What to Teach an Heir About Investing

I started thinking recently about how I would pass down stock investments to my children when I pass away. It’s one thing to just give them the stocks, but there would be little stopping them from just selling those stocks, cashing out, and blowing all of that money on cars and vacations. The real gift that I would want to pass down is my mindset for saving and investing in quality companies. I also couldn’t expect them to read everything I’ve ever written about stocks either, so I thought it would be a good challenge to try to get everything down to a single article. So this is my attempt to pass down important chunks of knowledge to accompany the portfolio.

“1 dollar every month is better than 50 dollars now”

I believe this concept to be the cornerstone to building wealth and living a secure and enjoyable life. A set amount of money being paid or received is only ever going to be that amount of money, but money moving at a regular rate has the potential to become far more over a long enough timeline. If I receive 1 dollar every month for 5 years, I’ve received a total of 60 dollars, and will keep making more every month. This also means that something that costs me $1 per month will exceed the cost of a $50 one time payment after 4 years and 2 months.

Another way to look at this concept is renting versus owning. If you plan on owning something long enough that the cost of renting exceeds the one time cost of ownership, then it is a better choice to own it. The best thing you can do is own an asset that other people want to rent, so you pay once, and they keep paying you forever.

“The value of stocks is not the price they can be sold for, but the income they produce”

This goes back to concept #1. Owning dividend paying stocks gives you free money for the rest of your life, with no limit. In fact, the amount of money you receive from the stocks you own will probably increase each year. The best companies increase their dividend payments every year. Selling a stock for a one time payout is basically robbing yourself of all the future dividend payments you would otherwise receive. The only time a stock should be sold is if this income is going to be lower this year, than it was last year (disregarding any special 1 time dividends or splits).

“If you can’t explain a company’s business in 2 sentences, you probably don’t understand it and probably shouldn’t buy it”

One of the biggest mistakes an investor can make is buying shares of a company without any knowledge of how that company makes money. This doesn’t mean knowing all of the details of Coca-Cola’s distribution channels. It means knowing the products or services that a company sells and knowing the general demand for that product or service. People everywhere drink Coca-cola soft drinks, and they probably will continue to do so for the foreseeable future.

“Buying a stock in the hopes that its price will increase over any period of time shorter than 2 years is gambling. Don’t gamble your money”

This is pretty self-explanatory. Gambling is not a reliable way to build wealth, and buying a stock with the intention of selling it later is gambling. Instead, focus on buying shares of companies that are going to keep growing their business and profits and share those profits with investors. This is the difference between buying some apples with the intent of selling them tomorrow and buying them to plant trees that will provide you with apples for life.

Without getting into the highly technical concepts with which I use to evaluate my investments, I think these values could help set someone along a path to financial wisdom.

And of course, my favorite phrase: “Buy Smart, Never Sell”

Things I’ve Learned From Yard Work

I have finished moving into my new house. Lately, I’ve been spending a lot of time working on the backyard to make it into something that not only looks beautiful, but provides food for me and my family. My primary project is making a self-sustaining ecosystem in the form of a pond (with freaking sweet waterfall of course!). We also plan on planting apple trees and berry bushes. It’s a lot of work now, but in the future, I’ll be glad I made these sacrifices today. Does this sound familiar? Building a passive income portfolio full of dividend growth stocks is very similar philosophy. Sacrificing today for a better tomorrow.

There is a Chinese proverb I really like: “The best time to plant a tree was 20 years ago. The second best time is now.” Planting a tree that will bare fruit means taking the time and energy to dig a hole, watering it diligently, and pruning where needed. You must work hard on the front end, but after it has had time to grow, you will be able to harvest fruits and berries without any extra effort.

Digging the Hole

Our most precious possession is time, so it is hard to dedicate it to things that we may not enjoy. Maybe it’s digging a hole, maybe it’s meeting new people, or maybe it’s your job. Many times, the things we don’t enjoy doing now are the things that will reward us in the future. Instant gratification benefits us today, but fills us with regret (or nostalgia) every day after, but delayed gratification is regretful today, but benefits us every day after.

As much as you might want to splurge and buy a new TV this weekend, the joy it will bring you is only temporary. In a year or 2 you will want a newer TV with a bigger crisper screen and cool new features. Alternatively, use that money to buy shares of Target (TGT). The great thing about dividend growth stocks, like Target, is that your very first dividend payment will be the lowest one you should ever receive from it. If you’re reinvesting the dividends, the next payment will be a little bit bigger. Then when the dividend distribution is increased next year, it will grow even more. So in 2 years, you’ll want a new TV, just like you would if you had already bought one, but you also now have a passive income stream that will keep growing throughout your life.

Watering Diligently

For most things to grow, you must nurture them to make sure the growth is healthy. Plants need water, relationships need attention, and your portfolio needs fresh investments for diversification. If your portfolio is to heavily weighted in one company or one sector, you run the risk of that company/sector facing hard times where dividends must be cut. By diversifying, you encourage natural growth and mitigate risk. I don’t believe in needlessly diversifying in bad companies just for the sake of diversification, the same way you wouldn’t try to plant an avocado tree in the tundra in case your apple tree doesn’t work out.

Prune Where Needed

It can be difficult to trim the branches you’ve worked so hard to grow, but when it comes to berry bushes, you have to prune the branches that have already produced berries, because the empty branches are the ones that will produce next year. The philosophy here is that when you can identify something that will no longer be benefiting you, it’s time to cut it. In an ideal world, the companies you invest in will never reduce or cut their dividends, but you need to be ready to sell them if they do. I like to say that if you buy smart, you’ll never need to sell, but things can change over several years. The stocks you buy should only be companies you are willing to own for 10+ years. It’s important that you can distinguish between a dividend cut and basic under-performance. If you sell a stock just because it is under-performing, you’ll miss out next year when they get their act together and over-perform. The only time to sell a dividend growth stock is if the dividend payment is going to be less than it was last year.

Homes – Investment or Liability?

I’ve mentioned earlier that I am looking for a home to buy, and have heard some readers share their opinions about how a permanent residence is a bad investment.

Buying a home as an “Investment” brings out a lot of heated argument in the investing world. There are typically two schools of thought. Many people believe that paying rent is wasted money that could potentially be building equity. Why subject yourself to a continuous expense to have nothing to show for it, right? Well, the folks on the other side of the table see it differently. Owning a home means you are liable for all repairs and maintenance, additionally it means you’re tied down to living in the same place.

Personally, I think both views are too rigid which have major flaws in their logic. You do gain value from the money you pay each month in the form of having the service of someone else handling the maintenance issues. So saying that the money is wasted is a little extreme.

In regards to flexibility, it is true that needing to sell your house before you move is more complicated than moving out of an apartment. However, people often forget about the fact that renters typically have a 1 year lease with expensive penalties for leaving early. Additionally, when it comes time to renew that lease, the tenant usually needs to commit to the next term months before the current lease is even up. So if you want to move without penalty, you need to know you’re moving months ahead of time and can only move in that short window as the lease is ending. I really think the flexibility argument is pretty weak on both sides.

I’m curious to hear from the people who say that a residence is a liability instead of an investment and what they think of owning rental properties. With a rental property, you still have all of the problems of a residential home like maintenance but with the added complication that you could have a crappy tenant that doesn’t respect the home. I think people also tend to forget that you need a place to live just the same as you need food and oxygen.

Owning a home is like owning a rental property where you are the tenant. If you rented out a rental property to a tenant, and then rented your residence from someone else, you’re basically breaking even, assuming they rent for the same price. So at that point, you’re really just taking on additional risk by involving a 3rd party as the tenant.

That’s just my 2 cents, what do you think?

P.S. – The home in the photo is one we’re buying next month! We’re very excited.

Fund Vs. Fund – Month 4

Somehow, the time of the month for this exercise always sneaks up on me. We’re now looking at the returns after 4 months.

The purpose of this exercise is to compare a focused approach to investing in quality dividend paying companies to using a fund of cherry picked stocks selected by experts. At the time I started this comparison, Kfund1 was composed of my personal holdings in MCD, MSFT, MRK, WMT, JNJ, and LMT, all of which are also part of the Vanguard Dividend Growth Fund (VDIGX). KFund2 was composed of my personal holdings in PEP, PG, WMT, KO, XOM, CVX, MCD, and MMM, all of which are also part of the Vanguard Dividend Appreciation Index Fund (VDAIX).

Below are the 2 Vanguard dividend funds I have and the change in value they have seen in the past 3 months.

VDIGX
up 6.40% (last month 5.78%)

VDAIX
up 6.75% (last month 6.17%)

Gains seem to have slowed down a tad, but what’s important to note here is that the returns are still up from last month.

Now let’s see how the individual companies that I own did in that time.

KFund1
up 6.66% (last month 7.20%)

KFund2
up 7.69% (last month 8.86%)

So my individual holdings actually went down in value compared to last month, which is unfortunate. However, if we’re still just comparing returns, the individual holdings are still ahead. These results do not surprise me as funds are intended to minimize risk. The asset management probably attributed to the continued gains during a down month, but at the cost of overall high-end returns. Like Warren Buffet, I consider myself an optimist when it comes to American business. While we all like to avoid losses, in the long run the market will continue to rise. This is why avoiding risk is not a priority for me while investing in big established businesses with proven performance and a track record of continuously rewarding shareholders.

I Dream of Panic

The dividend growth investor loves to see high quality businesses trading at a discount. The problem is that the “good deals” are hard to find these days. The overall market is up, real estate is recovering, and nobody seems to be flailing their arms and desperately selling their shares. Times are good, but that means opportunity is limited.

If we turn the clock back to 2011 or 2008, great deals on dividend stocks were easy to find because there was panic in the streets. Stock prices were falling, which created more panicked selling which lead to even lower prices. If you weren’t viewing stocks as dividend engines, you’d be freaking out that your portfolio was plummeting. These were huge opportunities for dividend investors to pick up some great deals.

I had not found my strategy yet when those price dips came around. So now, I’m hoping for another chance to get in on the ground floor. I’m hoping, people panic.

Fund vs. Fund – 1 Full Quarter

One month ago today, I started my new job. So as you can imagine, I didn’t manage to get around to comparing the funds. However, this will be the 3rd month I’m comparing, which is a substantial benchmark for comparison. This means, I will have 1 quarter’s worth of dividends contributing to the returns of these investments.

The purpose of this exercise is to compare a focused approach to investing in quality dividend paying companies to using a fund of cherry picked stocks selected by experts. At the time I started this comparison, Kfund1 was composed of my personal holdings in MCD, MSFT, MRK, WMT, JNJ, and LMT, all of which are also part of the Vanguard Dividend Growth Fund (VDIGX). KFund2 was composed of my personal holdings in PEP, PG, WMT, KO, XOM, CVX, MCD, and MMM, all of which are also part of the Vanguard Dividend Appreciation Index Fund (VDAIX).

Below are the 2 Vanguard dividend funds I have and the change in value they have seen in the past 3 months.

VDIGX
up 5.78%

VDAIX
up 6.17%

Not too shabby. I don’t like comparing results to major indexes, because major indexes don’t reflect the cost of a Doritos Locos Taco from Taco Bell (Yes, I eat these every week). A 10% yearly return is far better than you see in any savings account or treasury bond these days. With over 5% in 1 quarter, breaking 10% for the year seems like a low ball goal.

Now let’s see how the individual companies that I own did in that time.

KFund1
up 7.20%

KFund2
up 8.86%

Unlike my comparison 2 months ago, My investments actually significantly outperformed the funds. I think a big part of this success is due to JNJ, MCD, and MMM, each of which have seen at least 7% gains in the last 3 months.

I’d love to continue reporting on this comparison, but with the house hunt accelerating, I fear I may need to sell some of these positions to make the down payment. We’ll see though. Stay tuned.

Dream Job – Dividend Growth Investor

As I mentioned earlier, I’ve recently started a new job. It’s a great opportunity for me and I’m very excited to be starting this chapter of my life. The office is in downtown Seattle, so I take the bus every day to get there. I’m enjoying the bus a lot more than driving because it gives me time to play my 3DS, or even just rest and think about things. One thought that has crossed my mind is what my “dream job” would be. Honestly, I think the only perfect job would be one where they pay you to do absolutely nothing. Where you wake up and do whatever you want with the day, and the paychecks keep coming in. Unfortunately, no such job exists… or does it?

It turns out, this is exactly the kind of job a financially independent dividend investor has. Owning dividend stocks does not require you to be at an office at a specific time. Dividends have no dress code or weekly hour requirements. Nobody expects you to log the time you spend on a daily basis when your paychecks are dividend distributions.

There are some downsides to the dividend investor career. They don’t provide benefits like healthcare or dental insurance. There’s certainly no company car, however, there’s also no commute. If you’re the kind of person that feels a sense of fulfillment from working, you’ll be on your own to find ways to still get that feeling. You’ll also

There are also some significant advantages. Dividend income (if qualified) is taxed at a lower rate than normal income and capital gains. This job will give you a substantial raise every year, or least higher than the “standard of living raise,” most companies “generously” give each year. Dividends will also never fire you. Your worst case scenario is that 1 company will reduce or stop their dividend payment, in which case you can sell your stock and invest elsewhere, which is like taking a new job without even updating your resume.

Sadly, you can’t just apply to the job of dividend growth investor, it’s a job you need to work for over several years. It’s truly a grass roots start-up that you grow over time into an engine of freedom.

I love working towards earning this dream job, but in reality, I’m still very much in the start-up phase. Our house hunt is starting to really ramp up, so liquid cash is going to be more favorable than trying to bet on short term gains. This means my stock analyzing and purchasing will probably be paused until we close a deal.

What’s Your Difficulty Setting?

I’ve been playing a lot of Diablo 3: Reaper of Souls lately. One feature that helps you collect better items for your character is being able to change the difficulty. The game boils down to killing monsters so that they’ll drop items for you to use to better kill more monsters. By increasing the difficulty from “normal” to “hard” (and ultimately “Torment”), the monsters become much more difficult to kill, but they also are more likely to drop high quality items.

I can’t help but see the parallels to investing part of your income. “How?” you ask? Let me explain.

Sadly, your day job probably doesn’t involve killing demons (or luckily, depending on how you see it). However, you do have monthly challenges to overcome: bills. Every month, you need to use your hard earned cash to pay for life’s comforts: food, shelter, transportation, and fun. On the easiest difficulty setting, you spend all of your extra money on fun after the other 3 more important categories. This doesn’t get you any closer to financial independence or retirement, but it’s a lot easier to enjoy that instant gratification. If you instead save some of that extra money and invest, life in the short-term is more difficult to enjoy, but you’ll reap long-term rewards.

The best items in Diablo 3 are called “Legendary” items. As you increase the difficulty, these are more likely to drop. However, it can still take a fair amount of playtime in that harsher difficulty before you see your reward.

Your difficulty setting is basically how much of your income you choose to save. If you can save 5% of your paychecks each month, life shouldn’t be too much more difficult, and you’ll be investing toward a stronger financial future. However, if you can save 50% of your paycheck, things get a lot harder, but you’re going to be working toward that “Epic Win” at a much faster rate.

Let me create a scale based on Diablo 3 difficulties to give you an idea.

Normal – 5% saved
Hard – 15% saved
Expert – 20% saved
Master – 30% saved
Torment 1 – 40% saved
Torment 2 – 50% saved
Torment 3 – 55% saved
Torment 4 – 60% saved
Torment 5 – 65% saved
Torment 6 – 70%+ saved

Just like in Diablo 3, it’s about finding the difficulty setting that is the most rewarding while still being comfortable. If you’re dying too much in Torment 3, then maybe it’s best drop it down to Torment 2. Similarly, if you’re getting too unhappy saving 40% of your income and wish you could spend some of that money on movie tickets or video games, maybe you’d be better off aiming to save 30% and treating yourself to some fun right now. Just remember, by reaching for that long-term gratification, you’ll be thanking yourself later in life.

The good news is that it gets easier the longer you play. As you get better items in Diablo 3, you may find that you’re capable of taking on the next difficulty level. When it comes to investing, each dividend stock you buy increases your income, so after a few months of saving 30% of your income, you might start making enough to keep the same standard of living while saving 40% of your income.

Right now, I’m probably closer to Master difficulty than Torment 1, but by the end of the year, I’m hoping to be able to reach that 40% savings rate.

How about you, what difficulty setting are you taking on in investing?

Mid-April Updates

I have some good news and some bad news. First, the good news. I recently got a new job! it represents a significant pay raise, so in the future I will be able to buy more and more quality dividend stocks. However, this job is also going to require me to learn a good deal of new technology and focus most of my extra time towards growing into the caliber of developer I’ll need to be to succeed in this position. This, combined with some tax drama with my wife’s former employer, means that this month be a little short on Buy Smart Never Sell insights. (This is the bad news)

I believe in a week or two I should be able to find the time to get back into a rhythm of posting regularly. For now, I am focusing on finding my new routine and bettering myself as a programmer.

In other good news, March represented a new high in my joint dividend portfolio that we follow on this blog. We made over $30 in dividends in March! This is a huge win after such a short time of investing. There was a time when I’d be lucky to make that much in an entire year in interest. $30 hardly covers all of our bills, but it certainly covers 3 months of Netflix.

Rule The Air

In 2010, Verizon started a new advertising campaign that inspired my Starcraft 2 strategy, “Rule The Air.” I decided that if you had enough air units, and anti-air units to destroy the other team’s air units, you had a distinct advantage. By “ruling the air,” I was able to grab a good number of victories. Well, my Starcraft 2 days are over (it’s all about Diablo 3 now), but Verizon still has my interest as dividend stock. With a 31% market share, Verizon (VZ) is the current leader for wireless service (thus ruling the air) with AT&T in close second with 27%. Frugal phone owners will flock to which ever service is the best deal with little care for loyalty, so this could change very quickly, but I still like investing in winners.

Let’s look at the numbers. Verizon has a pretty solid dividend yield at 4.4% and has been paying a dividend for 30 years. In terms of growth, the company has been raising it’s dividend each year for at least 10 years. However, the average dividend growth per year has only been about 4.8%, with the most recent raise being only 2.9%. Based on my family’s current goals, low growth, high yield dividend payers are a decent target. Verizon’s P/E Ratio is currently about 12, but the PEG Ratio looks to be about 2.37, so it may still be slightly overvalued. Again I only take PEG Ratios with a grain of salt since it’s based on speculation.

Their payout ratio is nice and low at 39%, which means there is little threat of a dividend cut, so dividend growth should continue. If you invested $1000 in Verizon 10 years ago and reinvested all dividends, you would now have about 86.93 shares worth $4173.94 paying out $136.91 dividends each year. That’s a solid 13.6% yield on cost.

Verizon is on my list of potential stock to buy in the beginning of April.

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