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Introducing A DGI Retirement Strategy To My Parents

So here is the text from my second e-mail to my parents about investing for retirement. In the first one, which you will have to find yourself because I don't know how to hyperlink, I explained the importance of having sources pf income even in retirement, and trying to live within the constraints of that income rather than spending directly out of savings.

In this one, I try to explain why a DGI approach would be good for them, and what such a portfolio would provide.

"

Hi guys,

I know that you asked me for stock recommendations but I don't think we're quite there yet. Let's first talk about what we want these stocks to do for us. Get ready for another analogy.

Let's say you buy a machine that prints $8750 a year, every year, for $250,000. Let's also say that the market for such a machine is very liquid, you can sell it pretty much any time you would like. On the flip side of that nice liquidity, the sticker price for the machine is very volatile. A year after you buy it, you may only be able to sell it for half of what you bought it for, though some years you could sell it for much more. Every year, however, no matter what other people will pay for it, the machine prints out $8750.

Do you like your purchase? You may think that the price is pretty steep, as it would take about 28 years for this 250k machine to print out 250k, but remember that there is a market for this thing. If you sell it for exactly what you paid for it five years later, you still pocketed 43,500 along the way.

Are you worried about the price volatility? It's entirely possible that the thing will only be 'worth' 125k after a year (assuming something's worth is determined by what someone else will pay for it). No one is forcing you to sell it, though; at a selling price of 125k you can just hold on to it and it will still be paying you 8750 per year.

What I am quite obviously getting at here is that you can build this machine yourself out of stocks. Of course, your machine of stocks will be a little bit more complicated, but only a little bit. You will have to pay taxes on the dividends you receive, which is a bummer. There is a chance of volatility in the amount of income you would get, in the case of a company decreasing or stopping its dividend payment. (Pretty small chance though, as the companies you will be buying will probably be ones that didn't cut their dividends during the great recession of 2009, the return to sanity from the tech bubble in 01-03, black monday in 1987, or, in some cases, the Vietnam war) On the upside, the machine won't simply pump out 8750 per year. It will produce a steadily growing amount of income, at a growth rate that outpaces the historical rate of inflation.

This is really important because inflation is the single biggest destroyer of wealth you will encounter. Taxes definitely drain money, but at least you get some services out of them, and taxes are on things like income, property, and frivolous purchases. If you have income, property, and can afford frivolous purchases, than maybe you deserve to pay some taxes. Money management fees are insidious. A couple percent here, a couple there...suddenly any profit you would have made is in your broker's pocket. But inflation is a killer. It goes after income and savings, you never notice it because it doesn't affect dollar amounts (just purchasing power), and it's ridiculously powerful.

If, instead of buying our house when you did, you had stuck that money in a bank account to be "safe", what could you buy now? Really, what could you buy with that money? Not a house. Not a new car (well, maybe a small KIA or something). Not a year at a liberal arts college. Not much. Without losing any money, without your bank account going down a single cent, you would have lost a huge amount of purchasing power. Inflation is enemy #1.

So anyway, getting back to the land of solutions. It's entirely possible to buy a portfolio of 10-30 stocks that currently yields 3.5 percent. You can build that portfolio entirely out of companies that have paid and increased their dividend every single year since you bought your house. And you can build that portfolio from stocks whose dividends have been growing faster than the rate of inflation over 10, 5, 3, and 1 year periods. And because those stocks have been doing this, you can be fairly sure that they have the two most important things you can find in a company: growing earnings (how else could they pay growing dividends?) and a shareholder-friendly management (what's friendlier than cash every three months?).

Of course, past performance is no guarantee of future results. Maybe all of these companies will stop paying dividends at once. Maybe the stock market will crash harder than ever before and simply cease to exist. There are risks to anything.

But that's also exactly my point; there are risks to anything. This strategy is very, very unlikely to fail. It makes a lot of sense and it has worked over and over and over again. Is there anywhere else with less risk? Banks and CD's: Historically, the worst possible place to put your money due to inflation. Will pay off well in a ridiculously terrible breakdown of our entire economy. If that ever happened, who even knows if the bank will give you your money back? Real estate: Remember 2009? Bonds: More abstruse than stocks, less likely to grow in value, less likely to pay out income that beats inflation. Options: No. Growth, tech, and most small cap stocks: High risk. Annuities: Essentially the same outcome as this strategy, they just eliminate the small chance that the income will be cut and replace it with the sure chance of exorbitant fees. There is no other strategy that provides a better chance of preserving/increasing your purchasing power and providing a reasonable income.

In the quite likely case that everything continues to be pretty much the same (including flash crashes, great recessions, fiscal cliffs, sequestrations, etc., not just the good stuff) here's what happens: your portfolio provides you with a steady, consistent, growing amount of income that outpaces inflation. The value of your portfolio somewhat tracks the broader market, but is less prone to huge crashes in value because of the steady income (if coca-cola drops 30 percent in price, it will be available at a historically awesome 4 percent yield, and it won't drop much further because every smart investor in the world will be pouring their cash into it). Instead, it steadily tracks upward as the companies in it, that have been growing earnings and dividends for 25+ years straight, continue to do what they do best. You live off of a growing income stream for as long as you can, then pass a portfolio worth more than its original value on to [my sister] and I.

Read that last paragraph again. That's not the best case scenario. That's the most likely scenario.

Next e-mail, I promise, we will talk about businesses and stocks and how to pick out something to actually buy.

-Nat

"

As always, any comments are appreciated. Criticism, too. I'm still brand spanking new at this and I'm sure there's stuff I could do better.