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My Investing Manifesto

October 1, 2010

I started investing in 1998, when I signed up for my firm’s 401(k) plan. Two  bubbles (.com and housing) later, I’m getting back to basics and questioning everything I read or hear about investing. First it was the mutual fund marketing machine, then the S&P 500 index/passive investing crowd, currently it is the flight to safety in bonds. It is hard for an individual investor to tune out all the noise and stay on course.

Here then, is my manifesto:

The Goal:  Invest my money so that it generates enough income to pay my expenses.

I call this financial independence, or an F-U fund. When my income from investments is capable of covering my expenses, I can choose to say F-U to work, bosses, or anything that requires me to trade my time for money, should I choose.

As much as I’d love to get lucky and find the next Microsoft or Google, it probably won’t happen. This will be a long-term project but then most things that are worthwhile take time and discipline.

The Plan:

  1. Purchase dividend paying stocks in blocks of $1,000.
  2. Rinse, repeat until I feel sufficiently diversified across different industries – perhaps 20-30 companies?
  3. Add to existing holdings or purchase additional companies’ stock.
  4. I will consider selling any position that cuts or reduces its dividend, or falls below my investing criteria listed below.

The Strategy: I’m shooting for a dividend yield of about 5% across our portfolio. My current mix is a group of higher yielding stocks (over 5%) plus a group of stocks with a higher dividend growth percentage. Ideally, I’d like to hit 10% yield on cost within 10 years, or 10 x 10 as described in this excellent post.

I’ll use traditional stock screens to find potential investments, as well as the Dividend Aristocrats list. I will look for stocks with an attractive valuation – probably no higher than a P/E ratio of 15 and a price/book value in the 1.0-1.5 range.

The Reasoning:

First, I realize this will take extra time, as opposed to just putting money into a mutual fund and letting the professional managers do their job. For something as important to me as my future financial security, I consider it time well spent. I’ll save my rant on the mutual fund industry for another post, but suffice it to say I believe an individual investor can beat the pros at their own game.

Second, while index funds may be a step-up from managed mutual funds, I still see one major flaw. Any index fund, by design is reactive, seeking to mimic the index it tracks. Therefore, when the index falls, the associated fund will fall. This is not to say that my investments will never decline, but I prefer a more pro-active approach to investing: finding good companies at a discount and holding them, while earning a return in the form of dividends.

Third, what most people consider investing – putting their money into the stock market and hoping for stock price appreciation – is akin to gambling or playing the lottery. While the stock market has traditionally appreciated over time, and we’re talking long periods here, there is no guarantee it will continue to do so. I prefer to take current value into consideration, thereby eliminating some of my risk.

Fourth, I realize there are other investment vehicles available that may produce a higher yield – MLPs, royalty trusts, etc – but for now I’m focusing on dividend paying stocks. As I become more comfortable with those, I may explore other investments in the future.

Fifth, I believe dividend investing provides a built-in hedge against inflation. Take Johnson & Johnson* for example, a company that has been able to on average, double it’s dividend payment every 5 years since 1974. With historical inflation running 3-4%, you can see JNJ has more than kept up with that.

Sixth, dividend paying stocks inherently have a long-term horizon. Since paying (and raising) dividends annually is a major commitment, I see companies that are confident in their operations as attractive investments. That’s not to say a company couldn’t cut or eliminate the dividend (as many banks were forced to recently), but if that happened, it would be easy enough to re-evaluate the company. If you invested in an index fund, you’d have to wait for the stock to be removed from the index, which would surely come long after the decline in stock price.

Finally, what about bonds/fixed income? This discussion is primarily related to our personal savings outside my 401(k) plan, which is sadly only allowed to invest in crappy mutual funds. Until I can convince the powers-that-be to change that, I will use my 401(k) to purchase the bond component of our portfolio. I have a separate strategy within my 401(k) that I will touch on in a later post.

*Full disclosure – I own shares of JNJ.

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From → Challenges, Investing

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