# Figuring Out How Much Money You Need to Save for Retirement

Hopefully, you’ve heard the 4% rule, where you can withdraw about 4% of your retirement portfolio the first year of retirement and then increase that amount for inflation each year.  You can then figure out how much you’ll need to save up by 1) figuring out how much you’ll each year for living expenses, 2) guessing that you’ll get about \$15,000 per year from Social Security so subtracting \$15,000 per year from living expenses, then 3) multiply the difference by 25 to find the total amount needed (multiplying by 25 is the same things as dividing by 4%).  If you want to be really safe, multiply by 25 or 30 to reduce the chance you’ll burn through your portfolio early.  Oh, and also add \$400,000 to the total for a couple (\$200,000 for a single) for medical expenses.

So, if you’re a couple and want \$50,000 per year for living expenses.  The calculation would look like this:

Income needed = \$50,000 – \$15,000 = \$35,000

Retirement money needed = 25*\$35,000 + \$400,000 = \$1,275,000

If you wanted to be safer, you would take a 3% withdrawal rate instead of 4%, so you would multiply by 30 instead of 25:

Retirement money needed = 30*\$35,000 + \$400,000 = \$1,405,000

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I would actually recommend trying to have extra money saved up so that you could invest the extra fully in stocks, which have a larger return than bonds, while you invest the money you really need about 50-50 in bonds and stocks.  (This mix of stocks and bonds is right at retirement – you would add more bonds as you got older to reduce the effects of a stock market decline, roughly keeping the bond percentage equal to your age minus 10%.) Because stocks average about 12% per year, you could withdraw about 8% per year from this extra money and have a good chance of getting 15-25 years of extra income that you could use for fun and giving.  The extra 4% you would earn would allow the funds to keep up with inflation.   For example, with an extra \$1M, this would be:

Extra money = \$1,000,000* 0.08 = \$80,000 per year

Total Income = \$35,000 (main account) + \$80,000 (extra account) = \$115,000

Because this is extra money, if you had a couple of years where stock market returns were low or even negative, it would just mean that your extra money would decline a little.  You could also choose to not take 10% (or not take anything at all) if there is a decline and wait a year or two for the market to recover, which it usually does, then continue to take withdrawals at 10%.  That is why you can take the risk of being fully in stocks.  If it runs out in 10 years, you’re still covered by your main account.

Having the extra money also helps protect you should you see a big market decline early in your retirement.  If the market drops 40% the first year you retire like it did in 2008, you could shift some of the money from your extra portfolio into your main portfolio to provide enough income for daily expenses.  While it is mainly for extra income, saving up more is also an insurance policy against market declines.  (Note that while the stock market fell by 40% in 2008, the bond market actually rose, so having a 50-50 mix of bonds and stocks would have meant your account would only be down by 15-20% and you might have been able to just wait a year for the stock market to recover without adding to your main portfolio.)

These funds will typically be in a 401k or an IRA.  If you have a traditional IRA or 401k, where you will be taxed at ordinary income rates when you withdraw money, you’ll need to take taxes into consideration.  You can figure that you’ll pay about 15% taxes on the withdrawals (20% if you want to be safe), so you should increase the amount you need by 15-20%. To figure out how much you need to save for retirement, just take your retirement money needed amount and multiply by 1.15 or 1.20:

Assuming 15% taxes and a conservative, 3% withdrawal rate:

Retirement money needed with taxes = \$1,405,000 * 1.15 = \$1,615,750

Assuming 20% taxes and a conservative, 3% withdrawal rate:

Retirement money needed with taxes = \$1,405,000 * 1.20 = \$1,686,000

If you are using a Roth IRA or 401k, because the taxes are taken out before you put the money into the account, the withdrawals are tax-free.  This means you only need to save up the original \$1.4M, not the higher amount.

I know it seems like a lot of money, and it is.  We’re talking about \$2.7M in a traditional IRA or 401k if you want to have enough for expenses plus extra money coming in each year, which is probably more money than many people expect to see in their lifetimes.  The good news is, if you start early, it really isn’t all that difficult to amass such a sum.  That is the beauty of compounding.  Here’s how it works:

You can assume a return of about 8% after inflation if you invest fully in a diversified set of stock mutual funds.  If you start investing at age 20, right when you start your first job, you’ll only need to put about \$260 per month away to reach \$2.7 M by age 70.  If the stock market does even better, you might have \$4M, or you might be able to retire at 62 or 65 instead of waiting until age 70.  The beauty of investing in a 401K or IRA, as opposed to the old-fashioned pension plan where the employer decides when you can retire, is that you can flex things based on how the market is doing.  If you have a good market from the time you’re 60 to 65, you can retire early.  If things go south, you can stay on a few more years and let things rebuild.

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The best plan is to sign up for the company 401k (if they offer one) or start an IRA as soon as you start working and start putting money away before you get used to the extra income.  If you start out making \$50,000 per year, put away 10% into the 401k plan, which would be about \$420 per month.  Hopefully, your company will match part of your contribution, so you might end up putting \$600 or more away each month.  If you do so, you’ll have about \$4.4M at age 70.  At age 65 you’ll have more than \$3M, so you could retire a bit early.

If you wait until you’re 30 before you start putting money away, you’ll still have about \$2M at age 70.  Wait until you’re 40, and you’ll only have \$880,000 at age 70, so you’d need to work until you’re 75 or 80 before you could retire securely.  This is assuming that you don’t get laid off or have health problems that force you to retire.  Starting early is the best way.

Have a burning investing question you’d like answered?  Please send to vtsioriginal@yahoo.com or leave in a comment.

Disclaimer: This blog is not meant to give financial planning or tax advice.  It gives general information on investment strategy, picking stocks, and generally managing money to build wealth. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. Tax advice should be sought from a CPA.  All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.

# Why You Should Invest in Stocks

Personal finance begins with budgeting and controlling your money.  You need to make sure you are spending less than you make, putting money away for future expenses, keeping some cash around for emergencies, and staying out of debt beyond, perhaps, your home mortgage.  Do these things and you’ll be way ahead of 80% of the people out there.

But if you want to become financially independent, meaning that you have enough money tucked away to pay for all of your expenses for the rest of your life, saving isn’t enough unless you have a million dollar per year income and you live on \$50,000.  Realize that in order to pile up money for a year through work and saving, you need to do enough extra work beyond what you need for daily expenses to replace a future year of work, which takes a lot of time.  Think of it this way:

If you were a farmer with a mule, growing food for your family.  If you worked really hard, you would probably be able to grow enough food for your family during the year, plus put some food on the shelf for winter.  If you really worked the fields from morning to night, growing on all of the ground you could,  in a given year you might be able to grow, can, and store enough food to last an extra month or two beyond the start of the next year.  Maybe three or four months.  This means that it would take you three to five years, working like a dog every day during the growing season (and a lot during the offseason too – farmers work hard) to save up enough extra food to last you a year.  If you wanted to save up enough to last you through a twenty-year retirement, that would take you sixty to 100 years.  That’s a lot of work, and a couple of crop failures in the middle, or an injury that put you in bed for a few weeks, and you might not make it.  Plus, while you might be able to work those hours when you are in your 20s and 30s, you’ll start slowing down and feeling the pain of all of that labor when you are in your fifties and sixties.

Great beginner investment guides.

Working an office job or factory job in the modern age is really the same.  If you want to have money to live on when you are not working, you need to put away extra when you are working.  Money is just stuff on the shelves – IOUs for someone to give you an hour of labor in exchange for the hour of labor your gave someone else in the past.  The trouble is that it is difficult to save up enough money before your sixties or seventies through work alone.  You never get that sense of peace that comes with knowing that you don’t need to work to pay the bill until you reach your golden years.  And if something happens along the way like a job loss or a major illness, it can set you back and you may never become financially independent.

The answer to becoming financially independent is to get other people to help you.  You want to provide others with the ability to make a living without figuring out everything themselves, and in exchange get a little of the income produced by their labor.  If you were a farmer, this would be like letting other people farm on your land for a small share of the crops, or letting others borrow your mule and plow for some of what they produce.

One way to do this is to start a business and provide employees with a way that they can make money – feeding people in a restaurant, making something that other people want, or providing places for people to sleep for the night with a hotel – and in exchange you keep a small portion of the money produced through their labor.  For them, it means that they can make a living without going through all of the hassle of setting up their own business and figuring out something they can do that will make money.  For you, it means that you can make a bigger income using the help of others than you could by doing all of the labor yourself.  (Note, another thing you could do is to use machinery or computers to multiply your efforts, but we digress.)

Want all the details?  Try The SmallIvy Book of Investing.

Maybe you don’t want to start a business and deal with the hassles and take the risk, however.   Maybe you also don’t know how to start and run a business and don’t have the money to invest in a building, equipment, and inventory.  Maybe you also would like to just work for someone else and not need to be worried about market conditions, meeting a payroll, or preventing theft.

By investing in stocks, you can effectively own a business – in fact you can own great businesses like Apple, Google, or Amazon – but do so with just a small starting investment.  You get the advantages of ownership without all of the hassles of needing to run the business.  If you buy a mutual fund or an exchange-traded fund (ETF), you can own little parts of dozens or hundreds of businesses, meaning that you can reduce your risk should a particular business see declining sales or other issues.

So once you get past the initial personal finance issues like maintaining a budget, you really need to look at investing.  It can be complicated if you decide to make it that way, but it can also be really simple, in fact downright boring, if you invest through index mutual funds and ETFs.  So look into investing, perhaps starting with one of the investing books shown above (I, of course, recommend The SmallIvy Book of Investing).  In twenty years when you’re financially independent, you’ll be glad you did.

Have a burning investing question you’d like answered?  Please send to vtsioriginal@yahoo.com or leave in a comment.

Disclaimer: This blog is not meant to give financial planning or tax advice.  It gives general information on investment strategy, picking stocks, and generally managing money to build wealth. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. Tax advice should be sought from a CPA.  All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.

# Why You Really Need to Invest

You’ll find a lot of blogs on people getting out of debt.  Perhaps they start out with a student loan balance of \$150,000 and pay it off over a period of three years.  If they are persistent, and particularly if they see their income rise, perhaps because they get a lot of revenue from their blog and affiliate advertising, they will make their way out of debt.  But what then?

What happens after you pay off that last student loan?  After you close that last credit card account?  You make your last car payment?  You make your last mortgage payment?  And what if you never got into debt in the first place?  Often that’s where the blog stops.

If you want to move from just being debt-free to being financially independent – being able to pay for things without needing to depend on a paycheck – you need a way to make money efficiently.  There is only so much time in the day.  Even if you get a second job, unless you have a phenomenal salary, it is really difficult to simply work and save enough money to reach financial independence.  Plus, your income level is usually limited and it will top out at some point in your career.  If you make an average of \$60,000 during your working career and save 10% per year, you’ll have \$240,000 over your entire career.  If you save 20%, you’ll still only have about half a million dollars at age 60.  To sustain yourself, you’ll probably need something north of \$2 M unless you live a very meager existence.

Great beginner investment guides.

When you invest, it is like you are buying an ownership stake in a business, which means that, just like starting a business, your theoretical income is limitless.  There are people who bought a \$5,000 stake in Home Depot or Wal-Mart who are now millionaires.  The beauty of investing is that you get to enjoy the possibility of growth that you get from starting a business, but don’t have all of the headaches that come from actually running a business. You don’t need to check inventory, order supplies, or manage employees.

Not only that, but you get to benefit from other people’s good ideas.  You probably didn’t get the idea to build a search engine that everyone would use, let alone go through the hassle of coding it, getting servers set up, and getting the word out.  But you can buy shares of Alphabet and benefit from the efforts of people who did.  You can buy shares of Walgreen’s and have drug stores on all of the best corners in every city in America.  You can buy into a successful restaurant, a successful credit card issuer, or a successful tobacco company.  If it trades publicly, you can get a stake in the company and take advantage of other people’s good ideas, execution, and hard work.

Want all the details?  Try The SmallIvy Book of Investing.

There are some people who will become rich by working really hard and saving  every dime.  There are others who will become doctors or lawyers, get hired by the right firm or practice or start their own practice, and live on little enough to build up their savings and become wealthy.  There are still others who will start a business and work hard to grow it into a huge company and become wealthy.  For the rest of us, investing is the way to wealth.  If you’re interested in learning how, pick up a copy of The SmallIvy Book of Investing and keep reading The Small Investor Blog.

Have a burning investing question you’d like answered?  Please send to vtsioriginal@yahoo.com or leave in a comment.

Disclaimer: This blog is not meant to give financial planning or tax advice.  It gives general information on investment strategy, picking stocks, and generally managing money to build wealth. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. Tax advice should be sought from a CPA.  All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.

# Go from a Budgetor to an Investor.

So you’ve paid off your credit card debt, paid off your car, and you’ve shifted to a 15-year mortgage that you’ll pay off in 12.  Now you’re wondering, what’s next?  The answer is: Investing.

Many people have heard that it is good to invest in stocks and build up a portfolio but don’t know how to start.  In this article I’ll go over some of the basics to get you started.  There is really no secret to stock investing – it is just a matter of investing regularly, understanding risk, and properly evaluation companies for potential return.

The first concepts that one must understand are volatility, diversification, and time frame.  First, we will discuss volatility.  Stocks and other assets go up and down in price.  It is not like a bank account where one can calculate the interest rate and know the value at a future point in time.  One must therefore not invest money needed in the next few years; however, by taking on more risk, one can make returns that are much better than bank rates.

The potential return on an investment is proportional to the volatility.  Bank accounts and CDs are not volatile – the rate of interest is easily calculated such that the value at any given time will be known.  There is a slight risk that the bank may close and not be able to repay the money — a risk that was reduced after FDIC insurance was started — but most fo the time the money is repaid and one is able to ask for the money back at any time, albeit with a forfeiture of interest some times.

Great beginner investment guides.

With stocks and bonds, the value of the investment fluctuates with time.  One can not be certain what the value will be tomorrow or the next day, or even next year – it is whatever someone is willing to pay for the stock or bond at the time.  For a stock one can assume that the price will be close to where it was the day before, but news — good or bad — can cause the price to move by 10% or more in a day.  Sometimes a stock will rise or fall for reasons that have nothing to do with the company.  The whole market will move due to word of recession, war, pending legislation, or other events.  Sometime it is just movements of the stock prices themselves or various trading strategies that are being employed that will cause a stock price to move precipitously.

It is this volatility, however, that makes stocks grow more over time and provide a greater return than safer, fixed income investments.  Because there is risk involved, one is able to buy stocks at significant discounts to what the earnings prospects of the company indicate the price will be.  Because the company may not make the earnings, and later pay the dividends, that are expected the price will drop until it is low enough to justify the risk taken.

To reduce risk caused by uncertainty and volatility, one uses diversification.  Diversification is spreading out one’s money over several stocks.  It is uncommon, but not unheard of, for single stocks to drop by half or more over short periods of times.  If a scandal breaks out or a large lawsuit occurs, a stock may go bankrupt in a period of days.  By buying several stocks, however, a loss will be limited even if a single stock in the portfolio drops to zero.  If one owns 10 different stocks in equal amounts, one can only lose 10% in any individual stock.  If one buys a significant number of stocks, or buys a few mutual funds, one will get about the return of the market, which generally ranges between about -10% and +15% in a year, but can see swings of between -50% and +100% in a year time period.  During the Great Depression, the market fell by 90%, but then proceeded to rally back, increasing tenfold (1000%)in the years that followed.

Want all the details?  Try The SmallIvy Book of Investing.

The third concept is time frame.  Because stocks are volatile, it is difficult to predict price over short periods of time, between one and three years.  Over five to ten-year period or longer, however, stocks tend to rise.  Returns on stocks over long periods of time have averaged between ten and fifteen percent — much better rates that most other investments.  Also, buy buying shares regularly, rather than putting all of one’s money in at once, one can do even better since more shares will be bought while prices are low than when they are high.  This process, called “dollar cost averaging,” is a popular and effective technique.

The best strategy therefore is to:

1)Invest only with money that is not needed in the next several years.  If the money is needed, it is better to forego the added return and just keep the money in cash.

2) Have only as much money in a single position as you would be willing to lose.  As the amount of money invested increases, the money should be spread over more and more stocks and into other assets such as bonds to reduce risk.

3) Invest for the longterm.  Select stocks that have earnings that are growing steadily and have lots of room to expand.  Once you have invested, then ignore the price fluctuations that occur and focus on the earnings.  As long as earnings continue to increase, the price will also, eventually.  Remember that time is on your side – if things look bleak, just ignore it for a while.  A rally will eventually come.

Have a burning investing question you’d like answered?  Please send to vtsioriginal@yahoo.com or leave in a comment.

Disclaimer: This blog is not meant to give financial planning or tax advice.  It gives general information on investment strategy, picking stocks, and generally managing money to build wealth. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. Tax advice should be sought from a CPA.  All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.

# How Many Shares Should a Beginner Buy?

OK, so you’ve been interested in individual stock buying for a while, have saved up some money, and are looking to buy your first shares.  Or maybe you are just starting to save money and wonder how much you need to save to be ready.  Today we’ll talk about how much is needed to get started in stock investing, and how many shares you should plan to buy starting out.

First, make sure you are actually ready to start investing in individual stocks and that you have the right expectations.  To be ready to invest in individual stocks you should:

1.  Have your credit cards all paid off.  There is no reason to be investing while you’re paying credit cards 12% interest or more.  Pay off you high interest debts, then think about investing.
2. Have an emergency fund of at least \$9,000.  If you don’t have a good emergency fund, you’ll have just bought your first shares, then need to sell them to pay for something that breaks.  Or worse, you’ll pull out the credit card to pay the bill, starting you into debt.  Note this does not apply if you’re under 18 since you have your parents to pay the bills – and this is a great time to first start investing.
3. Be putting at least 10% of your pay into a retirement fund,  This could be a 401k, 403B, or even an IRA.  This money should be invested almost exclusively in a diversified set of low-cost mutual funds.  You still want to be able to retire even if you’re a bad stock picker.
4. Be ready to leave your money alone for at least 5-10 years.  Stock investing, particularly individual stock investing, is a long-term game.  Investing for anything less than five years is just gambling.
5. Have money you can afford to lose.  Individual company stocks can and do go bankrupt.  You should allow the possibility of losing ever dime you invest.

If you pass the criteria above, you might be ready to start individual stock investing.  While you can buy any number of shares, if you’re investing to make money, you’ll probably want to try to buy at least 100 shares, or what is called a “round lot.”  Invest less than this, and the amount you’re paying in commissions will start to make it really difficult to succeed.  You’ll also want to pick a stock in the \$10-\$30 range, which will mean you’ll need about \$1100-\$3100, when you include commissions.

If you’re not really investing to make money, but instead just want the fun of holding a few shares, you can buy around 10 shares.  We bought 10 shares of Home Depot for \$300 for my son when he was born, and now (15 years later), his holdings are worth about \$1200.  Even better , he gets a dividend every three months which has been steadily increasing.

Finally, if you really are serious about single stock investing, and you can afford to take the loss if something goes wrong, you should try to buy in increments of 500-1000 shares.  At this level you will really profit if you are right and the company does well.  If you hold 100 shares of company XYZ and they go from \$20 to \$60, you’ve only made \$4,000.  This is nice, but really not that substantial in your life.  If you have 1000 shares, you’ll have made \$40,000.  That’s enough for a year in college, a good down-payment on a house, or a couple of high quality, late model used cars.

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Getting to 1000 shares may take a while and require some build-up.  In fact, it is probably better to buy in increments of 200-300 shares a few times rather than buying 1000 shares all at once since then you can pick up more shares on dips and get a better price.  In fact, to reduce your risk, you should probably pick up 200-300 shares of stock A, then 200-300 shares of stock B, then 200-300 shares of stock C.  Then, buy more of whichever company’s shares are the best bargain when you’re ready to buy more.  Of course, sometimes a stock will take right off after your first purchase and never look back, so you never know.

Have a burning investing question you’d like answered?  Please send to vtsioriginal@yahoo.com or leave in a comment.

Disclaimer: This blog is not meant to give financial planning or tax advice.  It gives general information on investment strategy, picking stocks, and generally managing money to build wealth. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. Tax advice should be sought from a CPA.  All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.

# How to Select Your First Stock or Invest with \$2,000

Dear Smallivy,

In your 4th February 2013 you wrote:
“​If you are willing to learn to invest in individual stocks, \$2000 is enough to buy shares in one company in the \$10-\$18 range.  Look for a stock that you think has good long-term prospects – one that you think will expand and grow for years to come – and expect to own it for a long time.

A final way you could invest \$2000 is to buy shares in an Exchange Traded Fund (ETF) through a brokerage firm.  These are like mutual funds with super low costs that trade like stocks.

My question concerns stocks within \$10-\$18 range.  How do you find out stocks which has good long-term prospects – one that will likely expand and grow for years to come ?

Also, how many ETF shares do you buy with the US\$2000 investment and what type of ETFs are the best?  There are different types of ETFs.  Do you buy one, two three or more ETF types with than investment amount of US \$2,000?

Davidson

Davidson-

Thanks for the questions.  First on the question of finding a long-term growth stock, that is the subject of my next book, if I ever finish writing it.  In general you want to find a stock that has:

1.  A history of growing earnings in the 10-20% range (more is not sustainable).

2.  A lot of room to grow – they should have more markets to enter or they should be adding products.

3.  No dividend or a small dividend.  They should have plenty of places to put their earnings to grow the business, so they should not be returning money to shareholders just yet.  Also be wary of stock buybacks.

4.  A history of share price increases.  You want a company where you can almost lay a ruler over their share price for the last 5-10 years and see a steady climb.

Finding data is tricky, and finding a way to screen stocks is even harder.  I use a service called ValueLine Investment Survey, which is both online and in print, but it is pricey if you’re just getting started.  You used to be able to find copies in some libraries, which is a great way to go if you’re only going to be investing a few thousand dollars a year or so.  I’m not sure if this is still the case since today libraries are just where people go to watch you-tube videos.

Otherwise, just look around for companies that are relatively new and seem to have a good business, then check out their price charts and earnings on Yahoo or another online source.  I generally find restaurants and retail stores are great places to look since they can grow their businesses by just adding locations.  Be wary of stocks with a high PE ratio (greater than maybe 30) since these may be bubble stocks that will eventually come crashing back to earth.

The ETF question is much simpler.  With \$2000, just buy one and buy all that you can with that \$2,000.  Good choices to start are just simple, broad-based ETFs like those that track the S&P500 or the Dow Jones Industrial Average.  An ETF that tracks the small caps is also good.  Make sure the fees are low (less than 0.25% per year, maybe much lower).  People may think I get paid by Vanguard for endorsements (I don’t, except for the returns on their mutual funds and ETFs I receive in my own accounts), but Vanguard has a lot of great low-cost ETFs such as their S&P500 ETF and their Total Stock Market ETF.

In either case, you want to just make this your first step in investing.  Buy your first stock now, then save up and buy another, then a third and so on.  Build up positions in four or five stocks that are the best choices in four or five industries.  Start to diversify into ETFs or mutual funds when your portfolio starts to build beyond the point where you’re comfortable being concentrated.  (Also, you should be investing in mutual funds through your work 401k plan or a personal IRA as well since you can’t take the chances with your retirement savings that you can with your regular investing account.)

If you choose the ETF route, buy into your first ETF, then buy into a second then a third, getting positions in large caps, small caps, and International stocks, then add to those three ETFs regularly.  You could also buy into the Powershares High Quality Index (SPHQ), which is made up of solid stocks that won’t do as well in great markets but will not lose as much in bad markets.

Thanks for the question,

SI

Got an investing question? Please send it to vtsioriginal@yahoo.com or leave in a comment.

Disclaimer: This blog is not meant to give financial planning or tax advice. It gives general information on investment strategy, picking stocks, and generally managing money to build wealth. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. Tax advice should be sought from a CPA. All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.

# Should You Buy Dividend Paying Stocks?

In stock investing,  it really all comes down to dividends.  Either dividends that the companies you own currently pay, or dividends they may pay in the future.  Indeed, the price growth rate of a stock is normally tied to the growth rate of the dividend, both the one that it pays now and the one that it will probably pay in the future.

You see, a dividend is a portion of the profit that a company makes that it pays out to the owners – the stock holders.  When a stock is young and growing rapidly, it may pay only a small dividend, or even no dividend at all,  because it needs all of the money it can raise to grow the company.  When it becomes a big company many years later, however, it might making enough money to pay out a few dollars per share each year.

The nice thing about dividends is that they allow you to make money from a stock even in years where the prices of stocks are gong nowhere.  If you own shares in a stock that pays no dividend and the price just trades within a narrow range for several months, you will have received no return for your money during that period.  If the stock pays a dividend, however, you can still be making a few percentage points of return each year even when the price of the stock is going nowhere.  It is kind of like a bank account with the possibility of much bigger gains.  (Realize, however, that movements down in price can quickly erase the amount of money you are getting from dividends, so there is no stability or guarantee like there is with a real bank account.)

Often a company will continue to pay dividends even when the price of the stock declines, helping to reduce the sting of the loss.  In addition, because the percentage return (yield) of a stock will increase as the stock price goes down unless the company decides to cut the amount of its dividend, people are more likely to buy dividend paying stocks as they decline than those that don’t pay a dividend.  This causes something like a safety net to be placed under the price of the stock.  Of course this doesn’t work in cases where the business of the company declines since then they may need to cut or eliminate their dividend.

Despite the virtue of dividend paying stocks, they aren’t for everyone.  If you are young and have s long time to invest, you’ll generally do better buying a portfolio of young companies that don’t pay dividends but have a lot of room to grow than you will with older companies that pay a good dividend but have already seen a lot of their growth.   Dividends will also create income, which means you’ll need to pay taxes each year even if you reinvest the dividends unless the stocks are in a tax-deferred account like an IRA.

Dividend paying stocks can be great, however, if you need your portfolio to generate an income for you.  If you receive enough money from dividends to pay for things when you’re retired, you will not need to sell shares of stock to raise cash.  You can then let the value of the shares appreciate while you spend the dividends.

Another neat thing about dividend paying stocks is the compounding that comes.  When you start out, you may only be making a 2-3% return each year in dividends.  As the company grows, however, and makes more money, they may increase their dividend.  Because the stock price increases they may still only be paying 2-3% based upon the price of the stock, so you’ll effectively be making a greater return on the amount of money you invested.  Wait long enough and you may be making a 10, 20, or even 30% return based on your original investment each year!  The power of compounding, even when it comes to dividends, is astounding.

When investing in dividend paying stocks, here are some things to consider:

1.  To save taxes, keep your dividend paying stocks in tax sheltered accounts and non-dividend paying stocks in taxable accounts unless you need to spend the money now.

2.  Companies that raise their dividends every year tend to be great companies as long-term investments.  Find these and hold on.

3.  Don’t buy a stock with a dividend that is much bigger than the rate of similar stocks in the market.  It is probably about to cut the dividend.

4.  If you don’t need the money for a while, consider using a dividend reinvestment plan, or a DRIP, where the dividends are reinvested to buy more shares.  Again, this will need to be in a tax-sheltered account or you’ll still need to pay taxes on the dividends.

Got an investing question? Please send it to vtsioriginal@yahoo.com or leave in a comment.

Disclaimer: This blog is not meant to give financial planning or tax advice. It gives general information on investment strategy, picking stocks, and generally managing money to build wealth. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. Tax advice should be sought from a CPA. All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.

# A New Theme for the Small Investor Blog

When I started this blog about five years ago, my plan was to teach people how to invest and manage their cash flow to allow them to become financially independent.  This is the state where you are making enough money from your investments, and have paid enough of your loans off, to not need to work to sustain your lifestyle.  Since that time I have posted hundreds of articles and the blog has received hundreds of thousands of views.

Along the way, however, I realized that the scope of the blog needed to be expanded because the need was greater than the original focus.  Middle class Americans, along with those individuals in foreign countries that enjoy at least some economic freedom, have the ability to become financially independent if they make the right choices of how they handle their money.  And really, most people have the ability to enter the middle class in America if they make the right choices when they’re young, such as completing school, and getting to work when they are young adults.  This is because of financial freedom where you have the ability to make more by efficiently using your personal capabilities.

Things have been changing in America, however, where people have been giving away that ability in an effort for an easier life.  You see, freedom provides opportunity, but freedom also requires responsibility.  Being paid based on what you produce provides the opportunity to grow your income by working harder or gaining skills to allow you to be more efficient, but it also means that you need to put in the work to provide for yourself and your family.  Some individuals want to have a comfortable life but don’t want to put in the effort required under an economically free society.

Many people today are falling for the false notion that the government can magically provide for you without any effort on your part.  In actuality, you will always be the one doing the providing.  It is just a matter of whether you just produce and keep the goods for yourself, or you give the product of your work to the government and then have them give the portion that they choose back to you, minus the salaries of all of the people involved in distributing the goods.  When the government is collecting and distributing the money, you lose the ability to choose the less expensive option and invest the rest.  Also, if you make more the government just takes the excess, so you never have extra left over.  This is an impediment to becoming financially independent, which requires saving and investing, so an additional goal of the blog is to explain this false economics so that people can make better decisions in the policies they choose to support.

I’ll still be providing articles on how to invest and how to budget to have money left over to invest.  I’ll also discuss planning financially for retirement.  There will also be more articles on stock picking as I work on my second book that will be all about how to choose stocks that fit the serious investing model that I discuss in my first book.  I’ll just add articles on how to use this great thing we have called free enterprise to achieve the American dream of rising from poverty to wealth over a generation or two and discuss some of the forces trying to take away that dream from the next generation.

America has been a wonderful place because you don’t need to be born into a certain family or a certain caste to become wealthy.  You just need to learn skills, work hard, and manage your money effectively.  The goal of this blog is to preserve that ideal while sowing readers how to take full advantage.  I hope you’ll continue of the journey with me.

Got an investing question? Do you see something differently?  Have something to share with everyone?  Please send it to vtsioriginal@yahoo.com or leave in a comment.

Disclaimer: This blog is not meant to give financial planning or tax advice. It gives general information on investment strategy, picking stocks, and generally managing money to build wealth. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. Tax advice should be sought from a CPA. All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.

# Millennial 401K Investing

Companies have finally started getting better with how they enroll new workers in retirement savings plans, which are commonly called 401K plans.  These are defined contribution plans, which mean that the employee and employer each make a specific contribution to the plan.  After that, the employer has no responsibility to make other contributions should the investments in the plan not perform well.  This is different from defined benefit plans like pensions where the employer is responsible for paying a specific monthly payment when the employee retires.  With a 401k plan, you get what you get.

Luckily, you’ll probably end up much better off in a 401k plan than you would have with a pension plan.  This is because pension plans have a defined payout that is well below market returns to ensure that the employer will be able to cover the costs.  With a 401k, you can get market returns and do very well if you just follow a few, simple rules.  These are:

1.  Invest in a way that is appropriate for the time you have until you need the money.
2. Don’t touch it until you retire.

The first rule means that you need to be investing mainly in stocks, which can change price rapidly but provide a larger return over long periods of time when you are young, and then move into cash and interest-paying investments when you’re near retirement and don’t have time to come back from a big market drop.  The second rule means you don’t take money out of your 401k for any reason, including taking loans from your 401k, until you are ready to retire.  Because workers commonly break both of these rules, 401k’s have gotten an undeserved bad name in some cases.

One issue is that employees don’t enroll in the plans when they start working or invest too little of their paycheck to even get the company match (this is free money you’re leaving on the table), which is like pulling money out (breaking rule # 2).  The other issue is that they leave the money in a money market fund, which won’t event keep up with inflation, instead of putting it into stock mutual funds where they could get a return of 10-15% per year (breaking rule #1).  This means they’ll reach retirement with \$500,000 instead of \$20M, even if they save regularly.

To combat this, employers have started automatically enrolling new employees in the 401K plan with a reasonable initial contribution, although one that is still often too small.  They have also started putting them into target date mutual funds as the default rather than the money market fund.  This is also a great improvement since many employees have a great deal of inertia and end up just leaving things alone.  Without automated enrollment, many employees didn’t enroll for years if ever, giving up a lot of time, which meant a lot of compounding.  With a money market as the default, many employees just left their money in savings rather than investing. This new system means they are at least contributing a bit more and they are getting much better returns than they were in the money market fund.

If you were to just leave things alone in this scenario and not do something stupid like stop the contributions or take the money out, you would be looking at a comfortable retirement.  Still, you could often do a bit better, which will mean millions of dollars more at retirement.  Here are a few tweaks:

Up your contribution:  You should be contributing at least enough to get the full employer match, but this is often only 5% of salary or so.  To ensure a rock star retirement with travel and vacation homes, instead of a good book and small apartment retirement, up your contribution to 15% of your salary.  Note that this will also cut your tax bill, so you’ll actually be increasing the amount you keep.  Ideally you should contribute 15% right from the start before you’ll miss the money.  If you’re already locked in, try increasing your contributions each time you get a raise until you reach the 15% limit.

Reconsider the target date fund:  Target date funds include a mix of bonds and stocks.  They start with more stocks and then increase the percentage of bonds as you approach retirement.  This isn’t terrible, but some funds have a relatively large percentage of bonds when you’re young and others may not have enough bonds to provide sufficient protection when you near retirement.  Some target date funds also charge high fees (greater than 1% per year) because you end up paying for both the fees the funds charge and a fee for the company that selects the funds.  An article by Maggie McGrath and Janet Novack in the February 29th Forbes estimates that workers could end up with 15% less at retirement if they pay just 0.7% more in fees each year.  Again, that is millions of dollars.

To improve on your investments, consider investing directly in low-cost index funds if that is a choice in your 401K.  If not, see how the fees of the other funds that are offered compare to the fees charged by the target date fund.   If they are lower, consider switching out of the target date fund and choosing your own investment mix.

When choosing funds, keep it simple (and low in fees).  Really all you need is just one stock fund that invests in the whole market, or one that invests in large caps and another that invests in small caps and split your stock investment between them.  If you want, you can mix a little international in there, but not more than maybe 20-25% of your 401k.  Each of those funds will take its turn as the leader at different times.  In general they will all increase in value over long periods of time (more than 5-10 years).

While you’re younger than 30, and maybe even 45 or so, you might consider investing only in stocks.  Stocks will return 10-15% over long periods of time, compared to maybe 5-10% for bonds and other income-producing assets.  While you’ll need the stability bonds provide when you get closer to retirement, why give up that extra return while you still have time to wait through the bear markets and declines that will inevitably come with an all stock portfolio.  Certainly you’ll see a lot more rises and falls in the value of your 401K if you’re entirely invested in stocks, with some drops of 40% or more at times, but because the amount of return you can get from companies growing is a lot more than you can from making loans to companies or just receiving a share of the profits, stocks will do better if you have 40 years to wait.  Again, the difference will be millions of extra dollars at retirement.

So, contribute 15%, minimize fees, and increase your stock allocation when you’re young.  All of these moves will allow you to supercharge your 401K account.  When you’re ready to retire you’ll be glad to be able to invest for yourself in a 401k rather than rely on a stodgy old pension plan.

Got and investing question? Please send it to vtsioriginal@yahoo.com or leave in a comment.

Disclaimer: This blog is not meant to give financial planning or tax advice. It gives general information on investment strategy, picking stocks, and generally managing money to build wealth. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. Tax advice should be sought from a CPA. All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.

Investing in stocks really isn’t as difficult as some people think.  The first way everyone should be investing is through a 401k plan at work and then a private IRA at home.  Most of that money should be invested in inexpensive index mutual funds and ETFs.  Once you have your retirement covered, however, perhaps you wish to invest in individual stocks and try to pick some great companies that will outperform the markets over the next couple of decades..  Today I’ll go into how to buy individual stocks.

I chose \$2000 since that is about the minimum amount you can invest and get a decent ratio of the commission you pay to the value of the shares.  You should be paying commissions of 5% or less, and paying less than 1% is even better.  You might pay 10% or more if you buy only a few shares.  In general you want to buy stocks in 100 share increments.  With \$2000, you therefore can choose stocks with prices up to about \$19, leaving a little room for the commission.  You also generally want to avoid stocks selling for less than \$10, since they tend to be more risky, although during big declines in the stock market such as the current slump you may find even great companies who have seen their share prices beaten down below the \$10 mark.  For example, right now I own shares of two retailers, The Container Store and Pier One Imports, that are selling in the \$5 range because they have been beaten down during the current bear market.  Both have also made missteps and seen a decline in their performance as well, however, so they do carry some risk since they may not find a way to turn things around.

If you are going to invest regularly you should setup a brokerage account.  When I started investing all trading was done by phone with a broker.  I had an account with Merrill Lynch, mainly because my father had an account with them (and because I was only 12 years-old, and didn’t really have a choice).  Merrill Lynch is what is known as a full service broker, which is kind of like a full service gas station:  You get a lot of bells and whistles and pay extra for them.

One of the biggest bells is a broker that you can talk to who can advise you on the best ways to make a trade, give you some stock picks, and do things like analyze your portfolio each year for issues.  Today I really don’t need much advice, but I am still with Merrill Lynch out of inertia, sentimentality, for some of the other services they provide, and because I like to phone in orders and have a relationship with another person.  Most brokers I’ve dealt with I’ve had as a broker for ten years or more.  In addition, because I invest for the long-term and trade infrequently, the difference in commissions I pay versus a cheaper online version doesn’t really matter.

In the late 1980’s, discount brokers emerged.  These brokers charged a lot less (50% less or more) than full service brokers because you didn’t get any frills or any advice.  You simply called in an gave them your order and they did what you asked.  You may or may not talk to the same person each time you called, so you probably wouldn’t build up a relationship with a broker.  The creation of the  internet and the ability to enter orders yourself has cut costs even more, making it possible to enter trades very cheaply, but again with even less personal interaction and advice.  There are numerous online brokerages, the most famous of which is probably E-Trade.

With any broker, setting up an account is just a matter of calling or going online, giving some information, and sending in a check or doing a bank transfer to fund the account.  Once you have an account there will normally be an account fee each year (I think Merrill Lynch charges \$125 per year) to pay for the accounting they do.  Most of the money they make is from commissions, which is a charge for making trades for you, interest charged when accounts go into margin (borrow money to buy stocks), or the normal bank process of lending out money you have in your account to others.

Normally when you have a brokerage account, the broker will keep the certificates for the shares you buy and put them in what is known as the street name.  This means that to the company the shares will appear to be owned by your broker, but you will have a listing of what you own in your account.  When the company sends information to the broker, such as yearly reports, the broker will forward the information to you.

If you want, you can request that certificates be issued to you.  This may come with a small charge, plus it will then require you to protect the certificate since someone could theoretically steal it and then sell your shares and collect the money.  If you choose to hold certificates, it is therefore a good idea to get a safe deposit box and keep your certificates there for safe keeping – both to guard against theft and fire.    If you ever want to sell your shares, you would need to send the certificate back to the broker.  Most people keep shares in the street name to avoid this inconvenience, but it might make some sense to keep certificates yourself if you were worried that the brokerage firm might dissolve and lose the record of your shares or something, but this is very unlikely.

Figuring out which stock to pick is a whole different matter and will be the subject of future posts and the next SmallIvy Book of Investing.  In general you want to find a company that has a lot of room to grow and that is well managed.  Factors to look at are the number of years that they have had profits and that those profits are growing at a steady rate, a share price that increases regularly but not at an enormous rate, and the return on equity and debt levels for the company.

Got an investing question? Please send it to vtsioriginal@yahoo.com or leave in a comment.