The Savings Rate – Revisited

My dear loyal readers,

I sincerely value your readership and appreciate your patience over the last few weeks in sticking with my blog updates. I am hoping that I have not lost you. Life has been crazy busy over the last several weeks. As I stated in my previous post, I am going through an fairly significant change in my professional life which has been consuming a lot of my free time. I would finally like to talk about this in this post.

Before getting started, I wanted to take you back to the topic of “Savings Rate” which I have also talked about previously on this blog.

A simple equation to look at your savings is as follows:

Savings = Income Generated – Expenses

Our objective is to improve the savings rate to the best extent possible, because higher the savings, the more capital we have to invest into our own future. For dividend growth investing to work as a strategy, it is important to ensure that we are investing as much capital as we possibly can atleast during the accumulation phase of our investing journey.

None of this should be overly controversial as the subject of improving the savings rate is pretty critical to the success of ANY investing strategy, let alone dividend growth investing.

The part of the equation that does not get as much attention as it should is the “Increasing Income” part. Since we are so hyper-focused on the “reducing expenses” part of the equation, we generally ignore the aspect of getting better at our day jobs and “coast” through it. Some of this is due to the relative comfort of our job, we understand it pretty well, why push ourselves in the quest for something better? Is it really worth it?

In my case, I saw a couple of interesting dynamics that prompted me to seriously ponder over this question. The rising inflation was one of these factors. At the time of writing this, we are seeing record-high levels of inflation and it is unclear how long this situation will last. The other dynamic was a question about my employer’s profitability in the years to come. As an investor, I am now used to reading through financial statements and questioning aspects of the businesses that I am invested in. I used some of these learnings to study the financial statements of my own employer. The exercise revealed some interesting insights. I was able to make reasonable approximations about the company’s long-term profitability and make reasonable guesses about how long it would take me to reach my financial goals if I would stick with this employer. It also dawned on me that while things are great with my employer at present, there is only so much I could do to boost my pay beyond a certain level. Ultimately, this exercise prompted me to start considering other options.

Interviewing in my area of expertise (i.e. tech sector) is incredibly hard and requires months of arduous preparation. This is because the interview process itself is fundamentally broken thanks to the FAANG (Facebook/Meta, Apple, Amazon, Netflix, Google) style of companies. These companies have tailored the software engineering interviews to include questions surrounding topics that an engineer would have typically studied back in graduate school. These questions, while academically interesting, have arguably little practical relevance. Unfortunately, the rest of the tech industry has been so enamored by these FAANG companies that they have replicated the interview process as well. It can be mind-numbingly stupid at times, but there is nothing much anybody can do about this.

Anyhow, the mere thought of preparing for interviews can be demotivating by itself. In my case though, I had to look past this and focus on my larger goals. So I prepared….juggling my responsibilities between a full-time job, my family responsibilities and using every little free time available to prepare.

After interviewing with several potential employers, I landed up with offers from a handful of them. Apart from evaluating the offers themselves, I studied each employer’s history by looking through their annual SEC filings, reading up about the management itself and factoring those into my decision making. This is something that I never did previously in my career. I would mostly look at the role itself, look at the offer in isolation, rely on the recent media news about the company and just take a blind leap of faith about the health of the company. My education as investor has forced me to research these other aspects of a potential future employer and use that to make a decision.

In the end, I am happy that I went through this process. Change is incredibly hard to accept especially as one progresses through life. But sometimes it is important to take a step back, analyze and make a difficult decision. At this point, I have no idea if my decision is right or not. But the decision is based on a logical premise, and that is all that is in my control.

Thoughts on investing philosophies

I wanted to take a step back from the dividend portfolio updates and talk about a subject that has been on my mind lately. Investing is such a diverse topic with various facets that sometimes it is easy to muddle things up and ultimately lose focus. While I was beginning my investing journey, I found it overwhelming and confusing to listen to so many “experts”. It was difficult to understand and chalk out what was the right path forward that would meet my goals. I would like to share my thoughts on this subject to aid some new investors who can hopefully learn from my experience. I’ll try divide these into individual sections and cover them one at a time.

Investing strategy

This is such a hotly debated topic in the investment community. There are various strategies available to the individual investor: growth investing, value investing, dividend investing, index fund investing etc. And while there is no right or wrong approach with each of these, it is amazing how passionate some folks get when discussing this subject. Eventually, this discussion starts tending towards “the approach that I have chosen is the best and all other approaches suck!”. Ultimately, this leads into a mindless debate with no desirable outcome for anyone involved.

I can illustrate this with several examples with regards to dividend growth investing. For instance, the inter-web is full of discussions regarding the dividend irrelevance theory. I have also heard several other arguments against this strategy. Some of these revolve around subjects such as: taxes incurred on the dividend income OR how there is very limited stock price appreciation on some stocks that get touted as great dividend growth stocks (think PepsiCo (ticker: PEP) or Johnson & Johnson (ticker: JNJ). Often times, this discussion starts to get into ridiculous territory with comments like “dividend growth investing is so boring and not sexy at all”, whatever that is supposed to mean.

It is important to understand that there are multiple approaches to investing and your approach is unique to YOU. And since it works for you, that is all that matters in the end.

It is also important to highlight that your approach could be a unique mix of different styles of investing. Just because you are invested in dividend stocks does not mean you cannot invest in growth stocks. You can do both! In fact, when I own companies like Microsoft (ticker: MSFT) and Apple (ticker: AAPL), I can justify that I am owning both dividend AND growth stocks. It is called dividend growth investing, after all, for the same reason.

Similarly, just because you are invested in individual stocks does not mean you cannot invest in ETFs. You can do both here as well! You are just using your unique strategy to achieve your financial goals and you must avoid getting into the business of championing the strategy itself. The strategy is just the means to achieve the goal, it is NOT the goal itself.

“Sin” stocks

This is a subject that has come up so often in my education as an investor. In general, sin stocks refer to companies whose central business can be considered to immoral or unethical. The tobacco stocks such as British American Tobacco (ticker: BTI), Altria (ticker: MO) or Phillip Morris (ticker: PM) often get cited in this bucket. Other companies that are lumped together in the same category are the “Big Oil” companies such as Exxon Mobil (ticker: XOM), Chevron (ticker: CVX) etc. The rationale being that these companies are causing harm to our natural environment and therefore “bad“. The next category of companies are those that are involved in producing weapons, which then subsequently are used in wars by defense forces. Some examples are Lockheed Martin (ticker: LMT), Raytheon (ticker: RTX) etc.

In my opinion, the moment you start mixing ethics with your investments, you are going down a slippery slope. Every single company, irrespective of how great it is or has been in its past history, would have been involved in some questionable business practices throughout its history. In one of my earlier posts where I discussed JNJ in fair detail, I mentioned how even a great company like JNJ has been involved in some litigations. One could argue that snack food and beverage companies such as Coco-Cola (ticker: KO) and PEP are “evil” because some of their products are bad for their consumer’s health. There are several other examples in other industries: Microsoft, Apple, Facebook, Google, Amazon etc. have all been in the dock at one point or another for anti-trust hearings and alleged business practices that attempted to thwart any competition. At the time of writing this, Facebook is in the news for wrong reasons where a whistleblower has indicated how Facebook and Instagram have deliberately ignored research data that shows how their platforms have a negative impact on the mental psyche of their users. To be honest, this news is not surprising to me, and one of the reasons why I dropped off from Facebook a few years ago. Looking back, it was a fantastic decision!

Every company at some point in its lifetime has had some such negative news. Even with a boring and predictable business like that of Waste Management (ticker: WM), we have seen instances of fraud.

So, where does one draw a line? Is this such a black-and-white classification after all or are there several shades of gray here? It is hard compass to judge any company on.

For this reason, my metrics when choosing a business are pretty straightforward: does it make long-term sense for me to invest in this business AND is it a business that I can understand and reason about logically. If the answer to both those questions is yes, I then proceed forward with further analysis. Most of my analysis is tended towards looking for reasons to NOT want the own the stock. This way I play devil’s advocate against myself with a hope that doing so will keep my biases at bay.

I also support my analysis in a quantitative fashion with valuation techniques such as discounted cash-flow and dividend discount model, padded with a margin of safety. The margin of safety here is critical, since there is risk associated with every business, the risk being that I could potentially lose 100% of my invested capital.

Once I am happy with my analysis, I initiate a position and then consistently dollar-cost average into that position. This further attempts to keep emotions out of the decision of buying.

Investing for other motives

During the whole GameStop fiasco earlier in the year, I was carefully waiting and watching on the sidelines as that whole episode was playing out. While reading about the news on various platforms, I was coming across comments where some people were investing “to teach the big guys a lesson” and “standing up for the small time investor”. While I can understand the enthusiasm and the thrill, using your (or someone else’s) hard earned money to “make a statement” OR “be a part of a public movement” is a recipe for disaster. In general, if there such a mass hysteria going around, it is always better to take a step back and really contemplate if the investment decision you are about to execute really makes sense to you and is in your long-term interests.

We have had so many examples of such events from the past. Tulip mania comes to mind readily. Here is another excerpt from The Intelligent Investor, arguably the best book on investing ever written.

And while we are on the subject, beware of those who are instigating you or asking you to invest in a stock because they think it is the right thing to do. Such people are two-faced liars and are only looking out for their interests.

Summary

So there you go. I think some of that post might sound like a incoherent rant to some folks and some others might take this as useful advice. In any case, my central goal is to motivate you to do your own research and think about what your strategy is before investing a dime in the market. If I have forced you to think about this subject, I would count that as objective achieved.

Thank you for reading thus far.

PS: You can find me on Twitter @LifeWDividends

Disclosure: Long JNJ, MSFT, AAPL, WM, PEP, XOM, LMT. No positions in Facebook, Google, Amazon or Coca-Cola, MO, PM, BTI, CVX, RTX

John (“Jack”) C. Bogle – 10 Investing Principles

One name that keeps consistently coming up in my education as an investor is John C. Bogle, the person who gave us Vanguard and also the concept of index funds. I have been watching/listening to some of his interviews before his death in Jan. 2019. Even at an age of 87, the man was so sharp! And I must say, every single time I listen to him speak, I learn something new.

John’s statements are easy to co-relate with the historical stock market data i.e. passive index investing generally gives the investor better returns at lower costs compared to actively managed funds. It is for this reason that a large portion of my net worth is tied up in low-cost index funds from Vanguard.

Regardless of what your investing strategy is like, it would be wise to listen to experienced heads such as John and adopt those learnings into your overall investing mindset.

In this post, I wanted to highlight 10 such investing principles that I have heard from his various interviews/speeches/books.

1. Reversion to the mean

“Don’t choose funds based on past winners. One way or the other, all mutual funds do badly in one period and do better in another period“

This is true of all investments in general. Past performance alone cannot guarantee future results. With every investment, it would be wise to look towards the future and question if the investment makes a good long-term choice for your portfolio.

2. Time is your friend.

“Think of the value of compounding. Get yourself a little compound interest table and see that at 7%, money doubles every 10 years and it doubles again and again and again. And by the time you are at your retirement age, it might 35 to 40 times your original investment…maybe more than that.“

I demonstrated this very concept in my previous post where I discussed Yield-on-Cost. This is such a powerful concept that can achieved through a simple buy-and-hold strategy with dividend growth investing.

3. Buy Right and Hold Tight

“Pick a good fund and hold it through thick and thin. Don’t get despondent when it does badly, because it comes and goes. So don’t let yourself get distracted by changes in the fund performance or changes in the market.”

Again, some sound advice about any investment vehicle. During a market correction, it would be wise to disregard all the market headlines and look instead at the fundamentals of the businesses you have invested in. If nothing materially has changed, stay put.

4. Have realistic expectations

“I think common stocks should return at a nominal rate, nominal meaning before inflation…at a nominal rate of 7%. The dividend yield is very important in all this. Reasonable rate of return would be 7%, don’t look for 11, don’t look for 15, don’t look for nothing, don’t keep waiting for the next bear market….those are all guesses! Some of these guesses will come good, some not so good.“

Several pearls of wisdom in that statement alone. In general, when attempting to draw estimates about projected growth in your portfolio or also things like valuing a business, it is better to remain conservative. Other useful takeaway is to remain invested in the market and not wait on the sidelines.

5. Forget the needle, buy the haystack

“You don’t need to take the risk of owning individual stocks, take the market risk, which is high as it is“.

I think I largely agree that for a common individual who is least interested in the stock market news and the world of finance, this would be great advice. However, I prefer a slightly hybrid approach where I have a large portion of my net worth invested in low-cost index funds and a smaller portion invested in dividend growth stocks.

6. Minimize the Croupier’s take

“Cost is an important factor“

Ensure that if you are investing in a index fund, it is low-cost. The expense ratio can add up over time and take away a significant portion of your total return.

7. There is no escaping risk

“Think about this for a second..I don’t like the risk of the stock market. I am putting my money in a savings account or certificate of deposit. There is no risk there. Wait a minute! The return there is probably going to be about 1.5% and we are going to have 2.5% inflation. The real return is -1%! So is there any risk in putting your money in a savings account? You better believe it!“

Stay invested and stay the course. Obviously, set aside some cash for emergency expenses. But keep the remainder invested. Cash sitting in a bank account will slowly get devalued over time.

8. Don’t fight the last war

“Your job is to get the biggest gross return…inflation is going to take whatever it takes out of that. If it is big return, it will take a little of it. But if the gross return is small, it will eliminate it!“

Jack was referring to safeguarding against inflation through special funds like “inflation beaters” (his words, TIPS?). In general, my takeaway from this was staying focused on one primary strategy and to not make sweeping decisions based on problems that existed several years back or that might possibly exist several years into the future.

9. The Hedgehog beats the fox

“The fox knows many things. But the hedgehog knows one great thing. In our business, foxes are those harvard business graduates with their fancy computers…armies of them..who know many things. I know one great thing, which is if you own the market in a low-cost index fund, you are guaranteed to earn your fair-share of what the market is kind enough to give us, and lets be clear on this, whatever returns a bad market is mean-spirited enough to take from us. So it is the hedgehog who wins ultimately“.

Simple boring strategies ultimately have the highest probability of success, as compared to complicated strategies that involve timing the market.

9. Stay the course

“Let me start with this premise…Many investors lose because of their own behavior and not because of how stocks and bonds do. They are trailers…they buy something that has done well and expect it to perform the same in the future, and it doesn’t. A whole lot of bad behavioral patterns…the find a hot stock manager, they jump on the bandwagon and that does not work….that will not work. So figure out a sound program, set the right course and don’t let all these superficial emotional momentary things get in your way! Another way of putting that is, don’t do something, just stand there!“

Again, so many pearls of wisdom from the legend. I have previously written about cognitive biases and how that impacts investment decisions. A good investor must be cognizant of these and try their best to avoid such biases creeping in. Another advice is to avoid frequent tinkering with the portfolio based on market news. In fact, I find it easier at times to “zone out” and stay away from the news and headlines and instead focus on big picture and long-term fundamentals.

So there you go! Words from the legendary John C. Bogle. Dear Sir, I thank you humbly for all your contributions to this world. I am a better investor thanks to you.

Making sound financial decisions

Over the course of investing in high-quality dividend stocks, I have realized that this strategy relies on two key facets:

• Time
• Capital Invested.

Let me elaborate on how each of these impact your portfolio’s performance.

Time

In general, the longer you stay invested in the stock market, the greater the odds of you generating a better return on your original invested capital. Hence, it is generally better if you start investing early in your lifetime and stay invested throughout.

Capital Invested

The other factor is simply how much amount your can contribute towards your investments and at what frequency. This is largely dependent on your personal lifestyle and the financial choices you make throughout the course of your lifetime.

I wanted to touch on this second aspect since it is often overlooked when it comes to investing.

A simple equation to look at your savings is as follows:

Savings = Income Generated – Expenses

Common sources of generating income are your regular day job and any side-hustles. One approach to maximize your savings is to excel regularly at your day-job, invest in yourself through improving your existing skillset such that you can command a higher salary. You can further supplement this by having one or more side hustles. But pretty soon, you will come to a point where you will simply be unable to maximize your income: either because of factors that are simply not in your control (eg. your employer cannot afford to pay you more), or because you simply do not have the time or the bandwidth to pick up more side-hustles.

This brings to the other piece of the equation: expenses. Compared to your income, on the face of it, this seems to be a little more under your control. Sure there are aspects such as groceries, gas or daily-use items that we cannot avoid paying. Because we all got to eat, take a shower, commute to work etc. 🙂 I get that.

But what about that fancy new car you are planning to buy (or just recently bought)? What about that fancy new smartphone you are planning to buy during Christmas this year? What about those frequent takeout meals you like spending on? These are lifestyle choices and they eat into your savings, thereby reducing the available capital that you could have otherwise deployed towards generating more wealth.

Even before you begin investing a single dime in the stock market, it is critical that you self-introspect and take note of your current financial situation. Monitor all of your expenses for any given month (or months), sit down with your family or loved ones who live with you and seek guidance on which expenses can be cut down. Work towards creating a reasonable monthly budget and stick to it.

Among the daily expenses that are common in each household, the ones related to paying off debt will impact your journey to financial independence the most. In this specific regard, I highly encourage the interested reader to look at Dave Ramsay’s baby steps. The first four steps, in particular, are critical. While I do not agree with Dave Ramsay’s thoughts on investing, I also cannot agree with him more about paying off debt sooner.

If you are currently in debt, please know that this is not the end of the world. We have all been there (including yours truly 🙂 ). It is actually pretty easy to turn this around and knock off this debt. You just need to turn that “Beast Mode” setting ON and aggressively eliminate this debt. If I have managed to open your eyes and forced you to think about this seriously, I have achieved my goal.

If you are not having any outstanding debt (other than your mortgage), pat yourself on the back! From this point on, you should first look at having an emergency fund. I typically recommend keeping a stash of cash to cover for expenses for atleast 3-6 months. What this amount would be is subjective to each family’s individual lifestyle.

You should then look at maxing out your retirement accounts such as 401(k) and IRAs. Note that these retirement accounts are applicable to US residents only. Your country’s tax laws might call them something else and treat them accordingly for tax purposes. Please check with your tax advisor.

If you have maxed out your retirement accounts, you are killing it! Congrats!! Now, it is really a question of how to choose to invest the remaining money into income generating assets. There are several options available to you depending on your preferences and risk tolerance. My personal preference is to use part of my capital and invest in high-quality businesses that will pay me back cash in the form of dividends. Your strategy might be something else. There is no one right/wrong answer here. It depends. The key here is you are making financially sound decisions to invest in yourself and securing your future.

I would love to hear your views on this subject. Please let me know by dropping a comment below.

Photo courtesy: Damir Spanic

Disclaimer: Please read my disclaimer here.