Monday, February 1, 2016

The importance of multiple income streams

It is nice to have a diversified income stream. While many seem to look for a focused method, I look for a diversified method of generating income. The more diversified, the better.

One of my primary income streams today is my employee salary. This is the main and only income stream for majority of people in the US. The problem is, I generate it from one employer, so if they don’t like me, this stream will end. So I am at the mercy of the employer at some level. The goal is to diversify away from relying 100% on this stream.

The second income stream is the dividends from my income portfolio. I am not dependent on any one company for this income stream. In fact, I believe that if one holds at least 30 – 40 dividend paying companies, they should not be worried if one or two of them simply stopped paying dividends. Of course, the portfolio would likely be built slowly and over time, and should be representative of as many sectors as possible. If you have half of your portfolio in a single sector such as energy, or financials or consumer staples, you are way too concentrated however. You want to avoid risks that will take down a whole sector during a crisis, or a change. An example was the dividend cuts to banks during the financial crisis. Many expect a lot of dividend cuts in the energy sector today. Whether those fears are overblown, or not, remains to be seen.


Most of my dividend income (89% - 90% of it) will come from approximately 50 stock positions. I therefore feel secure in this income stream, because I am not overly reliant on any single stock. Even if I were to sell a stock because it cut dividends, I could replace a large portion of that income by purchasing another income generating security. This is what I recently did by selling Kinder Morgan (KMI) and purchasing Enterprise Products Partners (EPD) and Diageo (DEO).

The reason why I really want to be diversified is in order to protect myself from factors in the future that I fail to see materializing and getting out in time. The truth is, I purchase a company after I do an extensive amount of work. However the worlds is largely unpredictable, as consumer tastes change, business environments change, competitive factors change and also investors make mistakes as well. It is difficult to forecast certain factors in advance. For example, investors in Kellogg (K) were doing pretty well after 44 years of increased dividends through the early 2000s. However, after changes in environment, the company froze dividends. Investors in Winn-Dixie did well with over 58 years of dividend increases, after which the company stopped raising and then cut it, only to go bankrupt a few years later.

The thing to remember is that things change. Just because McDonald’s (MCD) has dominated the fast-food restaurant industry for 40 - 45 years, doesn’t mean that the next 40 years will be as good. The thing that does it in, might not be known until 2030. Or it could be something that you see today, but choose to ignore. That’s why one needs to expect the best, but still prepare for the worst just in case. Just like the case with my personal income however, it is important that corporations you are investing in have diversified sources of income. A company that is overly dependent on a certain supplier, or a certain geographical market or even a certain product is overexposed to the risk of something going wrong. For example, several consumer staples companies have operations in Venezuela, which have been a drag on results. Since those companies operate in almost every country on earth, these losses in Venezuela are just a drop in the bucket that doesn't affect results. A pharmaceuticals company that derives most of its revenues from a certain drug could be in a lot of trouble once the patent for this drug expires, and it is open to competitors.

I also want to avoid situations where a company has showered me with rising dividends for 20 – 30 years, and I stop being rational in evaluating the business. This means, if a company I own starts cutting dividends, I will get out of it right away. I bought the company because I believed it will raise dividends over time in the first place; Thus once this criteria is no longer met, it is evidence that something has changed. By selling off my exposure, I will be able to objectively evaluate the situation. If the company manages to grow distributions again, I will get back in, provided the entry price is attractive.

The other thing to remember is that one needs to get rich just once in their lifetime. The goal of a successful retirement is to convert a lifetime worth of savings into an income generating machine, which helps you stay retired. This dividend machine gives you the choice of doing whatever you want, even if you want to keep working. That’s why it is important to be overly conservative, than reckless. I constantly see investors who take huge gambles in a greedy effort for homeruns. It is important to never risk what you have and need for what we don't have and don't need. If one has the financial security to live off dividends, and thus the flexibility to be master of their own time, then gambling their nest egg in order to make them twice or ten time or one hundred times richer is actually not a very smart move.

Full Disclosure: Long K, MCD, EPD, DEO, KMI,

Relevant Articles:

The advantages of being a long-term dividend investor
Your most important asset
Living off dividends in 2016 – My New Goal
My Five Largest Dividend Portfolio Holdings for the Long Term
Dividend Portfolios – concentrate or diversify?

21 comments:

  1. I've focused on building multiple income streams ever since I started working for myself. I think a lot of 9-to-5 folks see their jobs as stable and secure and don't think about building additional streams (which can act as insurance).

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    1. Yep, having multiple income streams is very helpful. Having your work income, investment income and side business income definitely helps when something bad happens.

      In investment income, it is helpful to have a diversity in companies paying you dividends. It is also helpful to be earning not just dividends but interest income as well. If I earn $15,000 in annual dividend income largely from 50 – 60 securities, I would not be in a terrible position if 2 – 3 of those companies end up cutting or eliminating dividends. Plus, I can use any savings from my other two income streams to add to my portfolio and buy future dividend income at lower prices.

      Thanks for stopping by Jim!

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  2. For me, dividend is just one of planned.future income streams, important one, but not majority of planned income. Proceeds from active options selling and trading is another one. So far (less than 2 years), it actually beats dividends by about 3:1, but my portfolio is not pure DGI, so dividend yield is only slightly above 2%. Over time (plan to retire in max 10 years), dividends should make 60%, options trading about 35%, rest rental income and later, when reached 65+ years also a minor state pension

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    1. Interesting observations. In the past 2 – 3 years, most puts I have sold have resulted in really good income, but that is mostly because the stock market was going up or staying flat. If it goes down, and goes down fast, any options income is quickly turning into an options loss. I would be interested in evaluating how your options income fares over a longer period of time.
      Having some rental income could be helpful, as well as a state pension.

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  3. Very good read. I've been considering diving into rental properties in a few years as another income source. The dividend cut of KMI, which was huge to a lot of DGI, and what soon looks like will be another cut to BBL should come as a warning that even depending on 'safe' dividends is risky

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    1. I was lucky that I never bought into the BBL, NOV, ESV, SDRL of the world. On an interesting note of course, Kinder Morgan (KMP, KMR) had done really well for partners between 1996 – 2014. I did own a high position in KMI however, so I have a lesson learned.
      The lesson is to do your own research, and to be highly skeptical of everything, including forward company projections about EPS, DPS etc. The other thing to consider is that cyclical companies and pass through companies and companies that have high payouts are more likely to cut dividends if something goes wrong. And last but not least – do not fall in love with a stock.

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  4. Well said. Diversification is key for a lot of things in life. I think creating a second income stream (be it investing, freelancing, or some kind of side hustle) is important in this environment where NO ONE has job security.

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    1. There is no security in anything – jobs, markets, economies. While having a long-term mindset helps, one needs to be nimble, and not fall for narratives that sound catchy and good to be true. But having diverse streams of income can be helpful. This is where companies I own need to be diversified and not overly dependent on one product, one supplier, on customer, one market, etc.

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  5. I wish I would have come across this post 10-15 years ago. Just in the past two-three years I have been trying to diversify my income for the very point you raise. If the company decides tomorrow that they don't like you, BAM. You are gone and left high and dry!

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    1. Come on, I have been developing my dividend income stream for over 8 years here. Oh wait, you said 10 - 15 years ;-)
      In all seriousness, receiving dividends from 50- -60 companies that have global operations, and sell a variety of products and services, is more secure than just having one source of income – the 8 – 6 one (on a slow day)

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  6. This just about sums up how I feel as well. Your employer is a great check to depend on but it can't be solely depended on. The same goes for your portfolio that should be your backup should anything happen. If you fail to diversify and suddenly that small set of stocks stops raising or cuts the dividend all together, you're left out to dry before you can replace them. Uncertainty can be the worst of enemies. Let's all just do our best to keep it out of our lives.

    Thanks for the article, DGI. I enjoyed the read.

    -DM

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    1. I agree - uou have to diversify into non-correlated assets/income sources. Different sectors of stocks, ,maybe fixed income, side hustles, etc can be helpful.

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  7. Great read. I agree that diversifying income streams is ever so important, but I think it extends beyond just buying a basket of 30-50 stocks and calling it "diversification".

    Yes, there are more branches on the tree, but in the end it's all still coming from the same tree. For instance, if the tax code changes for dividend income, it will impact all your companies...

    To me, diversification means multiple, uncorrelated income streams: work income, dividends, rental property income, blog income, affiliate/advertising income, ebook income, etc...

    To achieve all that of course isn't easy, but you gotta start somewhere...

    Dividends are a great start, but I wouldn't say they are the end all when it comes to diversification, though.

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    1. The more the merrier of course – owning stocks, having a business/side hustle, having a job and certain job skills that are in demand, having rental properties, holding a CD ladder, can be helpful. This lesson can be applied to individual life but also businesses we analyze (and vice versa). On the specific points you raised, I have addressed them somewhat - tax deferred accounts, fixed income, side hustles etc. But since this is a site on dividend investing, it makes sense to stress about importance of a diversified portfolio of stocks for income, plus a day job ( and maybe even pension one day). This is what applies to the situation of most people out there. A lot of other methods require more time and effort than the average person is interested in exerting, particularly in retirement. Though I value your comment, because you made me think of addressing it, which stress tested how prepared I am for different events. I walk around thinking what could go wrong most of the time these days ;-)

      The important thing is having low correlation between sources, which will increase the odds that you are fine no matter what happens. Going back to correlation and risk If your silicon valley employer goes bust, your rental income could be in trouble too ( and your tech stock portfolio and possibly your advertising income from your blog). If my tech company fires me, I should be fine because I earn money from companies that operate in 190 countries, operate in different industries and have a track record of consistent earnings and dividends. Of course if no one wants to read about dividend investing ( possibly because it doesn’t do well in the short term or because everyone believes that index funds are the only way to go), then my blog income will suffer. I have a CD/GVT Bond Income ladder allocation, for the scenario where stocks and jobs and real estate (business like assets) suffer due to a depression/deflation etc. If we have the events like the 1930s in Germany, your gold would give you a safe passage out, while I would be digging holes somewhere.

      You have varying degrees of risk with each. Some are riskier than others because of the structure, leverage, and need for direct operating on your own part ( or hiring a manager which increases risk).

      I could make the argument that someone who owns a portfolio of rental properties that are not paid off is taking on larger risk than someone who owns their 50 - 60 dividend stocks outright.

      With your rental properties, your tenants might trash the place, your risks are more concentrated to the individual area your properties are at, you may take longer to find tenants that will essentially pay the mortgage, and since you are leveraged you may go bust losing everything and then owe some more to the bank (worst case low probability scenario, but it is still out there) .

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    2. DGI,

      Thanks for the discussion. I'm definitely not trying to turn this into a rental property vs. dividend investing argument... They both have their merits and I think it makes sense to own both, and many other types of investments. But on that point, if Silicon Valley goes bust, the entire US economy will be in shambles (no joke)... Although possible, and even though I feel like real estate is way overextended here, I would never bet directly against the talent/ingenuity here...

      Not sure I understand your point about my employer going bust impacting the rest of my rentals. Silicon Valley has many tech behemoths, and one company going bust won't take down everything... Further, I do own 3 rentals out of state in the Midwest. Your point about your tech company operating in many countries, industries, etc. would also apply to the numerous companies in SV... Apple, Google, Facebook, etc. are pretty global companies with diverse product lines... Then you have biotech, financials, etc...

      Yes, for sure leveraged rental properties are risky. That's why I've made every attempt possible to hold not only rentals, but lots of cash, gold, stocks, etc... I have many liquid assets to complement those rentals, and they all cash flow which is not something every real estate investor can say. In that sense, dividend stocks are definitely less risky since there's no debt service to account for.

      Yes, overall, the more income sources one has, the merrier! The markets are a bit unstable at this point, which only further hammers home that idea. But again, I agree that a diversified mix of dividend stocks is a great way to go...

      All the best!





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    3. I like the discussion too. I like talking to people outside dividend investing. That’s how I learned so much about taxes. I am still learing about RE. Luckily, I avoided Zero Hedge however ;-)

      “But on that point, if Silicon Valley goes bust, the entire US economy will be in shambles (no joke)”

      I somewhat disagree with that notion. When the tech bubble burst in 2000, we did have a recession and stocks did go down, but the damage was more concentrated in so called “new economy stocks”. For example, DJIA did a little better than S&P 500 and Nasdaq.

      Honestly, your quote reminded me of the old quote “ As goes GM, so goes the US economy”. This was relevant in the 1950s, when Detroit was the envy of the world with all ingenuity etc. Isn’t it funny how things have changed? Not saying that SV today is like Detroit in the 1950s, but still this is something to think about changes in the landscape.

      “Not sure I understand your point about my employer going bust impacting the rest of my rentals. Silicon Valley has many tech behemoths, and one company going bust won't take down everything”

      For example, if you work in Silicon Valley, own tech stocks and own rental properties in SV, and the influx of capital for startups and company investment dries up, this could affect your job prospects, your tech stocks you own and your real estate. Meaning that even if you own different types of assets, ( job income, stocks, real estate), you need to make sure they are not correlated in some other common denominator that could bring all those down. (If you live in Houston and work in oil and gas, you are not diversified if you own energy stocks and own a property in the area.)

      For whatever reason I thought you held tech stocks in your portfolio like BABA, TSLA, but maybe you sold them.

      I think that the point I was trying to make is to diversify income streams, but also to be mindful of entry price you pay, your knowledge of the income stream, correlation between income streams, etc. I feel “safer” owning 50 – 60 dividend stocks than owning rental real estate – I know nothing about real estate and have absolutely no experience. Furthermore, I would hate to have $1M in equity against $2M - $3M in debt on properties when I retire. Even if I have $100K - $200K in cash in this situation, this cash position would pale against my massive liability on my books.

      So adding leveraged RE (or even direct RE in my case) could actually reduce my income stream diversification. You on the other hand know RE better than me, though possibly not as much as dividend investing. So you went with RE ( nothing wrong with that). If you time RE purchase right at the right price, you can make a lot of money. Of course, if someone like me buys RE, they will likely lose their shirt.

      If either of us tries to buy “music royalties”, we may do poorly because we don’t know about the best opportunities at the best prices. Plus, we don’t know if Justin Bieber’s music royalties will be as valuable in 2025 or 2035 as they are today.

      As for your comment that taxes on dividends will go up as a risk, I think that rising taxes affect most other investment income such as capital gains, and deductions for real estate and maybe even tax shelters like partnerships and IRA’s too. I don’t think you can state that rising taxes are bad for dividend investing, without checking that there were a ton of companies that were raising dividends in the 1950s, 1960s, 1970s and 1980s, which were periods when top marginal tax rates were double what they are today. PG and KO did just that.

      Good luck in your investing journey! Hope 2016 is finally the year where you can call it quits and live it up

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    4. haha, yeah Zero Hedge gets a bad rap, but you'd be surprised with how quick they get their intel in on market moves... I ignore 90% of their articles, but there are occasional gems for sure.

      Here's an interesting stat on CA: "California is overtaking Brazil as the world's seventh-largest economy, bolstered by rising employment, home values and personal and corporate income, a year after the most-populous state surpassed Russia and Italy."

      Much of GDP here is from tech, obviously... As for tech stocks, nope I don't own a single one. When my company shares vest, I sell ASAP :)

      I don't believe in "all my eggs in one basket" approach either...

      Real estate does require a different mentality. I started out with DGI, definitely appreciate all its merits, and would agree REI is more risk/reward... I know I seem crazy with over $1 MM in debt, but I've got over $400k in liquid assets, non-correlated with REI... Debt doesn't kill you, it's lack of liquidity (CASH!) that will take you down... I learned that from my REI mentors... Long-term, just like stocks, REI is just about the best inflation hedge you can ask for... The appeal with REI is 30 year fixed low rate interest rates... As long as you are smart about not over leveraging, and generate sufficient cash flow, I would say the risks can be contained (obviously you can't eliminate completely).

      My point with the dividend tax increase was just saying if the law changes, it would impact all stocks... No different than if a new real estate law took effect and say raised taxes for all my California properties... That's why I like to own different assets, rental properties and dividend stocks...

      I don't own any dividend stocks atm, but this is of course in my long-term gameplan... Probably not obvious right now, but I first need to make a fortune off my gold trade ;)

      Take care!

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  8. I think your plan works during a bull market. Cannot stress how badly Buffett does during a bear market. Saying that, he has a large pc cash reserve ie his portfolio is not totally invested. Much respect to you nonetheless, but riding a bull market is very easy

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    1. If you are unwilling to hold stocks though multiple 50% corrections, you deserve the mediocre investment results you obtain

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  9. High quality municipal bonds can be another nice income stream. Their non-correlation with stocks tends to add diversification - when stocks go down, munis often go up. This can also make them inexpensive when DGI stocks are more expensive. Yes, there is no interest growth - a downside.

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