This article is Part I of two articles (Part II can be found here). Part I documents my journey towards early retirement and focuses on the necessary paradigms and behaviors I used to achieve my goal. It explains things I did right, and things I didn't. The second article summarizes my overall thoughts on investing, walks through my portfolio and describes my financial plans for the future.
I intend to share my experience as an individual who started with nothing (like most of us I assume) and achieved a long-term goal of early retirement. The target audience is younger, less experienced investors. I share my successes and mistakes, and in my case, my largest failure was entirely self-induced and nearly derailed my plans completely. I hope that this article, encompassing 33 years of life and investing experiences provides the beginnings of a roadmap for others to emulate. I am currently living off dividends at age 57.
A synopsis of my life term learnings are as follows. I have found, and proven, that investing in broad based index funds in tax deferred accounts during a lifetime of working builds up capital nicely, especially if one continues to add funds regardless of the market's ups and downs. Secondly, that moving to individual dividend paying companies prior to retiring can provide adequate income to live on and is a sustainable strategy provided that one owns quality companies. Quality is essential. While tempting to take risks for yield, I have learned that it is wiser to go with quality albeit with lower yields.
Stage 1: Starting out, doing the right things. Investing regularly in mutual funds coupled with dividend paying companies.
When I joined the workforce in 1983 after getting my Master's degree, my first job paid $22,000 per year. I'd been living on $400 per month as a graduate teaching assistant, so I thought I'd died and gone to heaven. Simultaneously with this newly found "wealth," I had just married, and dearest made a similar income. So, we were rich!
I always have had a strategy for various aspects of my life. For the financial aspect, I decided early on that I was going to focus on building a corporate career (versus say becoming an entrepreneur or non-profit), saving a significant portion of my income, and retiring relatively early. My fear of starting my own business and taking risk came from seeing my father lose a lifetime's savings on a business endeavor after 25 years as a very senior corporate professional. I'd seen the quality of life that working for corporations had provided my father and wanted the same for my family.
Dearest and I lived in an apartment and so were saving approximately $1,000 per month. Since I didn't want money just sitting in a checking account, I began to read about how to invest. Instinctively, I felt that an investment needed to pay me while I held it. I was unwilling to count only on capital gains. The two options that met these criteria and most appealed to me were real estate and dividend paying stocks. I proceeded to read books on both.
I got scared off of real estate as I realized that I had neither the temperament to deal with tenants nor the skills to take care of or manage repairs, late payments and so on, so that left stock investing. Since I needed my investments to pay me while I held them, I was left with investing in dividend paying stocks as the best option.
I used to subscribe to Money magazine, the content of which was relentlessly consistent about the need to save, invest in mutual funds, dollar cost average, stay calm during stock market downturns, and the benefits of buying and holding. After considerable research, I began to invest in mutual funds such as the Nicholas Fund and the Dodge & Cox Stock fund. Later, I began to get into the Vanguard Equity Income fund and STAR fund.
This went on till 1990 or so. I kept reading books. I also began to get a hankering for buying individual companies. There were several reasons. First, I learned that the standard retirement model was based on the four percent rule. One was supposed to accumulate assets, and then withdraw four percent a year upon retirement. I realized that dipping into assets (i.e., selling the principle) was not in my constitutional makeup. Second, I loved business and reading about business. My day job was directly focused on making operational excellence improvements and this drew my attention to well-run companies. Third, I realized that one could buy high quality dividend paying companies, retire, and not have to draw down on the underlying asset. Fourth, I didn't want to be dependent on mutual fund gurus. I wanted to manage my own money because no one cared about it more than I did, and, arrogantly, I thought I could do just fine by myself.
In 1990, we had our first son Nicholas. I also opened my first brokerage account.
One of the books I read at this point in time was Dividends Don't Lie by Geraldine Weiss. This book impacted me tremendously. Geraldine's contention was that dividend paying companies were the best investments. The "not lying" portion was that the cash distributed as dividends were real, and could not be created from thin air as, say, perhaps earnings could.
Geraldine had a newsletter. In it, she would chart stock prices and yields, and recommend for purchase those companies at a relatively high yield. It was a classic contrarian strategy. I never did understand what made up her universe of stocks, but they were almost always companies I had heard of. The subscription was expensive for me at the time-more than $200 per year.
From 1990 through 1999, I never had a losing position. Let me repeat, for close to nine years I never had a losing position. But I made mistakes. The first was that I'd sell any position where I'd made 20 per cent annualized. Thus, sometimes, I was selling positions in a few weeks or months. There were of course two problems with this approach. First, I constantly had to find and buy new companies and pay capital gains and trading fees. Second, I was not really allowing compounding to occur.
During this period, our second son Alex was born and my wife quit her professional job to focus on raising our sons. We were living on one income.
Stage 2: Losing my way. I invested in technology companies without any understanding of fundamentals.
By 1999, we had a portfolio. I always maxed out on 401(k) and IRA contributions and these funds were invested in equity mutual funds. Our taxable funds were in a brokerage account, typically holding 10 to 15 positions. The accounts experienced significant churn due to my philosophy of selling whenever a price increased by 20 percent; I experienced no capital gain losses and incurred lots of short-term capital gains.
If I'd simply left this strategy alone, even with excessive churning, I would have been retired by 2012. Even though I was buying and selling way too much, I always understood the business I was buying and owning. I understood Long's drugs and their business model. I got how Exxon (NYSE:XOM) made its money.
One of the self-defeating behaviors we engage in is not leaving well enough alone. Even if something is working, we've got to tinker with it. The biggest driver for this is probably "looking for excitement". Even though I was doing just fine, reading about the internet stocks was driving me crazy. I wanted IN.
In 1999, the Sunday before a business trip to Stockholm - I can remember this clearly - I gave in. Buying staid companies that I understood, that produced necessary products and consistently made me money slowly but surely was too boring. I wanted excitement and instant riches.
I read an online column by Jim Jubak and bought $5,000 worth of two internet companies. When I got back at the end of the week after my trip, they had each increased by 50 percent or more. Clearly, I was now a genius. I had discovered the secret to real wealth building. Buy companies you know nothing about, don't pay attention to valuation, and then sell to some other equally deluded fool when prices magically continue to go up.
Fortunately for me, I only started "investing" new funds into this genius strategy. I left my mutual funds alone, and didn't touch previously purchased stocks, but new money went into the exciting stock of the moment. I could not tell you how any of my Internet holdings made money, or whether or not they'd ever be profitable.
In April 2002, I got laid off from my company. I had worked for a terrific employer for 15 years, where I had been able to develop both technical and non-technical skills, travel worldwide and make real friends. At around the same time, stock prices for the glamorous Internet companies began to reflect their real value, which was closer to zero than any other number.
I remember sitting in my study the weekend after getting laid off, my sons, who were then nine and twelve, were playing in a corner, and dearest and I began to conduct a financial state of the union. We wrote every asset on a big white board. Bottom line: I had managed to lose up to 60 percent of our assets. Even worse approximately 40 percent of our assets did not have much value, and were not going to either.
With a certain horror, I recalled that my own father had lost a significant portion of his wealth in his early 40's. He'd been a very successful corporate executive who had decided to become an entrepreneur. He failed, and badly. Was I going to have the same fate and have to work till I was 72 like he did? Had I learned one darn thing from his experience?
I am an optimistic person by nature. Even when I first came to this country, with no friends or money, and went through a period of eating one meal per day, I was always happy and positive. I didn't have to work at it, I just was that way.
But after this "review" it was very difficult to be positive. I actually was having trouble breathing and getting my thoughts together. Trying to get a job in a very tough job market, and making up for lost opportunities in the net worth department were daunting. I remember thinking that if I didn't take it one day at a time I wasn't going to make it. If I didn't hold it together, I could lose a whole lot more than just money.
Stage 3: The way back, one day at a time. I went back to the dividend paying ETFs and mutual funds.
If you take enough shots on net, some get through. After a lot of rejections, I managed to get a contract job in Milwaukee. Contract jobs are where you get paid by the hour. You receive more than you would in a salary, but you cover your own benefits and there are no bonuses or stock options. I flew to Milwaukee every week. After a few months, I managed to get an employee position with a financial services company in Dallas, where I lived and still live. Things stabilized.
After the shellacking, I decided to only purchase dividend paying ETFs (SDY was a favorite). Further, the prices of the original higher quality holdings (the non-Internet ones) began to reflect their underlying value (i.e. they went up as earnings increased). I then was fortunate enough to do two smart things. First, in the mid-2000s, I heard about and started reading a website called Seeking Alpha (SA). Second, I started reading about the psychology of investing. I found Buffett, Munger, Klarman and Templeton to be particularly interesting. Michael Mauboussin and Terry Jones are others I read about and watched on YouTube.
I realized that psychology is the primary reason investors engage in self-defeating behaviors. Whatever people say about Buffett, in my book, it is not praise enough. His clear thinking regarding companies, the economy and investor behavior is something every investor would do well to understand. I also learned the power and value of social networking. People far more knowledgeable than you will share their experiences and opinions on SA for no seeming self-interest. They just do. I went from reading articles and comments (often the most valuable aspect of the article), to contributing comments as a way of giving back to the DGI community. This is my first article in an ongoing effort to pay back to the community.
Stage 4: Retiring and living on dividends. I moved from dividend paying ETFs and mutual funds to individual DGI stocks in order to generate enough income to live on.
Since 2008 in particular, I consider myself to be in my third evolution as an investor. In this stage, I began to transition away from dividend paying ETFs and began buying individual stocks. Owning individual stocks allowed me to generate enough dividend income to retire on. I also moved from mutual funds in my 401(k)s/IRAs to individual stocks. Since I gave myself three years to make this transition, I sold a lot of Puts to put cash to work. Selling Puts provided me with three things. First, it put cash to work. Second, it allowed me to establish prices at which I could own companies I'd already decided to buy but were not "at value." Third, it allowed me to ease into stocks over a period of time. thus reducing the risk that I would overpay. I was able to generate 10 percent returns on the cash I set aside for Puts (please note that these are taxed as short-term capital gains).
My current situation and lessons learned
If I am successful, I give Seeking Alpha writers and commenters a significant part of the credit, as I do the pros (Buffett, et. al). The highlights of Stage 4 are that I began to document and execute a strategy. The core of the strategy is to buy high quality dividend-paying companies at value, and to hold on to them for the long term.
The four stages of my evolution to early retirement consist of the following:
- Stage 1 (17 years): I contributed the maximum to 401(k) and IRA, and invested all of it in equity index mutual funds. I also invested taxable savings in high-quality dividend paying stocks.
- Stage 2 (2 years): I incurred significant losses because I invested new taxable savings into momentum stocks.
- Stage 3 (11 years): I reverted back to stage 1.
- Stage 4 (3 years): I transitioned from ETFs and equity mutual funds to an all-individual-stock portfolio over a three-year period.
My key learnings include the following:
- Always save (If you think it's difficult living on $30,000 per year, remember there's a person on your street living on $28,000).
- Invest savings in quality companies. This IS the foundation. Time works for strong companies. Valuation matters, but you don't have to be extreme about it.
- Diversification matters. Studies indicate that 15 companies provide most of the benefits from diversification. On SA, experienced authors have discussed the merits of holding between 25 and 50 companies. My personal target is 50 companies, with my top 35 contributing 80 percent of my income.
- Dividends are real cash; a long history of dividends provides some evidence of the strength of the underlying business model.
- Hold assets for the long haul; allow compounding to occur.
- There are no free lunches. You earn equity like returns by dealing with the associated volatility.
- No one has all the answers, including me or this article. Make your own decisions by triangulating after reading extensively.
- You will make mistakes. Correct them sooner rather than later. One effective way to reduce errors is to answer the question: Would I buy more of this company if prices went down by 35 percent? When I bought Arch Coal (OTC:ARCH), after it had already gone down 80 percent, I found companies can go close to zero when they're not strongly capitalized. The fact that I was unwilling to buy more as prices kept going lower was telling. I had conducted inadequate research. I was hoping for a turnaround. Losses? $16,000. If it hurts you reading about this, I cannot begin to tell you how I felt. When Disney (NYSE:DIS) went down 30 points towards its 52-week low, I was adding as much as I could. Proctor & Gamble (NYSE:PG) below $80, thank you. Johnson & Johnson (NYSE:JNJ) below $90, again my thanks. These are all fairly recent cases by the way, not from five years ago. This is a question I ask myself every time I initiate a new position: Will I buy more when prices go down?
Again, I share my experience so that you have one more point-of-view. Using multiple points-of-view allows investors to triangulate and develop their own belief systems, which hopefully leads to a strategy.
My questions to you are:
- Have you documented your strategy for wealth creation?
- Are you sticking to this strategy?
- What has been your biggest mistake and associated learning?
In Part II, I explain specifics on my holdings and my process.
I wrote these articles four months ago, but am only now posting them. Why the delay?
I suffered a heart attack on August 24, 2016. My main artery was blocked and I ended up going into surgery to have the blockage removed and to have a stent put in. Three weeks later I had to go in again to have a second stent put in on a second artery.
For two plus months, I had to wear an external defibrillator. This is a machine worn like a bra and if it senses an irregular pulse, it begins to beep. If you don't stop it by pressing a button, it shocks you within 45 seconds. So, many times I'd wake up at night with the machine beeping, and be scrambling to find the button in the dark before the machine shocked me.
After the second surgery, I had to go for an MRI. That's when I found out I was claustrophobic. So that was another 90 minutes of terrifying agony. I pressed the panic button, got out of the chamber, but with the help of a really kind technician, managed to re-enter the machine and get through this experience.
Bottom line, the doctor cleared me as normal. I do have damage to my heart, but I can lead a normal life without a pacemaker or defibrillator.
My point is that this was certainly not in my plans. The experience has made me even more determined to enjoy each day that I have. I've completely changed the way I eat and am now 34 pounds lighter. Life is back to normal.
"It is better to have a permanent income than to be fascinating." - Oscar Wilde
Disclosure: I am/we are long PG, DIS, JNJ.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.