Category Archives: Investment Strategy

What is a Dividend Aristocrat?

When I first started on my journey toward financial independence, one of the first things I became interested in was dividend investing. There’s nothing necessarily better about dividend stocks, but they do offer advantages for people who are looking to escape the 9 to 5 job much earlier than the conventional retirement age. The number one advantage is that they’re somewhat more predictable than non-dividend stocks. When the market is volatile, it’s hard to know what your investments are going to do. But if you hold stocks that pay dividends, you can be reasonably sure they will continue to pay you dividends, even if the stock price drops. This gives those of us looking to escape the rat race early a level of predictability that helps us plan our futures. We don’t know what the stock price is going to do, but we know that every year we’ll receive x dollars in dividends.

Dividends will also turn into a predictable cash flow once we achieve early retirement. While we’re building up our investments, we re-invest dividends, but once we’ve established a large enough nest egg so that our dividends are big enough to live on (or big enough to supplement a part time job), we may opt to start receiving dividend checks and living off of truly passive income.

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New Purchase and a Bit About REITs

Today I accomplished one of my goals for the year. After quite a lot of difficulty dealing with Vanguard (more on that later), I have become a real estate investor. I don’t have the kind of capital to purchase a rental property, but that doesn’t mean I can’t have real estate investments. Thanks to real estate investment trusts (REITs), anyone can invest in real estate.

REITs are companies that own income-producing real estate such as offices, hotels, healthcare facilities, apartments, shopping centers, etc. REITs are set up differently than most companies, in that they are required to distribute at least 90% of their taxable income to shareholders, and generally pay little or no corporate income tax. However, because the money is not taxed at the corporate level, the dividends are taxed as ordinary income for the shareholders, as opposed to the 15% dividend tax you’d pay on most of your investments. 
Because REIT dividends are taxed higher than other dividends, a good strategy is to keep your REIT investments in a tax-advantaged account, where the dividends can grow tax-free. Following this strategy, I purchased two REITs today in my Roth IRA. 
My first purchase was Digital Realty Trust (DLR), a company that owns 108 data centers in Europe, North America, Asia, and Australia. I was drawn to this company immediately because I like the idea of investing in data centers. With the recent rush toward the cloud, many companies are abandoning costly in-house data centers and storing their data with hosting companies that operate large data centers. I don’t see this trend stopping any time soon, so I see this as a great opportunity.
While I’m admittedly not an expert in understanding the inner workings of a business and predicting future success, DLR seems like a solid company. Sales and earnings have been growing over the past 5 years and are projected to continue doing so. The current dividend yield is 4.57% with a dividend growth rate over the past 5 years of 20.59%.
My next purchase was Senior Housing Properties Trust (SNH), a company that owns 375 properties, primarily senior living facilities, in the US. With an aging baby boomer population, I thought senior living facilities would be a solid investment. It was a tough call for me between SNH and Health Care REIT (HCN), which also owns senior living facilities, but additionally owns many other medical facilities.
HCN is much bigger than SNH and arguably a safer investment. In the end I chose SNH for one reason: while both companies have had similar 5 year dividend growth rates (2.19% for SNH and 2.31% for HCN), and earnings are projected to grow modestly in the next 5 years, HCN’s P/E ratio is too high for my comfort at just over 100. (Oh, and the 7.22% dividend yield for SNH didn’t hurt.) Now I reiterate that I’m no expert, and SNH’s lately stagnant price, which contributes to its lower P/E ratio, may be an indication of trouble, but the company’s recent dividend increase this month offers some confidence that they are doing well. Hopefully this decision will work out in my favor, only time will tell.
Now about Vanguard. They did not make this transaction easy for me. I already had three accounts with Vanguard: one account that holds my mutual funds, a brokerage account that holds my individual stocks (which is connected to a money market fund in my first account), and a Roth IRA that holds my retirement funds. To invest in REITs, I had to open a separate brokerage Roth IRA. No biggie, but I assumed Vanguard would be intelligent enough to recognize that I already had a Roth IRA and open up the required linked money market fund in my existing account. Instead, they opened up another Roth IRA to house to money market fund, so I then had three separate IRAs! My call to the help center was very easy at least, they immediately saw what happened and told me they’d fix it within 24 hours. It actually took them three business days, but at least it’s now fixed. I’m not sure if this is a common problem, the support guy said he’s seen it happen before, but I think I’d recommend that if you’re trying to make account changes and at any point in the process it doesn’t seem intuitive, just call Vanguard and have them do it for you.

Patience is a Virtue

I received a lesson in patience this morning. I made sourdough bread for the first time this weekend. I had a slice when it was fresh out of the oven, and it was delicious. Then I had another slice this morning. Not so delicious. It was a dense mass that is now sitting heavily in my stomach, making me feel like crap. I followed the recipe exactly, so I did a quick Google search to figure out what went wrong. Best I can tell, it’s one of two things: I either didn’t let the dough proof for long enough before baking, or I didn’t knead it for long enough. I thought I had mastered the art of patience, since this bread already took roughly 15 hours or so from start to finish, but apparently that’s not long enough!

Would it be too cliche to use this paragraph to talk about how bread making and personal finance are related? Well too bad, they are! And when I think in terms of personal finance, I realize that I haven’t mastered the art of patience at all. How many of you out there check on your investments every day? My hand’s up. There is absolutely no reason I should be checking on my investments so frequently. What do I think will have happened overnight? But I can’t help myself, I always want to look and see what they’re doing. I can at least say that I have the will power to not tinker with my investments whenever there’s the slightest change, but checking in on them constantly is a clear sign that I have not mastered the art of patience.

Financial independence doesn’t happen overnight. It will takes years of hard work, and monitoring my progress on a day-to-day basis will only make that process seem longer. So breathe, relax, think about something else, and let that damn bread proof for another couple hours!

Baby Steps

It can be very difficult when you’re just starting out to not get discouraged that things aren’t happening faster. I check in on other dividend investment blogs and often the authors are making a handful of purchases each month. Because I’m focusing primarily on my down payment fund, dividend stock purchases are few and far between. A huge portion of my monthly savings are going into the down payment fund, and just a couple hundred dollars a month are going into a money market holding account that I use to purchase stocks. The stocks are the more exciting part of investing (though when my down payment fund gets big enough that I can start looking at houses, that will be pretty exciting!), so it’s a bit discouraging to see the months pass by without making any new purchases. And while I am making a significant contribution to my down payment fund each month, the housing prices in my area are so high that it will still take me several years to get a sizable down payment. So it seems like nothing is happening.

The relative inactivity makes me question a lot of things. Are my long term goals really realistic? Should I be doing more to reach my goals faster? What the hell should I write on this blog when I’m doing nothing with my money?

Well I should probably write about my frustration so I can try and channel it into something more productive. I’m sure there are many other Gen Yers out there who are just as frustrated as I am that they don’t see their net worth growing as quickly as they’d like. So what should we do when our goals are still so far away and every step we take toward them seems infinitesimal?

There are two primary ways to turn our frustration into determination. First, we should be looking for ways to increase our income and save more money. My last post described how I finally switched my cell phone onto my company’s plan, saving me about $100/month. I’m also going to be selling a few larger ticket items on eBay before too long, so that will bring in some more money, though it will just be a one time spike in income. The second, and much easier, way to channel that frustration is to focus on more appropriate goals. When I first started this blog last month, I set out some year end goals for myself. These goals are great, but to keep myself motivated, I need to focus on much smaller goals on a day-to-day basis. Some good micro-term goals would be going three days without spending any money, watching less TV, making a great dinner out of leftovers, etc.

These small goals give you an opportunity to accomplish things every single day, so you’re not waiting until the end of the month to see how much your net worth creeped up. You may already be doing a lot of these day-to-day savings tactics without even thinking about it, but treating them as small daily accomplishments helps you to let go of some of the frustration.

So no, on a month-to-month basis things are not happening very quickly. But every single day I’m making progress and accomplishing little goals. Don’t ignore those small accomplishments, you can’t get to the big accomplishments without them.

Investment Advice from Scott Adams?

Before I made my first stock purchase last year, I read some investing advice from Scott Adams. Now I know, I should probably be taking my advice from economists, not cartoonists, but the man is just so damn brilliant! And the article was published in the Wall Street Journal, so it’s got to be legit, right? Even his intermittent reminders to ignore his advice don’t deter me! His theory is that you should invest in companies you hate. Why? Because there’s a reason you hate them – they’re giant evil corporations that only care about making money. Sucks for the good of the world, but great for my wallet. But I’m also into dividends, so by combining these two philosophies, I dove into investing with a very clear plan – look at the list of Dividend Aristocrats, and pick the ones I think are evil. And so I picked McDonald’s.

Scott Adams points out the flaws with pretty much every other method of picking stocks, my favorite being this gem:

Perhaps you can safely invest in companies that have a long track record of being profitable. That sounds safe and reasonable, right? The problem is that every investment expert knows two truths about investing: 1) Past performance is no indication of future performance. 2) You need to consider a company’s track record.
Right, yes, those are opposites. And it’s pretty much all that anyone knows about investing. An investment professional can argue for any sort of investment decision by selectively ignoring either point 1 or 2. And for that you will pay the investment professional 1% to 2% of your portfolio value annually, no matter the performance.

So far, I’m not sure there’s a fallacy with this plan. Dividend Aristocrats that I hate seems like a solid investing strategy. Wal-Mart may be next on my list. And I hate Aflac commercials… does that count? The only issue is I’ll run out of suitable investments pretty soon because I don’t know enough about most of the companies to know which ones I hate. Or I could just base it on arbitrary things, like the scrabble score of the ticker symbol… JNJ here I come!!

My Strategy

When I opened up my Vanguard account last year, my mother told me I should invest in index funds because they will give me the best return in the long run. Solid advice, mom. Thank you. But the problem is that I’ve become a bit obsessed with learning about investing, and the boring, buy-and-hold, index fund strategy isn’t very intellectually stimulating.

I read about dividend investing, and was intrigued. I can recognize that a solid, value stock with a good dividend may not be any better than a solid growth stock that doesn’t pay dividends, but psychologically, the dividend is important. In these hard economic times, it’s difficult to have faith that an increase in the price of a stock is going to be anything more than a momentary high before something else goes wrong with the economy. A dividend is tangible, it’s there every month/quarter/year, whatever the price of the stock is doing, and it allows me to automatically buy new shares of the stock.

My current strategy may be a bit disjointed, and possibly a bit misinformed, but I’m ready to learn and grow, and shape my financial future over the coming years.

The Strategy

While I like the idea of building a diversified portfolio of dividend stocks, I’m nowhere near wealthy enough to able to do that yet, so it’s important that I stay invested in an index fund. If I decide at some point that my individual stock holdings provide sufficient diversification, I may phase out the index fund. But that wouldn’t happen for a long time. I’m currently split about 50/50 between my index fund and individual stocks. For now, I’m sticking with Dividend Aristocrats, which are stocks that have increased their dividend every year for at least 25 years. I figure since I am not very knowledgeable yet about picking stocks, this is a pretty safe place to start.

Index Fund: Vanguard Total Stock Market Index Fund
Individual Stocks: MCD, T

Separate from my 50/50 mix, I started a more conservative fund to save for a down payment on a house. It will be several years before my boyfriend and I can afford a 20% down payment on a house in the Bay Area, so I’m comfortable with a bit of risk here. As my time horizon shortens, I will probably sell this and keep the money in a savings account or CD.

Down Payment Fund: Vanguard Wellesley Income Fund (about 60% bonds / 40% stocks)

As for retirement funds, I’ve been investing in a pretty well-diversified set of index funds in my 401k for the past  four years. Earlier this year, I opened up a Roth IRA for 2011 with just one index fund. I’ve been reading up on REITs lately, and I’d like to add a healthcare REIT to the IRA this year.*

401k: Vanguard Developed Markets Index Fund (15%), Vanguard Small Cap Index Fund (20%), Fidelity 500 Spartan Index (25%), American Funds American Mutual R6 (25%), DFA Emerging Markets (10%), DFA Inflation-Protected Securities (5%).

IRA: Vanguard 500 Index Fund

*REITs operate differently than other stocks/funds. They are required to distribute 90% of their taxable income to shareholders, but those dividends are taxed at your ordinary income rate, rather than the 15% rate that applies to other dividends. Since I am above the 15% bracket, it makes sense to own REITs in a tax sheltered account, so the dividends can accrue tax-free.