- My 28 year old roommate with no investments asked me where he should start.
- I told him to open a Roth IRA with dividends reinvested (specifically, a Sharebuilder DRiP).
- Then I gave him the names of three stocks to buy for this account.
Yesterday over burgers at the local watering hole, my roommate asked me for investment advice. I'll call him Noah.
Noah is 28 and has no investments or retirement savings besides what he's put away through his workplace retirement plan.
He isn't saving for anything in particular, so my first thought was that he should open an IRA and have some retirement savings independent of his workplace plan. Noah is a government employee, so he doesn't make a ton of money. Plus, because he has no investment experience, I knew I needed to make things simple.
Since I know he doesn't plan to actively manage his investments, I immediately thought of dividend stocks. And since I know he's a bit of an activist at heart, I had some basic questions.
"How do you feel about owning an oil company?"
"What about tobacco companies?"
"Not feeling it."
"Ok, what about Kimberly Clark?"
"…Ok…let me think about it."
I've thought about it.
Here is my investment advice for Noah: Five steps and three companies.
Step 1: Open a Sharebuilder account.
Sharebuilder makes investing really simple and easy. It especially makes "dollar cost averaging" really simple, one of strategies touted by legendary investor Benjamin Graham in his book The Intelligent Investor.
Noah should set up the account as a Roth IRA. An IRA because he should have some savings besides the default payroll deductions he has at work and Roth because I highly doubt he's taxed at a higher rate now than he will be in the future. Plus, I'd much rather see someone take the minor tax hit now to have tax-free retirement savings.
I like Sharebuilder for a number of reasons, including its friendly user interface, excellent customer service, Dividend Reinvestment Plan (DRiP) structure and simple automatic investing system. There are others like it I'm sure…but Sharebuilder is very intuitive and has served me well.
Step 2: Make either a lump sum transfer or set up regular savings. Preferably both.
Ideally, Noah would start his account with a lump sum and continue adding to it with regular savings depending on what he could manage. For example, if he started the account with $3,100 and set up an automatic transfer of $200 per month, he would perfectly max out his allowable annual IRA contribution of $5,500.
That said, with $4 commissions on the Sharebuilder automatic investment plan and a long horizon for his investments, even starting out with $500 per stock would do the job. And he could do it one at a time.
I selected three companies in which Noah should invest.
Frankly, I'd prefer to add a fourth purchase and have it be some kind of index-tracking ETF like the iShares ETF that tracks Russell 2000 Small Cap Index (NYSEARCA:IWM) or the SPDR S&P 500 ETF (NYSEARCA:SPY). But since I know he doesn't want to own certain kinds of companies, he'll have to avoid index ETFs.
That leaves individual companies and bonds. I like that he has boring workplace retirement savings, so I decided to leave bonds out of my advice to him.
Diageo is the world's largest producer of spirits and one of the world's top major producers of beer and wine. Its brands include Noah's beverage of choice (other than craft beer), Bulleit Bourbon. As a stock yielding 2.5%, it'll fit in nicely with his Sharebuilder DRiP and its automatic and fee-free reinvesting of dividends.
Plus, the stock offers considerable growth opportunities as it expands around the world. And, most importantly, the investment is very safe. I mean, what are the odds that people will stop drinking?
Next, I selected Dunkin' Brands Group, franchisor of Dunkin' Donuts and Baskin-Robbins. We're both from the Northeast and Noah is a huge fan of Dunkin' Donuts. When the company opened a location in downtown Denver, he braved long lines to get his first Colorado Dunkin' Donuts experience and have his picture taken with the donut mascot.
Dunkin' yields 1.90% right now, so it'll also fit in nicely and compound in his DRiP. But most importantly, the investment has a tremendous growth opportunity as Dunkin' Donuts moves from a regional favorite in the Northeastern United States to a major national player. As of the end of 2013, Dunkin' Donuts had only 214 locations west of the Mississippi.
Dunkin's domestic growth opportunity is huge, just like its margins. With higher margins than similar investments such as McDonald's (NYSE:MCD), Yum Brands (NYSE:YUM) and Starbucks (NASDAQ:SBUX), Dunkin' is an attractive investment. It has shareholder-friendly practices like share buybacks and it increased the dividend in March. Still, shares have been largely anemic in 2014, up less than 1%.
The final company I'd insist my roommate buy is also the most important one. The company pays a dividend north of 5% and pays it out monthly, increasing the compounding events and harnessing the true power of his Sharebuilder DRiP. The company is Realty Income Corp, a REIT that owns the properties used by some of the largest retail brands in the world.
Realty Income Corp leases to companies like FedEx (NYSE:FDX), Wal-Mart (NYSE:WMT) and Walgreen (NYSE:WAG), so the company's investors can rely on the consistency of long-term and stable lease agreements. Since Realty Income Corp's tenants make monthly rent payments, the company has monthly cashflows that it pays out to shareholders through monthly dividends.
And with 75 dividend increases and 524 total dividends paid out since 1994, this company is a serial dividend payer.
Step 4: Set up automatic investing.
Once he determines how much he can invest to start and how much he can add every month, Noah's next move is to set up automatic investing.
Sharebuilder makes this super easy. Let's say my roommate plans to save $300 every month. He could set up his automatic investment plan to purchase shares every time he had $900 available, split between the three investments.
Four times a year, his account would purchase $300 worth of each company minus Sharebuilder's measly $4 commission for automatic trades.
However he structures it, he can't exceed the maximum annual IRA contribution, and he shouldn't purchase shares with less than $200 for each automatic investment. With a $100 investment and $4 commission, the commission is 4%. That drops to 2% when he increases his investment amount to $200.
Though that is still a high percentage to pay, I'd much rather see him investing consistently and on a schedule to take advantage of dollar-cost averaging.
Step 5: Leave it alone.
I would strongly encourage my roommate to remember the password to his Sharebuilder account and check it monthly…but the reality is that for this kind of investing and these kinds of investments, leaving it alone is one of the best things he can do.
Like many, I've made the mistake of selling a perfectly good investment with a perfectly solid investment thesis to chase an investment idea that popped into my head or throw good money after bad instead of cutting my losses in the bad position and leaving the good position alone.
The Bottom Line
The framework I've laid out here is just that: a framework. I'm not a financial planner and my number one piece of advice for my roommate is to talk to a professional with letters after his or her name, specifically C F and P (Certified Financial Planner), though there are a couple of similar letter combinations that would work.
But the framework above is, I think, solid. It incorporates some of the investment strategies I wish I'd cared about sooner, namely emotionless dollar-cost averaging and a mix of income and dividend-growth stocks.
What would you change about the framework I suggested to my roommate?