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Forget the Noise: A Common Sense Approach to Investing
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Wealth & Economics > Building a long-term income stream with Dividends

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message 1: by Geoff (last edited Oct 12, 2016 05:13AM) (new)

Geoff Noble (geoffnoble) | 7 comments Hi all,

In a prior life, I was a fund manager. Now I am interested in building a long-term income stream using dividends. I was interested in connection with people who do something similar or are interested in doing so.

Perhaps, it would be useful to outline why I see the real purpose of investing is. Any comments welcome. Here are my thoughts:

IF YOU ASK an average joe why you should invest in shares, he will tell you that you should do it because share prices will increase over time. In my opinion, this is fundamentally incorrect. Rather, we should invest to replace income from working with income from investments.

Every month, quarter or however so often, we should buy shares (or any other investment) that generate a regular income. The first goal should be for your portfolio to generate one month's worth of your annual salary (or whatever amount you think you need to live off). Then, after that, aim for two months, and then three months, and so on. The ultimate goal is to be able to replace your annual salary with the income generated by your investments.

I think we are so fixated on the price of our investments and whether they are going up or down that we lose sight of our true investment goals. I propose forgetting about the price return of your portfolio (I can hear asset managers who focus on selling investment performance protesting). Rather, focus on income. Specifically, focus on the income replacement ratio.

Income Replacement Ratio = (Annual Investment Portfolio Income) ÷ (Annual Salary)

Your aim is to achieve an income replacement ratio of 100%. Think of your investment portfolio as a tree and the income as the fruit. In retirement, if you have a sustainable income replacement ratio above 100%, then you can live off the tree’s fruit. If, however, your income replacement ratio is below 100%, you need to sell some of your investment capital so that you have money to sustain your lifestyle. This is like chopping branches off the tree. Eventually, if you chop too many branches off the tree, it will die. This is not the position you want your investment portfolio to be in.

Building a sustainable income replacement ratio is not something that can be achieved overnight. Firstly, you need to invest in companies that generate real (i.e. inflation-beating) dividend growth. This is necessary as your annual salary will hopefully increase over time, typically in line with inflation.

Secondly, you need to make regular investments. You should aim to invest monthly, or at the very least, quarterly (i.e. every three months).
Thirdly, you must start early. Do not leave building your retirement nest egg until you are 10 years from retirement. (As an aside, if you get this investment thing right and have a bit of good fortune, you will be retiring well before you are 65.)

Fourthly, you need patience and must have the temperament to stay the course. Do not get caught up with the latest investment fads and fashion.
Next, you must not stress about short-term macroeconomic factors. Do not worry about what the Bloomberg TV or the financial press are carrying on about. For example, at the end of 2014, who would have thought the oil price would crash as far as it did? Rather, invest “through” cycles.

Lastly, follow a theme-based approach. Make sure you have exposure to industries that you think are going to be important. (For example, as populations age, healthcare will become more important.)

In summary, your investment plan should be to accumulate a share of great businesses over your working life. The focus is on building an income stream to replace your salary. Do not be concerned on timing your purchases or buying them at the best possible price. Try not to pay excessive prices, but it is more important to accumulate positions in the businesses and spend the longest possible time exposed to the market.


message 2: by Nik (new)

Nik Krasno | 14949 comments I can certainly agree with the goal - of having an income stream, independent of your personal efforts that would allow you a fair subsistence. Not everyone wants to retire (as we discussed on some other thread), but everyone probably wants to be in the position to do so harmlessly.
Not sure - shares alone can be the means to avail a steady income through dividends though. I agree that looking at long-term, some on-the-way turbulence on the markets shouldn't be of immediate concern, but still shares are considered as 'speculative' and thus risky instrument. That's how they are viewed by banks, pension funds, etc, which usually hedge portfolios with 'solid' instruments like government bonds (also not foolproof in my opinion) and so on.
Having zero interest on deposits in many countries these days, the banks developed different products where you can choose shares of some industry (say - high tech) and earn increase, but not lose, if they decrease.
For example, you can say - hey Google (Alphabet) is the (or one of the) most valuable companies, what can possibly go wrong? And I mean, I understand the point that it doesn't matter if their share costs 5$ today, 10 tomorrow, 1 in a year, as long as the dividends are paid. But what if it disappears: like AltaVista before or Yahoo (almost)? A better algorithm may win, monopoly may be dissolved (hardly but still), billions dollar worth fines levied (like EU threatening Apple) or suits brought. Or is there something that will yield dividends no matter what happens? One can lose the tree -:(
Shares can certainly be a part of an overall investment portfolio, but probably a diversification would be a bit safer - to have income generating real estate, deposits, royalties (hardly, huh? -:)) and so on.


message 3: by Geoff (new)

Geoff Noble (geoffnoble) | 7 comments Thanks for your thoughts, Nik. Agree on the diversification point - I suppose shares are what I know. I only really have 4% to 5% of my portfolio exposed to any one company. All the companies I invest in are good dividend payers so not a train-smash if one or two of them let me down!


message 4: by Joanna (new)

Joanna Elm | 145 comments One problem of investing in companies that are good dividend payers while you are also working and making an income from employment is that you pay income tax on both. At least that is the case in the U.S. That is why the more traditional route is to go for growth while you are employed, grow your portfolio with shares in companies or funds that will increase the value of the shares, and then when you want to retire convert your portfolio to good dividend payers.


message 5: by Geoff (new)

Geoff Noble (geoffnoble) | 7 comments Thanks for your comments, Joanna. Food for thought.


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