money but still don’t pay any dividends at all.  Warren Buffett’s Berkshire Hathaway is one of those companies.  Mr. Buffett thinks it more efficient to reinvest all the corporate earnings from Berkshire’s holdings instead of giving part of the earnings to shareholders in the form of dividends.  Berkshire Hathaway’s impressive track record of outperforming the S&P 500 by 4-5% annually for a few decades means Mr. Buffett knows what he’s doing.

I mention Berkshire Hathaway’s solid investment performance to highlight a company you would completely miss if you were strictly a dividend investor.

Dividend focused strategies can pay off, but so can investment strategies that are spread across many asset classes.

 

 

Do you follow a dividend-based investment strategy? What’s your dividend yield?

 

 

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