Wednesday, January 28, 2015

My Dividend Goals for 2015 and after

Early each year, I try to discuss what my goals for the next few years are. However, I really do not like to set financial goals. Rather, I try to behave in a way that fosters wealth building.  This helps me stay on task an accomplish those goals, better than simply setting up goals. This essentially means always spending less than what I earn, always questioning expenses, and continuously monitoring ways to cut expenses and stretch my dollar, without sacrificing quality of life. I also do not like to set goals, because things change, and I learn more about different opportunities along the way. If I adhere strictly to my goals, I will achieve them, but I might be worse off overall. Therefore, it is important to have some flexibility and focus on the best opportunities available, rather than adhering to specific goals for specific goals sake. What I am saying might seem confusing at first. What I am trying to say is that I try to make it a habit to follow a few common sense guidelines all the time, and have found that I have been better overall. If you spend less than what you earn, and invest the different, you will be better off overall financially. That's why you never hear people who enjoy working out 3 - 5 times per week set goals to lose 10 pounds in 2015 - they don't have to because they have the habit to not have to set goals. If those people got into the mindset of consciously trying to be healthy by avoiding overeating and spending some time on a little regular physical activity, they would be successful without really setting specific goals.

For example, between 2007/2008 and 2012, I put most of my money in taxable accounts. My dividend income was growing exponentially, I was reinvesting it back into more dividend paying stocks. I was able to achieve that by constantly saving money and also by focusing on growing income. As I made more money from job, dividends and other sources however, I noticed that I was paying way too much in taxes. Those dollars were lost forever to the tax-person, and were hard earned dollars which would never compound for me. As a result, I made a decision to max out my tax-deferred accounts in early 2013. Those accounts include:

- Pre-tax 401 (k), where each dollar deferred results in immediate savings of 30% (Fed and State)
- Pre-tax SEP IRA, where each dollar deferred also results in immediate savings of 30%
- Roth IRA, where each dollar earned will compound tax-free and be tax-free upon distribution when I become 59 ½ years old
- Health Savings Account, where each dollar deferred results in immediate savings of over 37.60% ( defers Federal, State and FICA taxes)

I have calculated, that if I wanted to save $100,000 in taxable accounts, I would have to put $10,000/year for 10 years ( I am only looking at contributions, and ignoring compounding in order to make comparison easy and straightforward). If I implemented tax-deferred accounts such as 401 (k) and Roth IRA, I would be able to save something like $3,000/year on taxes. Those savings come from maxing out the 401 (k) at $10,000 at a 30% tax rate ( Federal and State). Those tax savings could be put in a Roth IRA, and compound tax-free. Therefore, by using only taxable accounts, you can contribute up to $100,000 over a ten year period if all else is equal. By using a smart strategy of tax-deferred contributions and immediate tax savings today, the investor will be able to save $130,000, which will compound tax-free until they get to be age 70 ½ years old. Therefore, by utilizing tax-deferred accounts, the second investor is essentially speeding up their accumulation process, and brings their financial independence/retirement date closer by 3 years for every 10 years of saving. Since your lifetime is limited, any shortcut that can shave off spending time at a job you might not enjoy 100% could be worth it.

Most of the funds in the SEP IRA, regular IRA’s and Roth IRA’s are invested in individual dividend paying stocks. The money in the 401 (k) is invested in index funds, since this is the only option available. As I change jobs however, I plan to rollover that money into IRA’s, and select individual dividend paying stocks available at attractive valuations.

With that being said, I am deferring an awful lot of money in tax-deferred accounts mentioned above. Therefore, I am essentially starving my taxable accounts from fresh capital. To grow that dividend income in taxable accounts, I am essentially relying on organic dividend growth and selective dividend reinvestment. My assumptions for historical organic dividend growth are approximately 6% - 7%/year, while the assumptions for dividend yield at reinvestment is somewhere between 3% - 4%. This is why I expect them to generate income growth of approximately 10%/year. In 2014, I was able to cover approximately 66% of my target monthly expenses with dividend income from my portfolio. My estimate for 2015 is to have my dividend income cover approximately 73% – 75% of expenses.

As I have mentioned earlier, if everything works as planned, I will be able to cover my expenses from taxable dividend income sometime around 2018. This of course assumes that I do not spend much time on the unemployment line. Unfortunately, most employers these days are streamlining operations in an effort to achieve profitability for their investors, which means mass rounds of layoffs for employees, and increased level of stress and responsibility for those lucky souls who are left to man the fort. The dividend income generated by tax-deferred accounts is not counted in the income replacement goal by 2018. That money is essentially a buffer, that will be used just in case something unexpected happens. Since the probability of me using that tax-deferred money ever is moderate to low, it is being stashed in a way that it will compound tax-free for several decades. This is one of my tools in my quest to have margin of safety in financial independence.

My plan also assumes that there are investment opportunities out there available at good prices. If there aren't any quality dividend growth companies available at decent prices, I might have to end up building up a cash reserve. I do not want to pressure myself to make buy decisions, when the opportunities are simply not there. I would not want to pressure myself to buy companies of poor quality or companies at overvalued prices, merely to achieve a goal.  In another example, if I find myself short of my objective, I might feel pressured to chase high yielding stocks. This could lead to me reaching my dividend income goal on time ( or early), but might expose me to excess risks, which could derail long-term dividend income growth for my dividend portfolio. The point is not only to reach the dividend crossover point around 2018, but to have this income stream grow above the rate of inflation for the subsequent 30 - 40 - 50 years. I am not interested in reaching a goal for the goal's sake, but rather to achieve an investment objective in a sustainable matter.

The types of companies I might add to in 2015, if their valuations are right and things do not change:

Baxter International Inc. (BAX) develops, manufactures, and markets products for people with hemophilia, immune disorders, infectious diseases, kidney diseases, trauma, and other chronic and acute medical conditions. The company has raised dividends for 8 years in a row. In the past decade, the company has managed to boost dividends by 13.20%/year. Currently, the stock is selling for 14.80 times earnings and yields 2.90%. Check my analysis of Baxter.

Diageo plc (DEO) manufactures and distributes premium drinks such as Johnnie Walker, Crown Royal, Buchanan’s, J&B, Baileys, Smirnoff, Captain Morgan, Guinness, Shui Jing Fang, and Yenì Raki.. The company has raised dividends for 15 years in a row. In the past decade, the company has managed to boost dividends by 5.80%/year. Currently, the stock is selling for times earnings and yields 2.70%. Check my analysis of Diageo.

Exxon Mobil Corporation (XOM) explores and produces for crude oil and natural gas. The company has raised dividends for 32 years in a row. In the past decade, the company has managed to boost dividends by 9.80%/year. Currently, this dividend champion is selling for 12.50 times earnings and yields 3%. Check my analysis of Exxon Mobil.

Unilever PLC (UL) operates as a fast-moving consumer goods company in Asia, Africa, the Middle East, Turkey, Russia, Ukraine, Belarus, Europe, and the Americas. The company operates through Personal Care, Foods, Refreshment, and Home Care segments. The company has raised dividends for 19 years in a row. In the past decade, the company has managed to boost dividends by 7.50%/year. Currently, this international dividend achiever is selling for 21.30 times earnings and yields 3.50%. Check my analysis of Unilever.

United Technologies Corporation (UTX) provides technology products and services to the building systems and aerospace industries worldwide. The company has raised dividends for 21 years in a row. In the past decade, the company has managed to boost dividends by 12.90%/year. Currently, this dividend achiever is selling for 17.70 times earnings and yields 2%. Check my analysis of United Technologies.

I do expect to keep earning money in some capacity (1099 or W2) after 2018 however. Therefore, it is very likely that this dividend income will be reinvested, while I live off that salary income. This is why it was important for me to defer any excess income in tax-deferred accounts. Plus, if I ever find myself at the age of 70 and still have money in a 401 (k) plan that I have not rolled over to a Roth IRA, I might have to find a job in order to avoid required minimum distributions. I would only have to ensure I do not own more than 5% of that employer, and that I roll over my 401 (k) into that employer plan. There are a lot moving parts to my plans, and since tax laws and investment opportunities are subject to change, I would have to keep up-to-date on them. For some this sounds like an insurmountable task - for me it sounds like a stimulating challenge to keep my mind sharp and benefit in the process. I do believe that continuously acquiring more knowledge is the key to achieving and sustaining financial success.

The goal of this post was not to brag about myself. Rather, it was to provide ideas to readers that dividend investing is just one tool in the wealth building process. I have done well with picking individual dividend paying stocks, as evidenced by the fact that I am on track to cover approximately 73% – 75% of expenses with dividend income alone. However, investors should not dismiss other opportunities available to them, simply because they might not fit in a certain model. I considered myself a solely as a dividend growth investor for a few years, and only put the bare minimum in 401 (k) to get the tiny match, and ignored Roth IRA’s. As a result, I am worse off, because of all the excess taxes I have been paying, which reduced the amount of capital I have at my disposal for compounding.

Just like companies continuously streamline their operations, and cut unnecessary costs, I also want to challenge you to review your largest expense items and look for ways to reduce them. My main expense item was taxes, which I have cut to the bone right now. The other major expense item is housing, which is a major expense item for most households in the US. So while I do not really look at formal goals, I have the mindset to continuously try to improve investment process, eliminate unnecessary expenses, and increase income in a sustainable way.

Housing is another opportunity I have continuously dismissed since starting this site in 2008. I have never owned a house/apartment. The more I think about it, the more I realize that I have been throwing money out the window by renting all those years. Of course, since I have changed jobs every 2 – 3 years, and changed cities and states in the process, it always made sense to rent. However, if I were to settle in one place for say a decade, it might make sense to buy a condo/house that is slightly larger than the places I have been renting ( but not a McMansion). Since I am not handy at all however ( as evidenced by the poor design layout of this website), owning a house sounds like a money and time pit right now. But were I to stay in one place for 10 years, it might be worth it to capitalize my expenses for housing. Everyone needs a place to stay, which is why capitalizing an expense might not fit with initial goals, but would make me better off overall.

So to summarize, the most important thing someone can do is have the mindset that is conducive of achieving the life they want to live. If you consciously live your life in a way that fosters health, wealth and quality relationships on a daily basis, you will achieve a lot more than merely setting goals or New Year's resolutions. Goals can be helpful for many, but it is more important to have the plan to accomplish something by having the mindset of accomplishing it. It is good to have goals, but do not blindly follow them for goals sake, and do not take actions merely to check a goal off the list, while potentially hurting your situation by limiting yourself too narrowly.

Full Disclosure: I own UL, DEO, UTX, XOM, BAX

Relevant Articles:

Margin of Safety in Financial Independence
Should I buy more high yielding stocks in order to retire early
Two Dividend Stocks I Purchased in 2015
My Dividend Goals for 2014 and after
Check the Complete Article Archive

31 comments:

  1. Excellent sensible advice. While ensuring financial independence and security is important, life balance and looking to others also should have an important place in our lives. Thank you for reminding us of these human values in the context of sharing financial info and experience

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    1. Thanks for reading and commenting. Getting to a situation where you can have some control over your life is the true end goal. Of course, getting there is the tough part.

      Delete
  2. I'm wondering what readers of DGI think about investing in the Canadian banks right now? Due to the low oil prices, depreciated loonie, and talk of a housing bubble in Canada, the banks have not been doing very well. BNS (Bank of Nova Scotia) especially has taken a hit, due to bad loans in it's Carribean operations. I seem to think that these problems are temporary, and are making this a good buying opportunity. Any other opinions?

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    1. I personally like the Canadian Banks, and own the largest 5. I bought some in 2013, and 2014. I might add some more in 2015. Canada is dependent on commodities, which seem to be going down in price. This could affect the economy, and loan charge-offs hence pressuring profitability in the short-term. In the long-run, the banks that survive will be earning more money and pay more in dividends.


      You might like this article:

      http://www.dividendgrowthinvestor.com/2014/10/canadian-banks-for-long-term-dividend.html

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  3. Regarding renting vs. owning a home, assuming you'd make a 20% down payment in the range of $30,000-40,000, that's 30-40k that you end up not investing in dividend payers in your late twenties and early thirties. Given that the cost between owning and renting is comparable (either can cost more at various times and depends on various assumptions), I think you and I (I'm also in my early thirties) have made the right choice to put investing before home-buying. Especially when you consider the importance of investing during the years 2008-2012 when valuations were so low.

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    1. I think it depends on many factors. My main idea is that I need to live in say a 2-3 (2br) bedroom space, no matter what. If my total annual cost of ownership is equal or just slightly higher than what rent for that comparable space is, I am willing to stay for say 10 years, I am better off owning.

      Yes, $30-$40K ion dividend stocks will compound well for 30 years. But a housing unit held for say 30 years could potentially keep up with inflation and provide a “house dividend” – you are essentially having the right to live in that space. There are expenses such as taxes, and maintenance. With maintenance being the wild card, especially for someone who has no experience with it.

      I have read reports on different REITs, and could see how they make money on renting out their properties. If I were to own the place I rent today, I would be better off since I will still have to pay mortgage, taxes and maintenance, but I won’t have to pay for the REIT profit or for their administrative costs. I think if I think about it as a direct RE investment, one can make the case that if I can buy a $200K house for 20% down, and then have at least a break-even cash flow ( meaning rent payment cover maintenance and mortgage and taxes), it could be a good deal.

      The downside of course is that one is locked in an area and cannot move away quickly without suffering a loss, they are not diversified, housing preferences change which affects prices, the housing unit might need a lot of work over time that could be costly, the area in which the house/apt is bought could become bad over time etc. Plus, you can always get a maintenance person who is terrible at what they do, and they will take your money for bad work.

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  4. But if all your savings is in IRAs and 401ks you can't draw on them till you're at retirement age. How will you live off your dividends if you can't touch them for years? Dividends from your taxable accounts and online income?

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    1. Hi Ken,

      You might like this article. It explains that it is possible to withdraw money before 59.5 yrs.

      http://www.dividendgrowthinvestor.com/2013/04/six-dividend-paying-stocks-i-purchased.html


      Also for 401K, you can withdraw before age 55, if you are retired.

      For Roth, you can withdraw contributions I think at any time.For Roth 401K/ Rollover Roth, I think you have to wait 5 years before you can withdraw contributions.

      The most important think is that I am hopeful that in my case, the tax-deferred money is a reserve I would never have to tap. I am hoping that the dividend income from taxable accounts is sufficient to cover expenses.

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  5. DGI,

    Not pretentious or bragging but rather a good old fashioned honest post. Our paths are similar but coming from different directions. I've been at the same job for 18 years and maxed out 401k and my Roth accounts from the day they were available, I wanted to hedge myself with tax deferred and after tax (Roth) retirement accounts to cover both bases. I've just recently started to move monies from mutual funds to individual dividend growth stocks, it's challenging and exciting at the same time and I welcome the diversity. Paying rent throughout college reminded me that I didn't want to pay rent through my adulthood, home ownership is not for everyone and it's an ever going learning process. My wife and I recently upgraded our home and are more then happy with or choice. If or when you decide to buy a home, don't pay it off with your current income thriving taxable or retirement accounts; however, I'd recommend 20 to 30 percent as a down payment. Remember, you'll make more money in the stock market then in the homestead market over the long haul, theoretically. I would also not recommend a fixer upper (fixer upper and a little upgrading are not one and the same), having done that in my mid to late twenties just takes too much time away from more important things in life, but that's just my experience. Time is precious and too much of anything is never good.


    Raymond.

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    1. Hi Anonymous,

      You said, "you'll make more money in the stock market then in the homestead market over the long haul, theoretically." Can you please advise what's the logic behind? I know I should focus on dividend investing, but couldn't help looking into housing market for opportunities. If there is concrete logic to convince me that DGI is better than housing investing, it'll help to keep focus. Thanks.

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    2. Raymond,

      Thanks for comment. Since I have only theoretical knowledge of housing, I am welcoming any feedback.

      I am going to research this further, but I wonder if it is possible (and what price) to buy a place with no money down, even if say interest rate on the downpayment is slightly higher. As for returns, I think it depends. I think my answer to Ryan D explains that if I evaluate a home I am looking to buy as an investment in a Rental House, it could deliver results that are close to that of say common stocks ( although not diversified etc).

      Delete
    3. MU,

      I think the answer is...it depends. If you buy a rental for 20% down, your tenants are nice, and the rent pays for mortgage, you could do pretty well. If you do not buy a McMansion, you might be better off than renting. And since you were going to pay rent anyway ( I of course assume naively rent expense is equal to total expense to own a comparable home), it is difficult to say that the money would have done better in the stock market.

      Of course, If you buy a money pit, your experiences will shape how you view homeownership. When you "own", you will likely have more "hassle", and less free time.

      Same is with dividend investing - there is some expected variability in results. You and I could both purchase the same company, but could do differently if say I overpaid and you didn't. Or you could end up selecting the next WMT, while I select the next SVU.

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  6. Good article....I contribute 6% into my 401k (enough to get the full company match of 50%), but no more. I don't like the investment options too much in the 401k, and prefer to have greater control. I also invest the max each year ($5,500) into my Roth IRA in individual dividend stocks. I then invest whatever is left in dividend stocks into my taxable account.

    I could invest more into the 401k and max that out, but I'd rather invest money into a taxable account and have more control. I'm not overly concerned about the 15% taxes on dividends in this account, considering I still am plowing money into my 401k and maxing out my roth each year.

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    1. Thanks for reading and commenting. You might want to check my response to Ken above.. It is possible to take money out of retirement accounts early... It just means more hoops to jump through :-)

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  7. Thanks for your post. I'm in a similar boat, where my taxable stocks (dividends) are costing me taxes. However, my 401k is already being maxed out annually. So with that being said, would you ever recommend investing in quality non-dividend paying stocks (such as Amazon, Google, etc) which will grow without paying dividends and costing taxes? My goal is similar to yours, being able to live off of dividends at some point. It seems like such a far off goal. I'm currently just at 7k/year in dividend income.

    I'm in the same boat on not buying a house as well. I get the benefits, but i live in Los Angeles, where even a 15 mile commute could take over an hour...

    Thanks!

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    1. I am not sure about pure growth stocks - I just have no framework/investment model that can pick those types of companies successfully. I would say something like Berkshire Hathaway or Markel would be the only non-dividend paying companies I would consider owning ( I own 1 B share). I have owned a few shares of Buffallo Wild Wings, but mostly since it is easier for me to keep tabs on companies when I have some (even minimal) ownership.

      I honestly do not like paying 15% in dividend taxes ( plus state tax on them). I wish the US deferred taxes on dividends that were reinvested and not spent. If I earned $1,000 in annual dividend income for 10 years, I would have to pay $1,500 in taxes. If you add say 5% state tax, we are talking about $2,000, which is equivalent to 2 years worth of dividend income. That money is forever lost, and would never compound for me. Sure it could pay for government services that I benefit from ( or others do), but I get the feeling I pay more than what I get ( although have no problem that this money can help people in a worse position than me, although this is where charitable contributions go towards - specific causes and injusticies I think are present today)

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    2. No state income tax in Florida, it's one of the few things I miss since moving.

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  8. Amazing! I love your philosophy and kaizen attitude. One of the many reasons I keep reading your blog.
    J

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    1. Arigatou J!

      Good luck in your continuous improvement and your dividend investing journey!

      DGI

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  9. An excellent summary of a successful and productive life style choices. It is helpful to me to see others who follow a similar strategy.

    I've been blessed to be able to save to 401k, DGI, 529, and for the past several years been adding another 1K per month directly to more quickly reduce the principal on our house. We live a parsimonious yet happy lifestyle with additional money given to our favorite charities. It's all a matter of settled priorites for God, family, neighbor and country.

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    1. Having harmony, being happy with lifestyle, and feeling blessed is something money cannot buy. I think subconsciously, this is what many people think that making/earning/saving a lot of money can bring them. The reality is by being happy in the moment, building relationships and maintaining the attitude of being satisfied with who you are, you are miles ahead of many others.

      Best Regards,

      DGI

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  10. It's tough to choose between tax deferment with IRA's and 401k's versus having access to your money before 70. I've focused mainly on tax deferred since my assumption is my income will keep increasing, the 401k will already be maxed out, and I'll have plenty of excess capital for regular trading accounts.

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    1. Tax deferred accounts can be accessed in multiple ways ( many of which - penalty free before 59.5), which can only be limited by your accountant's imagination.

      The best situation is the one where you are in a position to max tax-deferred accounts, and then also are able to contribute a significant chunk to taxable accounts in the process.

      Good luck!

      DGI

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  11. Thanks for the post. Utilizing all the useful tools that are provided by government is the easiest but the most effective way of smart investing!

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    1. That is somewhat true, but the options within a 401K plan are important as well. If you were limited to funds with 5% loads, and annual fees of 1% - 2%/year, then it might not make sense to max-out this account. My options include rock bottom costs, which is something not available for everyone.

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  12. Thoughtful piece, DGI. I am currently struggling with a related problem. To date, I've put most of my funds (about 85%) into tax-deferred vehicles and/or Roth accounts. My taxable accounts do not generate any significant income at this time as they are mostly in shares of a previous employer and a few other growth stocks.

    However, my goal is to retire somewhere between the ages of 50-55. That is between 11-16 years away since I am currently 39.

    In order to retire early, I really need to start building my taxable accounts and dividend income stream so that they can either

    a) cover my annual expenses outright or
    b) provide enough capital to reach 59.5, when I can access the retirement assets.

    My current approach is to work as much as possible to maximize income. I am maxing out my 401(k), ROTH and HSA. That should still leave a decent chunk for taxable accounts, but I wonder at what cost? I do not wish to sit behind a desk for 20 more years simply because I chose to avoid taxes in the here and now.

    There is a balance there somewhere, but I am still working on finding it.



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    1. Hi Gecko,

      Actually, there are ways to withdraw money from tax-advantaged accounts. Not sure of potential situation, but if you expect tax rates to be lower when you retire, then it makes sense to use a pre-tax 401K etc. There isn't a prize for paying the most in taxes - but your retirement could be potentially quicker if taxes are minimized on savings and on compounding. For retired 401K investors, you can start penalty free at age 55. For the rest, please see response to Ken above.

      Good luck in your dividend investing journey!


      DGI

      Delete
    2. Thanks, DGI.

      I'm definitely of the belief that I will be in a lower tax bracket in retirement, sans government intervention and/or changes to the tax code. Depending on whether I get married or not this year, I will either be in the 28% or 25% tax brackets. Not a bad problem to have. Either way, that's a minimum of $4,500 off my tax bill should I max out my 401(k). And another $800 in savings via my HSA.

      Eventually, I will look to utilize Roth conversions to shelter even more income from the tax man... on a permanent basis.

      As you say, it's all dependent on individual situations. 55 is my realistic goal, but 50 is my stretch goal and in order to get there, I will likely need significantly more in taxable accounts than I have today. You mentioned not having more than 15%-20% in IRA/401(k) assets in a previous article. I am headed for the opposite issue if I do not begin to put significantly more away in taxable accounts.

      Perhaps the best course of action right now is to cut expenses and save as much as possible, maxing out tax advantaged accounts in the process and hopefully finding ways to save at least as much in taxable accounts.

      Cheers

      Delete
  13. Visa is splitting 4/1 on March 19th YAY

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  14. Content is what matters, not fancy images. Keep writing DGI and good advice as always.
    DFG

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  15. Great post. Looking forward to following your journey to 2018, that seems like it will be a pretty important milestone for your journey.

    Cheers!

    ReplyDelete

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