Advice for beginning investors?

screen-shot-2016-07-08-at-22-01-51I never talk much about my journey to become financially independent (FI) to others. Although my family do know about my journey. I never gave anyone advice about investing or living below their means. The reason I don’t talk much about my journey is that I have the feeling most people don’t understand, or don’t want to understand the principles of FI.

Recently my brother phoned me. A few months ago he graduated from university and recently he got a job offer with a nice salary. The pay check is large enough to save and invest a significant percentage of his income in stocks. On the phone he asked me for advice.

Here are the 3 golden rules to become financially independent (FI):

  1. Start investing early, preferably directly after starting your first job. Compounding interest is the big power behind a big portfolio.
  2. The most important metric in becoming FI is your savings rate, not your income. If you have a savings rate of 50%, you are FI in 16.6 years (read the shockingly simple math behind FI). If you save and invest 25 x your annual expenses, you are FI. Living frugal or below your means, makes your savings rate higher, and your required portfolio worth lower.

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Put here your variables and check your FI date.

3. Invest regularly (monthly) in the stock market, there are 2 options to invest for FI:

  • Option 1 (for those interested in the stock markets) is to invest directly in (dividend) stocks. Like me. After years of investing you can live of the (growing) dividends.
  • Option 2 (for everyone else) is to invest in low-fee index-funds, for example like Amanda and Travis.

For golden rule number 1 and 2 you can read some background in the links provided. For the 3rd golden rule, there some discussion in the FI community. My view is this: If you are interested in the stock market, and like to follow it closely, you should buy a diversified portfolio with dividend stocks.

If you don’t want to follow the stock market closely you’d better buy low fee index funds. Here I will point out some pro’s and contra’s about the index funds.

Pro’s of the index funds

  • You directly buy a diversified portfolio
  • You don’t have to do the research which stocks to buy
  • The index funds have low fees

Contra’s of the index funds

  • You have to pay those low fees every year till the end of time
  • It’s more likely the index fund will cut the dividend in hard times, compared to your portfolio with dividend stocks
  • When you are FI, every year/month you sell a small part of your portfolio to pay your monthly expenses. You also have to sell your stocks after a big dip or crash on the stock markets.

Low fee index funds

After you made the decision to buy a low fee index fund, you have to pick the right fund. I suggest Vanguard low fee index funds, because they are one of the biggest, cheapest and maybe safest. I further suggest an index fund covering stocks from all over the world (especially when you are an European investor). Examples are VT (Vanguard Total World Stock ETF, expense ratio 0,14%), or a combination with VXUS and VTI (Vanguard Total International Stock ETF, expense ratio 0,13%; and Vanguard Total Stock Market ETF, expense ratio 0,05%).

Conclusion

When you are interested in the stock market and are willing to spend enough time analyzing stocks, then option 1 (investing in dividend stocks) is best to become FI. When you are just starting your journey or don’t have the time or the interest in the stock market to analyze stocks, then it is better to buy low fee index funds.

What advice did I give my brother?

It is important to know that he is not following the stock market like I do. Therefore I gave him the advice to buy low fee index funds. While doing it this way, he immediately buys a diversified portfolio. After some time, when he is getting more and more in the stock market he can switch to option 1, investing in dividend stocks.

High yield, or high growth?

 

Screen Shot 2016-06-25 at 19.59.58When buying stocks for my dividend portfolio I want to make sure that I buy the right stocks. The right stocks mean to me, stocks that provide safe dividends when I’m retired. The purpose of my dividend portfolio is to live of the dividends and not selling the stocks.

I divide dividend stocks into 3 categories:

  • Dividend stocks that have a relatively high yield at the moment, but have low dividend growth prospects.
    • For example AT&T (T). The company have a yield of (a little bit lower than) 5% and a dividend growth prospect of 2% per year.
  • Dividend stocks that have an average yield at the moment, and have average dividend growth prospects.
    • For example Pepsico (PEP). The company have a yield of (a little bit lower than) 3% and a dividend growth prospect of 7% per year.
  • Dividend stocks that have a low yield at the moment, but have high dividend growth prospects.
    • For example CVS Health Corporation (CVS). The company have a yield of (a little bit lower than) 2% and a dividend growth prospect of 10% per year.

Stocks from which category should I buy, assuming that I’m retiring in 14-20 years and reinvest all dividends before I retire? Let’s make a calculation.

Let me explain the table:

  • In the first row the number of years
  • In the second row you see what happens to the value of the stocks with reinvested dividends, without stock appreciation.
  • In the third row the dividends you will get without reinvesting your dividends.
  • In the forth row the dividends you will get with reinvesting your dividends.

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When you look at the dividends after 14 years, you see that the category 1 stocks (high yield stocks) provide the most income.

Category 1:2:3 –> EUR 13.21 vs EUR 13.04 vs EUR 11.16.

After 15 years the stocks with the category 2 stocks (with the average yield) provide the most income.

Category 1:2:3 –> EUR 14.34 vs EUR14.96 vs EUR 13.13.

After 20 years the category 3 stocks (with low yield high growth) provide the most income.

Category 1:2:3 –> EUR 22.07 vs EUR 32.13 vs EUR 32.93.

 

Conclusion:

In really depends on when you expect to retire to plan which stocks to buy. For them who expect to retire within 10 years, can retire earlier by buying category 3 stocks (high yield). For them who expect to retire after more than 20 years, it may be advantageous to buy more category 3 stocks.

For me it is not clear when to retire exactly, that’s why I will keep buying stocks from all categories.

How to handle Dutch taxes?

Screen Shot 2016-03-13 at 14.12.44In the Netherlands we have a special “wealth tax”, every year you have to pay 1.2% of your total portfolio worth. Crazy!! But as I have written before, there are a lot of benefits living in the Netherlands. Like a social student loan which can be used to buy a house. But indeed, the big negative side the damn wealth tax.

How does the wealth tax impact my race to become financially independent?

Everyone who wants to retire early knows the 4% rule. If you have saved enough money to retire, there is an annually safe withdrawal rate (SWR) of 4% of your savings/stocks. It means if you live off 4% of your portfolio worth, you will never run out of money. But, I (and everyone in the Netherlands) have to pay an annually wealth tax of 1.2%. What is my safe withdrawal rate (SWR) ? Is my safe withdrawal rate only 2.8% (4% – 1.2%) ?

The answer is: it depends on the type of assets/stocks you have in your portfolio.

A SWR of 4% is calculated for a portfolio with 60% stocks from the total stock market and 40% bonds from the total bond market. So if you can create a portfolio with an asset allocation with a SWR of 5,2% (4% + 1.2%) you can live of 4% of your portfolio and pay 1.2% wealth tax each year.

Is that possible? Yes it is!

Several assets have higher safe withdrawal rates than 4%.

  • The SWR for large cap value stocks is approximately 5.9%
  • The SWR for small cap value stocks is approximately 6.8%
  • The SWR for REITs is approximately 5.3%
  • The SWR for Europe is approximately 4.5%

On portfoliocharts.com you can play around with the asset allocation and the corresponding SWR. When I try to divide my portfolio into the different assets you will get this:

Screen Shot 2016-03-13 at 13.36.13

Conclusion: The right asset allocation makes it possible to have a higher SWR (in my case 5.2%) than the normal 4% SWR. Therefore it is possible to live off 4% of your portfolio in the Netherlands (and use 1.2% for taxes).

I used my student loan to buy a house!

In the Netherlands we have a social student loan system. This implies that everyone who is going to college can get a loan with an attractive interest. The interest-rate is very low and directly linked to a basket of dutch government bonds (5 years). Once every 5 year your loan gets a new interest-rate.

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There are more attractive conditions about the loan:

  • You start paying back two years after graduating.
  • The loan must be paid back in 15 years, but everyone may request (for whatever reason) a pay break of 5 years! Which means the 15 years will extend to 20 years.
  • In some circumstances, like if you have no job or your salary is below a certain level, the obligation to pay back stops. The loan will be converted to a gift.

There are some limits to the loan. There is a maximum of approximately 1.000 euro a month. It is not possible to take a loan at the beginning of your college years of for example 10.000 euro.

Fortunately my parents financially supported me during all my college years. For me a student loan wasn’t necessary. During my last college year I decided to max out the possibilities of the social student loan system. I gathered 10.000 euro to build an “emergency fund”.

Shortly after graduating I found a job. Shortly thereafter my girlfriend and I decided to buy a house. While working and saving, my emergency fund grew. I easily could have paid that 10.000 euro back, but I did something different..

I used the money of the loan to buy a house! Of course we needed a mortgage to buy the house. Because we had some money to lower the mortgage, the bank gave us a (small) discount on the interest rate.

  • The mortgage interest rate was 4,05% (now 3,85% because we made an extra deposit) for 10 years.
  • The interest rate on the student loan is 0,81% for 5 years.

There is some regulation from the dutch tax authorities that makes the student loan less attractive to use it to buy a house, but this loan is definitely the cheapest “mortgage” I will ever get.

A margin account? Are you crazy?

margincall

When I told my dad that I had a margin account, he said to me: “Are you crazy? That’s very risky!”. Is he right? Should I reduce my margin and close it after all?

There are several examples how things can go wrong with your stock account. So I want to play it relatively safe. Here are some numbers that are important to understand the risks of my margin account.

  • My net account worth: 17500 euro
  • On credit: 3500 euro
  • Total account worth: 21000 euro
  • On credit / Net account worth = 3500 / 17500 = 20%
  • On credit / Total account worth = 3500 / 21000 = 16.7%
  • Maximum credit on my account with stocks = 70% over the stocks I have, so not over my net worth alone.
  • Interest: EONIA (minimum 0) + 1.25% = 1.25%

When I decided to start a margin account, I realized that there are some risks involved. My intention is to be very careful with those risks. My plan is to keep the margin up to 20% of my net account worth in normal circumstances of the stock market. I will keep a margin up to 40% of my net worth in times when the stock markets crash. If stock markets decline I have to add new money to my account, to lower the margin. Unfortunately, I can’t buy cheap stocks at that time.

What happens when the stock markets crash tomorrow?

Let’s check some examples:

  • Crash 10%: 0.9*21000=18900. 3500/(18900-3500)= 22.7% of net worth
    • 22.7% of net worth = 18.5% of total account worth
  • Crash 20%: 0.8*21000=16800. 3500/(16800-3500)= 26.3% of net worth
    • 26.3% of net worth = 20.8% of total account worth
  • Crash 30%: 0.7*21000=14700. 3500/(14700-3500)= 31.3% of net worth
    • 31.3% of net worth = 23.8% of total account worth
  • Crash 40%: 0.6*21000=12600. 3500/(12600-3500)= 38.5% of net worth
    • 38.5% of net worth = 27.8% of total account worth
  • Crash 50%: 0.5*21000=10500. 3500/(10500-3500)= 50.0% of net worth
    • 50.0% of net worth = 33.3% of total account worth
  • Crash 60%: 0.4*21000=8400.   3500/(8400-3500)=   71.4% of net worth
    • 71.4% of net worth = 41.7% of total account worth
  • Crash 70%: 0.3*21000=6300.   3500/(6300-3500)= 125.0% of net worth
    • 125.0% of net worth = 55.6% of total account worth

Conclusion 1: These crash checks show that if the stock markets crash more than 40% in a short time, I have a problem according to my own intentions of keeping the margin low. Although, every month I have 1000+ euro new money and dividends are coming in every month. Which means if it is not a flash crash I have time to recover the percentage with new money.

Conclusion 2: If the stock markets crash even harder, again I have a problem keeping my own intentions. But, even if the stock markets crash with 70%, my account will still not blow away.

What to do if interest rates hike?

According to this picture below, interest rates can en will hike over time. I think these rates will be quite low for coming years. But depending on my dividend yield (on cost) at the time the interest rates hike, I can decide to lower my margin by using the new money I add every month to my account. Mostly the interest rate hike when stocks markets are high, so adding new money to lower the margin (instead of buying stocks) is not a big problem for then.

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Conclusion 3: When the margin is very high after a crash, I have to lower the margin to reduce risk. Unfortunately the stocks are very cheap then, and I have no money left for buying them.

Most likely in the end, near my financial independence, I would reduce en end my margin account slowly. Because I initially started the margin account to help and accelerate the growth. With financial freedom I don’t need that any more.

What do you think? Am I playing it safe enough? Has a margin account a role in dividend growth investing?

My first real post: Introducing myself

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This is my fresh start, to my dividend blog. Let me introduce myself.

I’m a 30 year old, medical schooled guy, getting a slightly above average income. I was born and raised in the Netherlands, where I still live. I’m living with my lovely girlfriend, who’s also working in the medical field, who’s also getting a slightly above average income. She’s still waiting for my marriage purposal.. No children yet, hopefully in the near future.

I want to become financially independent! Do I hate my job? Definitely no! Why becoming financially independent then? Recently I received a lettre from the social pension fund. They stated that when I reach my 71th birthday they will start paying. I don’t like the feeling that they decide for me when to retire, I want to decide myself when I stop working.

How to become financially independent? Living below your means, investing like half of your income in dividend growth stocks and financial freedom is possible within 15-20 years.

My goal is to become financially independent when I’m 50 years old. Maybe I still like my job when I’m 50 years old. That would be fantastic, then I’m postponing my retirement. But if I want to stop working (for a certain period of time), no problem, I quit my job.

Inspired by blogs like DividendMantra, I chose to start my own blog. For you? Hopefully you like it, hopefully it inspires you, but I realise that there are multiple blogs about this subject. I’m making the blog primarily for myself: to write my thoughts about investing, about living frugal and to have a diary about my journey to financial freedom.

This blog is called Dividend Mill. Of course the Netherlands are famous for the Dutch windmills, but it also stands for passive force and passive income. After a windmill is built, you can profit from the wind, generate power and electricity. After a dividend portfolio is built, you can profit and live off the dividends.

English is not my mother language, so don’t judge me too hard on my spelling errors.

Feel free to comment.