Dear Imaginary Jane,
Author MFFS recently authored an article on Seeking Alpha titled, "How To Quit Working In Five Years With $330,000 In Savings".
In that article he suggests you save hard and invest hard, and you can quit working in five years with $330,000 in savings. I believe there are many flaws in MFFS' sales pitch.
The MFFS' Sales Pitch
- Many young people are attracted to the idea of escaping the rat race with a high savings rate and an early exit from their careers;
- Focusing on conservative investing to build a nest egg that can last as much as 50 years or more, they ignore more aggressive and higher-risk options to getting out of the rat race quickly;
- There is an alternative for those who are not looking to build a nest egg that will last forever -- just an income stream that will allow them to check out of the real world for a few years.
The flaws in MFFS' Sales Pitch
- The table illustrating how to reach the $330,000 figure in 5 years -
- Shows a period of 6 years to reach $330,000, not 5 years;
- Takes no account of personal income tax on the yearly earnings from the investments. As these earnings are incremental to the gross employment earnings of ~$100,000 they would be taxed at the federal marginal tax rate of 28% plus state taxes of possibly 5% to 13%;
- If we ignore the tax on the incremental earnings, which we really cannot, the table shows you can exit your career at the end of 5 years on a passive income of just $21,781.74 before personal income tax.
- Adjust the gross investment income for say 15% federal and state taxes and the net income reduces to $18,514;
- But it gets worse. You have scrimped and saved for five years on $24,000 per year in real terms (after taking account of inflation of 2% per year);
- You are now going to quit that $100,000 per year career position and exist on $16,769 per year in real terms ($18,514 per year deflated by 2% per year inflation);
- After a few years of living in penury, you will then resume your career. Good luck with that.
MFFS Ups The Ante, Telling Imaginary Jane To Throw Caution To The wind
Appearing below is an extract and table from the article, "How To Quit Working In Five Years With $330,000 In Savings" --
Now let's really throw caution to the wind and assume that the next 5 years will offer the same return as the last 5 years. And let's also assume Jane will be able to get that 10.34% portfolio yield in 5 years. Now she can quit her job at 29:
The above table, created by MFFS, contains all of the mistakes and flaws as listed above for the first table. But the whole story just becomes a fantasy. Imaginary Jane -- if you do quit your job at 29, why does the table show you continuing to earn $70,000 per year from your job through age 35? And, if you do quit your job at age 29 and live off the earnings from your investments, there will be no increase in the value of your investment capital above the $301,742.53 shown in the table. Taking into account personal income tax on the passive income, the investment capital figure, and earnings from it, will be somewhat less than shown. In real terms, your net income after tax will be somewhat less than ~$24,000 per year. Living on that amount for a few years, and without a job to go to, would certainly be checking out of the real world. At least MFFS has that right.
The Proposed Investments - Leverage Is A Concern
The 4 stocks proposed for investment: Main Street Capital (NYSE:MAIN), AGIC Equity & Convertible Income Fund (NYSE:NIE), PIMCO Dynamic Income Fund (NYSE:PDI) and PIMCO Dynamic Credit Income Fund (NYSE:PCI).
There is widespread general concern at the amount of debt being taken on by listed companies to support dividend payments and for share buybacks to support EPS. At least two of the above stocks use debt to boost return available to shareholders from investments in companies which in themselves might be highly leveraged. For example, at December 31, 2015, Main Street Capital had a debt ratio of 41.6%. An increase in interest rates would not only adversely affect MAIN's investments but would also affect MAIN itself, thus potentially magnifying the effect. Some of the investments of the closed-end funds are in mortgage-backed securities that could also be vulnerable to rising interest rates.
MFFS also notes, "An 8.2% return over 5 years sounds impossible, but the S&P 500 (NYSEARCA:SPY) has actually yielded an annualized total return of nearly double that in the last five years -- 14.55%." I have to wonder why a leveraged fund should not do better than that. Perhaps the four stocks chosen might give the desired high yearly income but only at the expense of total return. The proposed investments warrant further consideration to best achieve the proposed objective.
Summary and Conclusions
There is much to be said for young people scrimping and saving to build a nest egg when young. The advantage for the young is they have time on their side, which together with the power of compounding, enables a relatively small investment early on to grow exponentially over time. Amounts put aside regularly later in life have to be much larger to gain the same amount of investment income at a future point in time, compared to small amounts put aside regularly early in life.
If that is what MFFS is trying to convey, that would be commendable. It is a shame the article loses credibility due to being so flawed in its inputs, assumptions, construction and suggested possible outcomes. Imaginary Jane, you might do well to look elsewhere for advice.
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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
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.