The Simple Dollar
Traders work on the floor of the New York Stock Exchange in New York. Dividend stock investing requires that you pay attention to diversity of investments, Hamm writes. (Keith Bedford/Reuters/File)
A guide to dividend stock investing
Several people have written to me recently asking me how exactly investing in dividend-paying stocks actually works. I thought I’d walk through this in a step-by-step fashion so that people can see how it actually works.
First, a few caveats.
Dividend stock investing is something I do with only a small part of our investments. It’s not my primary investment strategy, which is actually buying index funds through Vanguard. (Index funds are essentially single investments you can buy that are made up of small amounts of tons and tons of other investments – for example, some index funds just own tiny amounts of every publicly-traded stock in the United States.)
Dividend stock investing also requires that you pay attention to diversity. Buying tons of one company’s stock, no matter how strong that company is, is a bad idea because it lacks diversity. If that one company were to get into some sort of trouble and their stock begins to tank, you’ll lose much of what you have very quickly.
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The example I’m going to describe below follows investment in only one company. You would want to invest in at least ten different companies in ten different industries, for diversity’s sake. ( Continue… )
Three Dish Network satellite dishes, are displayed on an apartment house, in Palo Alto, Calif. The average cable/satellite bill makes up a pretty sizeable chunk of an average American family budget, Hamm writes. (Paul Sakuma/AP/File)
Four things to do today that will save money
Want some action points today that can change your financial situation pretty rapidly? Willing to make a few big changes to your life?
Here are four things you can do starting right now to make a radical shift in your finances and set you on a better track.
1. Cancel your cable or satellite service.
Cancel it. Pay the termination fee if you have to. Get a small antenna and a converter box (if you need one) and just watch what you can get over the air.
The average cable/satellite bill, last I heard, was around $86 a month. That’s a pretty sizeable chunk of an average American family budget, adding up to above $1,000 a year. There’s energy savings here, too – if you’re not powering up a cable box, your energy bill will drop a bit.
The average American watches 2.8 hours of television a day. Without television to constantly watch, you’ll suddenly find that you have more time to do all of the things that you’ve been meaning to do but somehow haven’t had the time for. ( Continue… )
A shopper leaves a Costco store in Portland, Ore.Hamm argues that buying in bulk may make groceries cheaper in some cases, but it may lead to using them more liberally, wiping away those savings. (Rick Bowmer/AP/File)
Does buying in bulk lead to overconsumption?
I love orange juice. I just love the stuff. When there’s orange juice in the fridge, I am constantly tempted to pull out the container and pour me a glass of it.
This is particularly true when the container is mostly full, but when the container starts to get low, I slow down. I know that the juice will run out soon, so I savor it a bit.
A couple things to think about:
First of all, if I have a lot of orange juice, I drink it faster. If I go to the store and buy one of the really large containers of orange juice, our family will go through the whole thing in three or four days. On the other hand, if I go to the store and buy a small container of orange juice, our family will go through the whole thing in… three or four days.
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Why is that? Well, when we have an abundance of something, there’s a tendency to overconsume. I’ll drink it with breakfast, in the morning, in the afternoon… if I feel there’s a lot of orange juice left, I’ll drink it. ( Continue… )
A house for rent and for sale sign sit in front of a home in Portland, Ore. According to Hamm, being a 'renter' involves making long-term sacrifices, while being a 'keeper' means making short-term ones. (Rick Bowmer/AP/File)
Are you a renter or a keeper?
A while back, I ran across this brilliant quote from Sam Lipsyte’s 2010 novel, The Ask:
She was from the people who kept everything. I was from the people who rented some of everything for brief amounts of time. I knew I deserved no pity, would get none from the people who kept everything. They only pitied the people with nothing at all.
Setting aside the political undertones of what he’s writing here, I thought the analogy of the financially secure “people who kept everything” and the financially unstable “people who rented some of everything for brief amounts of time” was an interesting comparison.
Think about this in terms of car ownership.
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One person buys a late model used car, paying cash. They save a little each month for the next late model used car purchase, and when their current car stops working well, they replace it, buying a new late model used car, paying cash.
Another person also buys late model used cars, but they take out a loan for it, preferably the longest possible term loan so the monthly payments are as small as possible. By the time the loan is over with, there’s only a year or two before they’re looking to trade off that late model used car for another one, taking out a loan for it, preferably the longest possible term loan.
One person “who kept everything,” one person “who rented some of everything.”
You can do the same thing in terms of home ownership.
One person buys a very inexpensive home, paying the largest down payment possible. They pay off that home as quickly as possible while dumping time and effort into refurbishing that home. They continue to save, then in a few years, they sell their home and pay cash for the remainder of the cost of a much nicer home.
Another person rents an apartment for years, then makes a small down payment on a much nicer home, also picking up a thirty year mortgage in the process.
One person “who kept everything,” one person “who rented some of everything.”
Are you going to be a person “who kept everything” or a person who “rented some of everything”?
The philosophy of ownership versus the philosophy of indebtedness.
The catch, for most people, is that sticking to the philosophy of ownership requires going without some things for now, while the philosophy of indebtedness lets you sacrifice some of the future to have those things now. Over the long run, though, the philosophy of indebtedness drains you. It gives you a pile of monthly bills, restricting your career and personal choices. It ends up depleting your net worth.
The philosophy of ownership, on the other hand, means that interest works in your favor. It means fewer monthly bills and thus more career and personal freedom. It means you have much more control over buying and selling the things in your life, and it means that you have little worry of things being taken away from you if you can’t pay the bills.
The choice is up to you, and you make it with almost every financial transaction.
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A worker counts US bills at a money changer in Manila. If your goal is financial independence down the road, you’re going to want to strive for debt freedom above all else, Hamm writes. (Romeo Ranoco/Reuters/File)
Making financial independence a part-time job
Carrie writes in:
I’m a 23 year old single woman with a solid government job that pays reasonably well. I have quite a bit of free time. What I’d like to do is somehow “bank” that free time so that I can have more free time later on when I (theoretically) have a child, as I’d like to be more flexible with my time then. What’s the most prudent way to go about this?
There are a few options here.
First, you want to make sure that your financial situation is as clean as possible. You’re going to want to strive for debt freedom above all else. That should be your first and biggest goal. You’re also going to want an emergency fund, probably equal to about a month’s worth of living expenses (an appropriate level for a young, healthy, single person).
Next, you’re going to want to save. The more money you have in the bank when you make the choice to have a child, the easier that process is going to be and the more flexibility you’re going to have. ( Continue… )
'Understanding Taxes' posters hang in the halls of the US Internal Revenue Service building in Washington. Using a solid tax preparation software package when you do your income taxes can help demystify investment taxes, Hamm writes. (Ann Hermes/The Christian Science Monitor/File)
Investment taxes: How do they work?
Johnny writes in:
The one thing that has kept me from diving into investing is fear of taxes. Every time I read about taxes and investments, it seems really, really complicated and I’m worried I’m going to be stuck with a big tax bill at the end of a given year even if I think I did everything smartly.
That’s an understandable worry. Investment taxes can be a bit difficult to swallow at times, but there are a few rules you can follow to make things easier for you.
My first suggestion is to use a solid tax preparation software package when you do your income taxes. A good software package like TurboTax will walk you through everything you need to do in terms of filing your taxes correctly. You’ll avoid making significant errors, so you can be confident about the taxes you file.
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The second step I’d suggest is to keep careful track of every dime you invest. Note the date that you invested the money, what you invested it in, and how many shares of that investment you were able to purchase. I use a spreadsheet for this very task. ( Continue… )
John Longo, 88, swims his daily mile at an active retirement community in Sun City, Ariz. (Lucy Nicholson/Reuters/File)
The 'I'm never going to retire' retirement plan
Stephen writes in:
I’ve basically made the decision that I’m never going to retire. I’m going to keep working until I literally cannot work any more, at which point my physical and mental decline should be pretty steep and swift. Given that, what’s the point of saving for retirement? It seems pretty ineffective for me.
Here’s the truth: the idea of “retirement saving” is shorthand for a somewhat different idea. Your 401(k)? Your IRA? They’re actually just “savings vehicles that defer tax benefits until you’re 60.”
With a Roth IRA, for example, you can begin taking money out of the account tax free at age 59 1/2. With a 401(k), you can begin taking taxable withdrawals (taxable as normal income) at age 59 1/2 as well.
Along with Social Security kicking in at some point in your sixties, this money will provide some extra support for you during those latter stages of your career. ( Continue… )
Bob Casey plays guitar at his home in the Wasena area of Roanoke, Va.earlier this month Hamm is letting go of some of his more casual hobbies so he can focus on learning the guitar, saving both time and money. (AP Photo/The Roanoke Times, Kyle Green (Kyle Green/The Roanoke Times/AP/File)
How many hobbies do you really need?
I’ll be the first to admit that I have a lot of interests. Without skipping a beat, I can name off a dozen hobbies that I actively enjoy and a dozen more that I enjoy on occasion.
I know I’m not alone in this. I have quite a few friends who are roughly my age, have careers, have children at home, and have a ton of interests.
The problem is that there’s simply not enough time for all of my interests. I don’t have enough time to do all of the things I want to dabble in.
When I do take a “dabbling” approach, I usually end up feeling like I’m letting other hobbies down. If I spent a lot of time dabbling in a wide variety of interests, for example, I feel out of touch with my reading. I also feel like I’m not improving at many of the hobby skills I want to build – if I spend an evening playing a computer game with an old friend, for example, I’m not getting better at the guitar.
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At the same time, virtually every hobby I want to dabble in has some sort of cost. Usually, there’s a fairly steep startup cost and a smaller but still relevant maintenance cost. Learning to play the guitar requires the cost of the instrument and, eventually, the cost of strings and picks and any learning materials I might need. Any sort of gaming hobby eventually includes the cost of new games. Exercise involves regular replacement of running shoes and other exercise gear. If you’re taking any kind of lessons, there’s that cost. Art projects involve art supplies of various kinds. Any entertainment-based hobby usually involves electricity and a monthly fee for the service.
So, the more hobbies I choose to dabble in, the less time I have for each hobby and the higher cost for my hobbies as a whole.
The solution is really simple. Figure out a small handful of core hobbies to focus on and discard the rest as active interests.
So, let’s say I go through my two dozen hobbies that I dabble in and I select three or four to really focus on. I decide to focus on reading, board games, exercise, and the guitar and drop the rest of my hobbies. (This is a thought process that’s ongoing for me, by the way.)
First of all, I now have a lot of hobby supplies to sell. The gear associated with the dozen or so hobbies I’ve chosen to de-focus are now just taking up space in my home. I can sell them off and use the proceeds to cover my hobby spending for quite a while.
Second, I’m actually going to gain significant skill at the hobbies that remain. I’m going to become much more well-read. My ability to look at situations and analyze them strategically is going to grow. I’m going to get in better shape. I’m going to be able to play music at a much higher level.
Third, I’m going to lose that sense of neglecting a “more important” hobby. As I mentioned above, whenever I dabble in other things, I find myself often feeling that I’m neglecting some other aspect of my life. By eliminating a significant number of things, I’m left with more than adequate time to address the things I care most deeply about.
In other words, this type of trimming is a triple win. It puts money back in my pocket, builds my skills, and leaves me with a sense that I’m not neglecting something more important.
I’m going to lose that sense of neglecting a “more important” hobby
If you find yourself with more hobbies and interests than you can handle and you sometimes feel like you’re neglecting the pursuit of something more important in your life, look at paring back on the number of hobbies and activities in your life. You’ll feel refreshed – and your wallet will be pleased, too.
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A home is for sale in Mount Lebanon, Pa. According to Hamm, there are sound financial reasons for both a shorter-term mortgage with high monthly bills and a longer-term mortgage with lower ones. The decisions may come down to non-financial elements of your life. (Gene J. Puskar/AP/File)
Shorter mortgage or lower monthly bills?
Jennifer writes in:
"My husband and I are shopping very seriously for houses right now. We will likely be in a home by the start of the summer.
I’m writing to you because we’re very unsure about the mortgage. On paper, it makes complete sense to get a fifteen year or even a ten year mortgage. We will pay far less interest over the long run that way.
But then we look at our monthly bills. If we get a ten or even a fifteen year mortgage we will have some enormous monthly bills for the next decade. This will leave us a lot less breathing room each month than the bills for a thirty year mortgage would give us.
It seems like financial sense is pointing us in two different directions."
That’s because financial sense is pointing you in two different directions.
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There are really two different schools of thought on this issue that you describe. ( Continue… )
Want to live off your savings? First figure how much it would take you to live for a year, then multiply that by 20, Hamm recommends. (Muhammed Muheisen/AP)
Living off savings: When is it possible?
You’d be surprised how often I’m asked this simple question. It’s something on a lot of people’s minds, apparently. How much do I have to save up to be able to live off of my own savings?
It’s impossible to come up with an exact number, but we can come up with an estimate.
Figuring this out takes a little bit of math, so I’ll walk you through some of the steps. First, let’s talk about assumptions.
Let’s assume that inflation is going to average 3% a year going forward. You can argue about that one all day long, but we’re using a rough estimate here. Similarly, let’s assume that you can invest in an index fund that will return 7% on average each year, but when you move to living off of your investments, you’ll want to diversify into other investments, perhaps returning only 5% each year. We’re also going to assume you’re debt free.
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The first thing you need to know is how much it actually costs you to live for a year. What are your actual living expenses for a given year?
The easiest way to estimate this is to request a statement from your bank for the year 2012 and total up all withdrawals from that account. That’s your total annual expenditures for a given year.
Now, add 20% to that total. For example, if you calculated your annual expenses as being $20,000, add another $4,000 to that total, bringing you to $24,000.
After that, take that amount and multiply it by 20. The 20 number comes from the 5% estimate for long-term savings mentioned above. That’s how much you’ll need in the bank to reasonably live off the interest, starting right now. You would simply take out your living expenses each year and let the rest roll back into the account, protecting you from inflation.
So, if your target number is $24,000, you’ll be shooting for $480,000. It seems like a lot, doesn’t it?
The next thing you need to know is what percentage of your living expenses can you save each year? Can you save 10%? 20%? 50%? The larger the percentage you can commit to each year, the faster retirement will come.
Let’s say you can commit to 40% of your living expenses each year – $8,000 in the example above.
After that, you’re going to want to fire up a investment return calculator. Using that calculator, you’ll put in an $8,000 annual investment and leave the rest of the defaults in place – a 7% rate of return and a 3% inflation rate.
Hit submit with that calculator and you’ll see that it will take 25 years to reach $480,000. (A quick note – this calculator automatically does the inflation adjustment for you.)
Bump it up to 50% annual savings? You cut the target date down to 22 years.
Seems painful to reach, right? There are still a few factors working in your favor.
First, you’ll presumably earn more in future years. This will raise the amount that you will be able to put away each year, bringing the date of living off your savings forward. With hard work, you can bring that number well under 20 years and start heading for the 15 year mark.
Second, you get to choose the lifestyle you live. If you inflate your lifestyle with more spending, you push that date into the future. If you keep things low-cost in perpetuity, you’re off the grind even sooner.
Finally, this doesn’t have to be a full income replacement. It can just be an avenue to try lower-paying career paths, for example.
Always remember that lifestyle inflation and laziness are your two enemies when working toward a goal like this one. Every bit you inflate your lifestyle puts off the date you can just walk away from work, and the same is true for apathy towards your work.
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