Do you needs bonds?

[Zaxon]

I keep enough cash in a HISA to survive for more than a year with no additional income from dividends and trading profits and then "pay" myself a weekly wage to a transaction account.

That all makes sense. I'm assuming you're not paying yourself a fixed amount, so there's no "4% rule" here. Do you pay yourself based on a percentage of your current, total portfolio, or is it based just on the dividends and profits you make during that week? If so, that's a tough gig

 

[Zaxon]

Listen to this video from the 4 minute mark, Buffett describes shares as “equity bonds”, this is a great conversation that brings up some of the points I said helped me understand equities better as I learned about bonds.

Oh yup. I've pretty much listened to every Buffett interview of YouTube, so it's just a matter of seeing which one you're talking about. So I agree with his sentiment, that a stock is like a equity bond that pays you in earnings (rather than coupons) over time. Particularly for a fundamental investor, this would be core to their understanding.

 

[aus_trader]

I retired early and am following option 1 although I don't use percentages.

I keep enough cash in a HISA to survive for more than a year with no additional income from dividends and trading profits and then "pay" myself a weekly wage to a transaction account.

Even in the GFC companies like the big four banks continued to pay dividends and in a down turn could probably survive more than two years without any drastic action.

Good to hear you've got 1 year buffer in savings. This gives you peace of mind and it's a great position to be in when trading/investing. I can tell you from experience that if you don't have money saved up for emergency living expenses, you tend to force trades to meet current living expenses or you try to make unrealistic gains from the markets. So I also have a revolving buffer of months of living expenses in cash/TD type liquid assets. I say 'revolving' because I sometimes draw on it for emergencies (medical, urgent car/home repairs etc) but then save up again. Also have the option to draw on the home loan but I prefer not to as it would drag out my mortgage to the grave. Instead I'd prefer to pay the whole thing off before or at least in early stages of retirement.

 

[Zaxon]

I can tell you from experience that if you don't have money saved up for emergency living expenses, you tend to force trades to meet current living expenses

I'm going to highlight this point, because it can be tied back so well to "Option 3": all your money in stocks + 1 months expense. If one did choose this option, it makes sense to time it with your natural selling activity. For a short term trader, they would have cash flow every week. For a long term investor, the natural sell cycle might be only 1 stock a year.

It can work based on forced selling: a pension from your super that pays you a monthly amount, is a forced sale for most people. But I feel it makes more sense to time it with your natural cash flow cycle.

 

[aus_trader]

I'm going to highlight this point, because it can be tied back so well to "Option 3": all your money in stocks + 1 months expense. If one did choose this option, it makes sense to time it with your natural selling activity. For a short term trader, they would have cash flow every week. For a long term investor, the natural sell cycle might be only 1 stock a year.

It can work based on forced selling: a pension from your super that pays you a monthly amount, is a forced sale for most people. But I feel it makes more sense to time it with your natural cash flow cycle.

I think while we are still working there is no need to be doing any kind of forced selling or liquidating any positions for meeting living expenses. But I totally understand the point becoming valid down the track when you may need to rely on that cashflow for living.

I have to think outside the box as well going forward. I had it kind of planned out in the olden days to put the bulk of the savings into cash/TD type assets in retirement earning a safe 5% and the rest in more volatile shares etc to earn dividend payments etc. It's not going to work with below 1% interest rates, so will have to re-work the retirement strategy and think long and hard how to structure it since I still have a few years to earn as an employee.

 

[Zaxon]

I think while we are still working there is no need to be doing any kind of forced selling or liquidating any positions for meeting living expenses. But I totally understand the point becoming valid down the track when you may need to rely on that cashflow for living.

Yes, we've got some people in this thread working, and others retired, so the conversation is bouncing back of forth . Although a lot of the principles are true in both cases, thankfully.

To throw a spanner in your "no forced selling while working" stance, which does make sense in general, I can think of a couple of examples where it could make sense.

First one is a vehicle. For the sake of this discussion, let's assume you're buying a new, reasonably priced car in cash, and keeping for 10-15 years. Now, it would be crazy to keep 35k in cash for 15 years, ready for the next car. With that timeframe in mind, you invest your "car money" in shares. In that case, you're justified in selling down when your car blows up unexpectedly at 9 years rather than at 15. You've probably double or trebled your car money by then anyway.

As a second example, we had a bathroom tap blow out, and flood half the house. Due to the damage to the bathroom, we sold down some shares, and put in a brand new, totally redesigned bathroom for 15k. That was a forced sell down, but I wouldn't carry 15k in cash permanently, just in case the bathroom needed doing again in another 20 years.

I have to think outside the box as well going forward. I had it kind of planned out in the olden days to put the bulk of the savings into cash/TD type assets in retirement earning a safe 5% and the rest in more volatile shares etc to earn dividend payments etc. It's not going to work with below 1% interest rates, so will have to re-work the retirement strategy and think long and hard how to structure it since I still have a few years to earn as an employee.

OK. So you're a pro-risk investor now, but an anti-risk investor during retirement. Gotcha. Yes, unless you have a massive portfolio, all your money sitting in a term deposit isn't going to cut it these days.

Well you have options. A common option for the risk averse, is to be a "dividend investor". Park all your money in high paying, stable blue chips, and sit back and reap 5% returns. Alternatively, corporate bond ETFs or P2P lending. Personally, I'd tread any single P2P company like a single stock. Limit the amount you put into it to 5% (or whatever your normal limit is).

 

[Value Collector]

I'm going to highlight this point, because it can be tied back so well to "Option 3": all your money in stocks + 1 months expense. If one did choose this option, it makes sense to time it with your natural selling activity. For a short term trader, they would have cash flow every week. For a long term investor, the natural sell cycle might be only 1 stock a year.

It can work based on forced selling: a pension from your super that pays you a monthly amount, is a forced sale for most people. But I feel it makes more sense to time it with your natural cash flow cycle.

I am a longterm investor, and the bulk of my earnings come from dividends, which come in roughly every 6 months.

Every time I get a dividend, I allocate 50% of it to my living expense account, 30% to reinvest in new investments, and 20% into my tax reserve account.

I keep roughly 2 years of expenses in my living expense account, some of this I store in my everyday account, some in a mortgage offset account, and the rest in 3year rate setter loans that pay principle and interest into my everyday account weekly.

————
Any capital gains I make are reinvested, I never spend capital.

And any profits I make in my options account are also reinvested back into growing my investments.

————

I also own a couple of investment properties, these simply build equity by using rent to pay off their loans, assisted by the cash I store in offset.

The investment property also covers the cost of my primary residence.

———-

 

[Value Collector]

First one is a vehicle. For the sake of this discussion, let's assume you're buying a new, reasonably priced car in cash, and keeping for 10-15 years. Now, it would be crazy to keep 35k in cash for 15 years, ready for the next car. With that timeframe in mind, you invest your "car money" in shares. In that case, you're justified in selling down when your car blows up unexpectedly at 9 years rather than at 15. You've probably double or trebled your car money by then anyway.

Check out this “free cars for life plan”.

I know his estimated return is a bit far fetched, but it is definitely a better way to manage your car payments.

 

[aus_trader]

Personally, I'd tread any single P2P company like a single stock. Limit the amount you put into it to 5% (or whatever your normal limit is)

Agree. I also like the idea of the higher interest paid by P2P companies but scared of the capital loss as you mentioned. It's not always smooth sailing as what people have experience with well known P2P lenders like the Lending Club in the US. I may put a small % into these accepting that if the whole scheme folds, I will not be losing the bulk of my savings. So it'll have to be a small % of my investment funds not money in 'mojo' buffer account which is for emergency living expenses.

 

[Zaxon]

I am a longterm investor, and the bulk of my earnings come from dividends, which come in roughly every 6 months.

Every time I get a dividend, I allocate 50% of it to my living expense account, 30% to reinvest in new investments, and 20% into my tax reserve account.

That's very impressive. And you don't have additional income from a job? I have read your amazing backstory with a certain honey company, so I suspect you're self-sufficient, but I'm not 100% sure.

Do you target high yield stocks deliberately, as would a dividend investor, as in never buy a company that pays <5% (or insert figure here) dividend yield? And what is your average dividend yield across your portfolio?

The current market dividend yield is 4.1%, so something like 5%+ is very achievable, if you targeted dividend stocks. The advantage with that over the "4% rule", is you only need capital of 20 times your desired earnings, rather than 25 times, which is a significant difference.

I keep roughly 2 years of expenses in my living expense account, some of this I store in my everyday account, some in a mortgage offset account, and the rest in 3year rate setter loans that pay principle and interest into my everyday account weekly.
Any capital gains I make are reinvested, I never spend capital.

That sounds like an amazing set up. And your dividends are likely to be far more stable than capital growth. Plus you've got that 30% reinvest buffer if your companies did cut their dividends.

I also own a couple of investment properties, these simply build equity by using rent to pay off their loans, assisted by the cash I store in offset.
The investment property also covers the cost of my primary residence.

Sounds like you could go on a holiday for a year, and still have everything automatically paid in the background. You can't ask for better than that!

I've drawn the line at direct real estate for me, personally. I think of the bad tenants, the property damage they might leave behind, and the lazy property agent who doesn't bother chasing things up, type stories I've heard. I do like REITs though. I own some of those. And they're "virtual" and hassle free, just like shares

 

[Zaxon]

Check out this “free cars for life plan”.
I know his estimated return is a bit far fetched, but it is definitely a better way to manage your car payments.

Agreed. Both that his figures are optimistic, and that investing rather than car payments are definitely the way to go.

We buy brand new but modest cars with cash. Hold them for 10 plus years. Rinse and repeat. We don't specifically have a car investment fund, but do have an "expenses" investment pool.

 

[Zaxon]

As I started this thread, I should give my personal thoughts on it, as it applies to me. We'll probably do option #1, which is most of our money in the market at all times, with a cash buffer of 1-2 years.

Our current setup is this. My "job" is as a full time investor, and has been for a number of years. My partner works a regular job. All our expenses come that salary. This includes longer term expenses like cars. We're mortgage and debt free. 100% of my market returns and dividends are retained. That money is marked for "retirement". And importantly, that gives me the opportunity for compound growth without having to tap into it for now.

However, with the offshoring rate in certain industries, there is the concern that the salary may not be viable in the longer term. When that happens, my partner may attempt to retrain or just may retire early. So it's likely we'll enter early retirement as a family with a modest sum, perhaps earlier than would be ideal, and well before pension age.

Once "retired", we'll take 5% of the total portfolio out each year for expenses. That's 5% of the fluctuating, total balance. This means if the market crashes 50%, you still take out only 5%, but of course, in dollar terms that's only half as much as you're taking out if the market hadn't crashed. So it has an inbuilt safety into it where you're taking out fewer dollars in a bad market, and more in a good market. In a sense, it's a version of reverse dollar cost averaging.

As a result, our "wage" will vary quite a lot each year. So 1-2 years in cash to smooth things over a bit. If we can't go on holidays or can't replace the car in the leaner years, I don't mind. Those can be done in the boom years.

My job then is to continue to growth the portfolio. 5% living costs + 2.5% inflation = 7.5%. Returns above that go back into growing the portfolio. I will invest actively, exactly like I'm doing now after we retire. Hopefully, the portfolio growth will well outstrip our expenses, and we'll slowly increase our lifestyle as the years go on.

 

[Value Collector]

That's very impressive. And you don't have additional income from a job? I have read your amazing backstory with a certain honey company, so I suspect you're self-sufficient, but I'm not 100% sure.

Do you target high yield stocks deliberately, as would a dividend investor, as in never buy a company that pays <5% (or insert figure here) dividend yield? And what is your average dividend yield across your portfolio?

The current market dividend yield is 4.1%, so something like 5%+ is very achievable, if you targeted dividend stocks. The advantage with that over the "4% rule", is you only need capital of 20 times your desired earnings, rather than 25 times, which is a significant difference.

That sounds like an amazing set up. And your dividends are likely to be far more stable than capital growth. Plus you've got that 30% reinvest buffer if your companies did cut their dividends.

Sounds like you could go on a holiday for a year, and still have everything automatically paid in the background. You can't ask for better than that!

I've drawn the line at direct real estate for me, personally. I think of the bad tenants, the property damage they might leave behind, and the lazy property agent who doesn't bother chasing things up, type stories I've heard. I do like REITs though. I own some of those. And they're "virtual" and hassle free, just like shares

I have no other income, I Live off my investments for 100% of my income.

I don’t target high dividend shares alone, I target companies that I think will be able to grow dividends over time, however as a value investor I do want to pick up these companies cheap, which means their dividends will sometimes be large compared to the price I paid after a few years.

For example based on my entry price into fmg (after options premiums), I have earned a dividend yield of 40% or so this year, the honey company you mentioned was a 25% yield based on my entry when I sold out.

But yeah, a dividend yield of around 5% is nice, but I want it to be from a company that is going to grow earnings over time, or an asset that will increase with inflation.

I do also have some shares that don’t pay any dividend, for example Berkshire Hathaway, but I use all the dividends I get from my Disney shares to build my Berkshire Hathaway holding.

Hahaha, I could holiday for a year, except for the fact I have pets, so don’t like to be away for more than 3 weeks at a time, but this year we are going on a cruise for 7 days, then later 3 weeks in the Uk, then 3 weeks in the USA and early next year we have 2 weeks into New Zealand.

So yeah, So for a self taught kid I haven’t set myself up to badly, so far so good.

 

[Zaxon]

For example based on my entry price into fmg (after options premiums), I have earned a dividend yield of 40% or so this year

So to put that into perspective, what is your current portfolio yield, as in last financial year's dividends / current value of those shares?

So yeah, So for a self taught kid I haven’t set myself up to badly, so far so good.

Not bad at all!

 

[Value Collector]

So to put that into perspective, what is your current portfolio yield, as in last financial year's dividends / current value of those shares?

Not bad at all!

I would have to work that out when I do my tax, in the next week or so, I am guessing it would be over 5% because I am about 50% fmg at the moment, and they have paid some big divvies this year.

 

[aus_trader]

Once "retired", we'll take 5% of the total portfolio out each year for expenses. That's 5% of the fluctuating, total balance. This means if the market crashes 50%, you still take out only 5%, but of course, in dollar terms that's only half as much as you're taking out if the market hadn't crashed. So it has an inbuilt safety into it where you're taking out fewer dollars in a bad market, and more in a good market. In a sense, it's a version of reverse dollar cost averaging.

I like your thinking Zaxon, taking out a % as opposed to a $ amount does make sense especially during leaner years for the reasons you mentioned.

I will take that into account in my retirement planning for the future rather than what I was thinking currently, that we'll need x amount of $ as a minimum for a year. We can live frugally in the leaner years and reward ourselves in the bounty years, so thank you for that insight.

 

[Zaxon]

I like your thinking Zaxon, taking out a % as opposed to a $ amount does make sense especially during leaner years for the reasons you mentioned.
thank you for that insight.

You're welcome! I believe the 5% balance drawdown works out to be somewhat equivalent to the 4% rule, which works on a fixed sum that increases with inflation. If so, that's only 20x earnings you'll need rather than the 25x for the 4% rule. And if you do grow your portfolio over time, your 5% gives you automatic pay raises. As the 4% is based on your balance on the day you retire, goodness knows how that works if you outpace your drawdown needs.

 

[Value Collector]

But if you are drawing down a fixed percentage of your capital, doesn’t that mean that the total amount you get each year decreases as your capital decreases?

 

[Zaxon]

But if you are drawing down a fixed percentage of your capital, doesn’t that mean that the total amount you get each year decreases as your capital decreases?

It could, but it doesn't have to. The market averages a return of 10%. This is capital gains + dividends. If your percentage drawdown + inflation is less than 10% then averaged out over time, your portfolio will grow. That's why a figure like a 5% drawdown works. But if your drawdown was 15%, sure, you'll eat through your money in no time.

This is the link between dividend investors and growth investors. A company has earnings. They can choose to pay them out in a dividend, buy back their shares, or reinvest it in growth. Let's concentrate on the first two.

Company BigDiv pays out 100% of their earnings. Their current dividend yield is 5%. All other things being equal, their share price will drop by the dividend amount on the day the share goes ex-dividend.

Company BigBuyBack uses 100% of their earnings to buy back their own shares. The shares are destroyed after they buy them. This puts pressure on their share price to rise by 5%, because fewer shares (even with the same earnings) means that EPS (earnings per share) goes up.

So the effect is the same. If you own BigDiv, you never sell down, and live off your dividends. If you own BigBuyBack, you sell 5% each year, and live off your capital gains. On BidDiv's dividends, you pay tax on 100%. On BigBuyBack's capital gains, if held > 367 days, you're only taxed on 50% of the capital gain.

The right choice between owning dividend paying stocks vs selling down, often comes down to your personality, and what you feel comfortable with.

But let's put that aside for a moment and assume you're open to both options. If you're choosing from a universe of stocks that pay 7% dividends, say, you have few options. But if you're choosing stocks from a universe that has 7% total returns, so that could be 4% dividend by 3% capital growth, then suddenly you've opened up a much wider world of stock from which to choose.

 

[aus_trader]

You're welcome! I believe the 5% balance drawdown works out to be somewhat equivalent to the 4% rule, which works on a fixed sum that increases with inflation. If so, that's only 20x earnings you'll need rather than the 25x for the 4% rule. And if you do grow your portfolio over time, your 5% gives you automatic pay raises. As the 4% is based on your balance on the day you retire, goodness knows how that works if you outpace your drawdown needs.

I do like the 4% though mate. It does give you that extra buffer of protection when it comes to prolonging the life of your nest egg. It also means you are unlikely to outlive your savings if the market returns are rotten.

So let's put in the worst case scenario: Let's say my retirement plan was to start the 4% draw-down process per annum at the age of 65. In the worst case scenario I will earn no capital gain and no income via dividends. Therefore each year the nest egg will go down by 4%. Therefore as you said,I will have 25 years to eat up my nest egg which means it'll be running out on the 90th birthday. Chances are, would've moved onto another life by then if you believe in re-incarnation otherwise Salute to this world. If not I'll have to downsize the paid off property (by then) to meet day-to-day living expenses. Sorry to sound gloomy, but I like to evaluate my worst case scenario.

On a more optimistic scenario the returns (capital + dividends) will outpace the 4% draw-down on most years and that means the nest egg will actually grow in tiny increments, which means all the luxuries like pay rises in the 'Golden Years' and having a nice pot of Gold to pass on to the grandchildren