Monday, April 25, 2016

How to have enough

I have shared with you early in the year, that I am essentially living off dividends and side income in 2016. I am saving my other income in tax-deferred accounts. I sleep like a baby*. I am happy with what I have achieved. However, I keep learning. I have a goal of generating a certain dollar amount from my portfolio within a certain timeframe. I also have figured out how to achieve that through regular screening, analyzing, and investing in quality dividend growth stocks.

Some people are never happy with what they have however. They never have enough. Their level of happiness is not dependent on what they have, but rather on what they don’t have. This is a slippery slope, which would put you in the rat race of its own. If you have a nice house, but your neighbor has a nicer and bigger house, you will succumb to a syndrome called ‘Keeping up with the Joneses”. If your portfolio generates enough dividends for you to live off, you should be happy. Many are not happy however, because their neighbor tells them they are doubling their money by investing in hot tech stocks. If you benchmark your success relative to the success of others, you will never be happy or accomplished. This is because there is always someone that is better than you at something else.

As an investor you need to have goals, and then create a strategy to achieve those goals.

For investors like you and me, the goal is to live off our nest eggs, and to never outlive them.

As investors, our biggest demons are within ourselves. When stock prices go down, I guarantee you that you will not feel good about the choices you made. However, if you had a strategy in place, and you knew why you selected it, and you were prepared for this wild ride, you will have the mental fortitude to stick to this strategy through thick and thin. You will not be scared by meaningless fluctuations in stock prices. In my case, I am able to stick to my strategy, because I focus on underlying earnings power of the businesses I select. I try to mostly select businesses that will keep earning money and paying me a stable and growing dividends even during recessions. When I receive dividends, this is cash I can use to spend or invest in more dividend paying stocks. When I receive a dividend, I am rewarded for being a patient business owner. This dividend serves as a positive reinforcement that my strategy is working, that the businesses I own are earning money. This provides me with mental strength to ignore price fluctuations. They are meaningless, and will not scare me away from parting with my businesses.

Many mistakenly believe however that they need to do better than a benchmark. This is perfect example of keeping up with the Joneses mentality. Focusing on meaningless short-term performance relative to a benchmark does not add any meaningful actionable information for someone who has specific goals and specific strategies to achieve them. The goal of the investor is to reach their goals and objectives, not to compare themselves over the performance of others. This way, an investor will be more prone to abandoning their strategy during times when things look bleak. The investor who abandons their strategy because it did “worse” than the strategy of someone else is someone who deep down didn’t believe in their strategy in the first place. This is a perfect example of envy.

When picking a strategy, you need to think about risk and rewards and requirement of the new strategy. What about sequence of return risk? This investor will spend the rest of their lives moving from strategy to strategy, and never really making much money. This same investor will be prone to abandoning the other strategy, when things get tough and there is a bear market for example.

I have envy as well. One of my friends invests in technology stocks. His investments from 2009 went up somewhere between six to eight times in value. I think he might have gotten lucky however, because his earlier investments lost half of their value, and he locked in his losses. His subsequent investments have not fared too good either.

My goal is to earn enough in dividends to live off my portfolio. My goal is not to beat anyone up.

Fun Fact: My grandma's checking account has beaten the S&P 500 since the end of 1999. But Wall Street is not calling...yet.

For example, I want to be able generate $1,500 -  $2,000 in monthly dividend income by 2018. Between 2008 and 2016, I saved money every month, and then put it to use in the best values at the moment. I define best values by running a  screen against a list of dividend growth stocks, isolate the ones I want to focus on, analyze them, compare them against each other and select the best values relative to what I own. If all the companies I select stop growing dividends, because their earnings growth slowed down, then I will not be able to reach my goals on time. If too many dividend stocks I own cut dividends, then I will be able to reassess that I may be making a mistake during stock selection. I do not need to review my performance relative to a benchmark to see something is not working. I only need to review performance relative to my goals. I also need to review each company I own every 12 – 18 months, in order to review if things are working on the fundamental level.

Of course, if I reach my goals, and earn enough dividend income that grows at or above the rate of inflation, then I am all set.

The problem with benchmarking is that you are comparing yourself to a moving target. Noone can predict where stock prices will be in 1 or 5 years. I can predict dividends better – they are more stable. I have more confidence predicting that my dividend income will be $1,500 -  $2,000/month in a certain year, than predicting what my portfolio value will be.

Let's put benchmarking into the perspective of living my own ordinary life. You can say that had I gone out and studied engineering or computer science, I could have earned more, and possibly even had a higher dividend income goal given the same amount of time in the accumulation phase. If you compare me to someone who earned twice as much as me, and saved twice as much as me, and has a monthly goal of twice as much as mine, I look like a failure. Also if you compare me to someone who needs more than $2,000/month, then I look like an even bigger failure, even if I reach my goals. Keeping up with the Joneses could be depressing, but ultimately lead to terrible decisions and outcomes. In my case, if I studied engineering or computer science, I would have likely dropped out of school and never ever accomplished what I have accomplished now.

An even worse moving target is predicting where stock prices will be and your performance relative to those moving prices. This is insanity. Let’s say I die with $5 million in 2046. Let’s say at time of death my portfolio generated $12,500 in monthly dividend income (this would roughly translate to $60,000 in annual dividend income at 2016 prices using a 3% annual rate of inflation). Let’s also say that by investing in something else, I could have died with a portfolio worth $8,700,000, which generates $14,500 in monthly dividend income. Many will claim that my portfolio was a failure, and use it as an example of how “dumb” individual stock pickers can be. After all, I could have had $3.7 million more by not being so thick headed. But I am fine if people disagree with me, as long as I am reaching my own goals and objectives.

Fun Fact: If on the other hand I die with $10 million in 2046 as a result of following my own stock selection strategy, but another approach would have "only" earned me $7 million. Then many supporters of a certain strategy would claim that my results were attributable to luck. This is a great example of how you will be considered the village idiot, no matter what you do, as long as you do not do things in a way that other people expect you to do them. This is where the concept of an inner scorecard comes into play. This is what was written on the topic in Buffett's biography " The Snowball":

"The big question about how people behave is whether they've got an Inner Scorecard or an Outer Scorecard...If all the emphasis is on what the world's going to think about you, forgetting about how you really behave, you'll wind up with an Outer Scorecard. Now my dad: He was a hundred percent Inner Scorecard guy. He was really a maverick. But he wasn't a maverick for the sake of being a maverick. He just didn't care what other people thought."

Of course, noone in 2016 could predict which strategy will do best for the next 30 years. Plus, noone knows whether the sequence of returns for my strategy will be better or worse than the sequence of returns in the other strategy. Anyone who claims so, is lying. Of course, if you believe having $5 million and earning $12,500/month in passive dividend income is a failure, you need to have your wiring checked out by a local psychiatrist.

The more important thing is to come out with your own investment goals and objectives that truly matter to you. Having a reasonable timeframe to get there is helpful as well. The next step is to determine how to get there, through meticulous savings and investments. Following an investment strategy that fits your personality is important, in order to ensure that you stick to it through thick and thin. You need to avoid the urge to switch strategies if someone seems to be doing better than you. If you frequently switch strategies, you may develop the mentality of buy high sell low, that could be expensive for you.

In this article, I discussed the importance of having enough to reach your goals. Keeping up with the Joneses in the spending or investing arena could be costly in the long run. This is why it is important to have an amount at hand that is "enough" for you. Otherwise, you will spend your life stuck in a rat race with no end in sight. And this is a stressful life.

* I sleep like a baby, because I wake up every three hours and I cry. This is a joke - it is nice to take it easy from time to time and not take yourself too seriously. This is what "enough" means to me - the ability to be perfectly happy with who I am.

- Simple Investing Principles to Follow
Should Dividend Growth Investors Dip into Principal?
The Biggest Investing Sin Exposed
How well do you know your investment strategy?
Emotionless Dividend Investing

Popular Posts