When an entrepreneur starts a business, one of the first and most important steps is to create a business plan. This plan is a statement of the business goals, the reasons these goals are attainable, and the method for reaching those goals. Once the business plan is created, it then acts as a compass to guide key business decisions. If the business ever changes directions, then a new business plan should be created to document the reasons for the change – this way the business can never get too far off track without acknowledging that a change was consciously and strategically made.
I believe the same method should be used when setting up your investment portfolio. After all, if you are serious about investing for your financial future, you should treat it as a business. Whether you’re seeking income or capital gains, whether you’re an index fund investor or a dividend growth investor, and whether you have $500 or $5,000,000 – the importance of defining your plan remains the same. Otherwise, you end up getting off track and you find that your investment portfolio is inconsistent with your life goals (which, I would suspect, is why you’re trying to invest your money for the future).
I’ll share my official BNL investment plan below. Regardless of age, income, and savings, I encourage everyone to document their own investment plan with a similar level of detail for their own situation and set of goals.
My short-term investment goal is to create a reliable and stable income-paying portfolio that will pay 100% of my family’s living expenses through dividend payments. The entire purpose of my investments is so I can comfortably retire in about a year. Long-term, I’d like the majority of that money coming from treasury bonds and “dividend growth stocks” that may yield a lower dividend now, but will consistently raise dividends at a pace above the rate of inflation. To supplement those lower yields (mostly 2.5%-3.5%), I’ll invest in higher-risk, higher-yielding investments that pay around 8%-15%. Those higher yielding investments may include stocks such as REIT’s, private equity investments, hard-money lending, and P2P lending, but they won’t be limited to this list.
Since my highest priority is to have a reliable and consistent income for my family, I’ll have a fixed portfolio allocation that helps keep the overall portfolio net value as stable as possible throughout different economic climates.
A lower priority goal is to keep ~10% of my portfolio in alternative forms of income (e.g. P2P, private equity, etc) so that I can continue to experiment and learn about these types of investments. There are two reasons for this: First, it’s fun. I’ve always enjoyed learning about uncommon investments, and I simply can’t learn as much researching them unless I’m serious about putting money into them. Second, most of these alternative forms of income investing generally have higher yields. This helps increase my average yield across my portfolio.
In order to provide stability in my portfolio, while also staying consistent with my Investment Goals listed above, I plan to use a 60/30/10 portfolio allocation.
- 60% dividend growth stocks
- 30% 20-year Treasury Bonds
- 10% high-yielding alternative investments
The 60/30 mix of stocks and bonds serves 2 purposes. First, it provides somewhere around a 3-3.5% initial average yield for my portfolio, which is close to what I need in order to meet my family’s annual expenses. Second, it reduces the volatility of the portfolio as a whole. Generally, when the stocks rise, bonds drop. When stocks fall, bonds rise. It’s more complicated than that, but you can see a clear trend in these charts:
Since my goal requires that my annual dividends equal my annual expenses, I’m estimating that I will need to start my retirement with a 70/20/10 split in stocks and bonds, and I can slowly move to 60/30/10 as my dividend stocks increase their payout. My goal is to be 60/30/10 within 5 years.
60% Stock Mix
I firmly believe that investing in individual stocks is only for those people that are willing to do the work. I recognize the concept of the “efficient market hypothesis,”, and I don’t completely disagree. On the other hand, I also believe that it’s possible to find undervalued stocks that are managed well and have shown consistent historical growth. Combining this with good evidence of strong historical dividend growth, I’ve set up these basic guidelines for my stock selection:
1. Increased annual dividends for at least 10 years. For this list, I will use David Fish’s list of Dividend Champions.
2. Payout ratio should be reasonable for the industry, and no payout ratio should ever be over 100%. It’s important to segment by industry since some industries commonly have a high payout ratio by nature, where as in other industries a high payout ratio could be a red flag that the company is raising dividends just to stay on the list of dividend growth stocks, rather than based on increasing profits.
3. Dividend growth should target 10% in 10 years. This means that the yield on initial investment should rise at a rate such that historical dividend growth along with good fundamentals and rising profits would indicate it’s likely that the stock should be paying 10% on initial yield within 10 years.
4. The initial yield must meet my personal expense needs. For example, let’s say I need an average of 3.5% yield to meet my income needs. But if I have 30% of my portfolio in bonds returning 3%, and 10% of my portfolio in higher yielding investments that yield and average of 10%, then my stock picks require me to be at a minimum yield of 2.7%. So if I find a company that looks great but only yields 2% currently, I would not purchase it unless I can also find a stock that I find to be a good value that can average back up to 2.7%. I realize this may be counter-productive at times, but there’s a mental benefit to retiring with 100% of expenses being paid by dividends, so that no shares ever have to be sold to pay the bills.
These are baseline requirements. Once these requirements are met, I’ll do a full stock valuation based on P/E ratio, EPS, EPS growth, and some other factors specific for the industry. How I do that valuation goes beyond the scope of this investment plan, and I’m also constantly tweaking my valuation method based on my continued studying of this area.
30% Bond Mix
For bonds, I’ll just invest in ETF’s that represent the 20-year US Treasury Bond.
10% High Yield Investment Mix
The primary purpose of this portion of my portfolio is to increase the average overall yield. For example, if the other 90% of my portfolio (in stocks and bonds) yields 3% on average, but I’m able to get 12% out of my high-yielding income investments, that takes my average up to 3.9%. Even if I only yield 10%, that’s still takes my average up to 3.7% yield.
The secondary goal of this portion of my portfolio is to keep active in learning about new investment opportunities. I’ve had a lot of fun learning about P2P lending, private mortgage lending, real estate investing, and other opportunities. There are still many more methods I want to learn about when I have more time in retirement (for example, I’ve recently been learning more about high-yielding energy trusts that have piqued my interest).
There are other variables to consider for my 5-10 year investment plan that will represent my first 5-10 years in retirement. Although I can’t predict the future, I should at least consider some of the more likely possibilities:
Currently, I make somewhere around $3000/year online (the vast majority is not this blog). Not exactly get-rich money, but I expect this income could very well go up after I quit my day job. I have a lot of projects I’ve considered in the past, but haven’t had the time to work on. In retirement, I expect my free time to increase dramatically. I also expect my energy levels to increase so that I’m more likely to go pursue these projects. If that happens and I see a reduction in the amount of money I need from my investment portfolio, I have three options (in order of priority):
1. Spend more – Yep, you heard that right. At first, I’ll likely take the majority of any additional income I don’t need and start paying off my mortgage faster. This is a guaranteed 3.2% return, since that’s the interest rate I pay. I’d also like to let my hair down a little, so we’ll also consider other luxury purchases in the future. Some ideas we’ve talked about are extended vacations, a pop-up trailer, and a new bike – I’m sure my wife has a longer list.
2. Save more – Ideally, I’d like to get to the point that I’m saving about 20% of my investment income into more investments. This will keep my investments growing at a faster pace than inflation, and increase my margin of safety. If all goes well, I can eventually retire from my active portfolio management if I choose to do so. Actually, I doubt I’ll ever do that…
3. Make less – Since I’d like to minimize any income taxes I’m forced to pay, I’ll probably never try to make more than 20% of my expenses in a given year. To do this, I’ll move away from dividend stocks to balance my taxable income with my expenses, and instead direct more of my portfolio allotment into non-dividend paying stocks that are valued well.
If the first few years of my retirement face a large downturn in the economy, forcing stocks to drop and reduce dividend payouts, I could see a shortfall in my income compared to expenses. Hopefully this won’t happen since any dividend stock I buy will have made it through the 2008 financial chaos without dropping dividends, and most will have also made it through the 2000/2001 economy as well. Since this scenario would be during an economic downturn, it also means it’s the most important time to hold stocks and even invest in new ones if I can, since they are most likely riding a general market downturn rather than actually faltering as a company. For that reason, I never want to cash out of a stock to pay the bills. If this were to happen, my plan is to make enough money to cover the shortfall, either by getting a short-term job, doing some freelance work (online or off), or amping up my current online profits just enough to cover my shortfall.
One Final Note
The most astute readers will notice that my current investments are not consistent with my investment plan. This is true, and actually it’s worse than it looks since this site only lists my income paying investments. I actually own several other stocks that aren’t shown there, since they don’t pay dividends. I’ve been slowly making moves to reconcile this difference between my portfolio and my investment plan, but I’m also sitting on some 10-year old stocks with a lot of capital gains. I’ll continue to move to the 60/30/10 allocation over the next 1-2 years while attempting to minimize my taxes by balancing capital gains with capital losses. Luckily, Europe is making this a lot easier these days.