Home

Home
Dec 162016

Mailbag – When Do I Replace My Car

By |December 16th, 2016|Personal Finance Tips|3 Comments

You can email me at adamwoods137@gmail.com

You can email me at adamwoods137@gmail.com

Hi Adam,

I just got back from the mechanic and my car (bluebook ~$9,000) needs $3,000 worth of repairs to be made drivable again.  Part of it seems to be routine maintenance but the other part is just part failure.  I don’t want to be regularly paying these kind of repair bills, but I’m also not sure I should get a new car just yet.  How do I tell when it’s time to give up on a car and just get a replacement.

Thanks,

Brian

 

Well, first off, if you’re going to replace your car consider buying a used car.  The rule of thumb is that a car loses 25% of it’s current value annually.  This means that the depreciation on that $9,000 car is currently running you roughly $2,250 annually. That seems like a lot of money to me.  Similarly, this is a huge repair bill.  As far as we’re concerned with maximizing value what you’d really like to do is know what the future repairs on the car were going to be, then you could just compare this with the depreciation and maintenance on the other car and go with whatever costs the least.  Unfortunately, my crystal ball is cloudy.

Great, so when do I replace my car?

Fortunately, I do have more information for you than a shrug.  First off, if the cost of the potential repair is more than the value of the fixed car, it’s time to get rid of the car!  This is well known, the car is “totaled”.

I would back out the part of the cost here that is routine maintenance.  If you have, say, tires that are supposed to last 5 years, you don’t really have to worry about them going out, and further you should have saved for that part of the car wearing out in any case.  Tires don’t wear out any faster on an old car than a new car.  Same goes for things like timing belts and clutches.  So from that $3,000 I’d subtract the routine maintenance cost.  Next, I’d compare the remaining value to two things, first the expected depreciation of the car (1/4 the current, working, blue book value), and second the expected depreciation on the car you’re thinking about buying.

Your Example

Let’s say that the total cost of your maintenance repairs was $500, and the other $2500 was catastrophic failure of your headlight fluid pump (I am a car expert guys).  You take the $3,000 subtract off the $500 to get the remaining $2500.  Then, calculate the expected depreciation of your vehicle.  You can use the rule of thumb or instead calculate the difference in blue book value between your car and the one year older model. (What I mean by this is, if you have a 2008 Chevy Cobalt, check the blue book value of the 2007 Chevy Cobalt.  The difference in the annual depreciation.)

Since we don’t have a model from your vehicle, I’ll just use the rule of thumb.  If we take 25% of $9,000 we get $2250 as I mentioned earlier.  This is less than your anticipated spending.  Then, we check the depreciation of the replacement car you’re thinking about getting.  Suppose you’re going to buy a $16,000 car.  The depreciation would be roughly $4000.  Since the repair is less than $4000 but more than $2250 I’d probably decide not to replace the car.  If I was thinking of getting a car that was more like $10,000 (estimated depreciation $2,500) I’d be more inclined to go ahead with the purchase.  If the repair bill I was looking at was higher I’d probably go ahead and replace it.  If a larger percentage of the bill was routine maintenance go ahead and replace This is right about where it’s close, and frankly other concerns might trump the economics.  Do you like the car?  Is it a relatively safe car?

Would I replace the car

I’d probably replace the car and buy a cheap two-door that runs, somewhere in the $4,000 to $6,000 range.  This keeps my annual car costs fairly low and I’ve experienced very few maintenance issues with this strategy, though the depreciation costs over $100 per month are making me sad.

Other approaches

You could try to harass your mechanic into giving you future estimates of the cars maintenance costs.  You could also think about another rule of thumb, over a car’s lifetime the depreciation, maintenance and fuel of a car all cost about the same.  So, for a $20,000 car, the lifetime maintenance, and fuel are also each about $20,000. You might be able to get from there to an annual estimate of maintenance, though to be honest I’m not sure how!  I suppose I leave that as an exercise to the reader (maybe it involves assuming that some types of maintenance, like oil changes, and tire replacements, are evenly distributed throughout the cars life, and other maintenance comes in sudden jerks?)

Disease Called Debt

Join the Thousandaire newsletter

Screen_shot_2017-04-25_at_1.36.50_pm

Subscribe to get our latest content by email.

Powered by ConvertKit
Dec 92016

Good Times – How to Value Restaurant Stocks

By |December 9th, 2016|Blog|Comments Off on Good Times – How to Value Restaurant Stocks

Indeed!I thought that now would be as good a time as any to share my process for finding and investing in individual stocks.  I should first disclaim that most of my money is in index funds which won’t be touched by me for quite some time.  I’m still quite firm in my belief that the best returns are had by investing like a dead person.  That being said, I do invest other money, thinking that I can outperform the market by focusing in areas that professional investors have difficulty being effective in.  Therefore, I look for very illiquid stocks trading for less than $50 million.

Good Times (GTIM) fits at least this criteria.  If you live in Colorado it’s been a staple of fast food for quite some time.  The food quality has declined somewhat over the last 5 to 10 years, but that’s been true of nearly every other chain around here.  Maybe my tastes were simpler when I was a teenager, I don’t know.  I looked at the company as a possible investment four or five years ago and concluded that it was probably going to go out of business, so I passed. Turns out, I was wrong.

Good Times situation now

Good Times currently owns two restaurant concepts Good Times Burgers and Frozen Custard as well as Bad Daddy’s Burgers.  Good Times Restaurants owns and franchises 37 Good Times Burgers locations and owns 19 Bad Daddy’s Burgers locations.   Over the last year or two the company has basically been flat as far as earnings are concerned. While it might be tempting to look at the price of GTIM stock at this point, instead I suggest on attempting to come up with an independent valuation first.  I don’t know a ton about what makes a restaurant valuable, so it looks like its time to get at least a grounding in the subject.

How to Value a Restaurant

All businesses are only worth whatever cash owners can pull out of the business in the future, discounted to the present.  This applies whether your talking about restaurants, biotech, or railroads.  It seems to me that the first place we should start to get an idea of how much money the business will make in the future is to check out what management’s ideas for the company are, and see if it passes our initial shit-test.

According to management’s most recent conference call, 9 to 11 new Bad Daddy’s Burgers locations in 2017, three in Colorado and three in North Carolina.  To fund this expansion they plan on using a new $9 million debt facility along with $6 million of cash on hand.  In the first 9 months of the previous year (the most recently available data) the company had $3.6 million in cash flow.  So the question is, can these 9 to 11 restaurants open on roughly $19 million?  Between 2016 and 2015 they opened five Bad Daddy’s Burgers locations.  They also spent $7 million on property, plant and equipment investments.  For the purposes of our back of the envelope, we go ahead and estimate $1.4 million per restaurant.  Twice as many restaurants might be twice as much, or $14 million.  This is basically consistent with management’s guidance for paying $14.7 million for capital expenditures in fiscal 2017 (October 2016 to September 2017).  So management probably is being basically truthful about their upcoming plans, or at the very least the numbers aren’t insanely wrong, and it seems unlikely that the company will go bankrupt in the next year.  This is a very important thing to check!

The next step in my view, is to check what the value of the chain of restaurants as it is, would be worth.  I’m always nervous about paying for growth.  I’d prefer to pay a reasonable price for, you know, stuff that actually exists.  So, what is the expected gross profit from the 37 Good Times Burgers restaurants?  There isn’t a lot of growth happening here and the company breaks out the profits for that segment.  Based on the most recent quarterly report for Good Times along with the most recent annual report, I estimate that the 37 Good Times Burgers locations will generate about $570,000 in net profits annually.  I value this stream of profits at $5.7 million (applying a 10% discount rate).

The Bad Daddy’s Restaurants are somewhat more difficult to get a good picture of.  If we only look at the amount the restaurants are earning as they open we significantly underestimate the profits of the restaurants.  Unfortunately, this is also an important segment.  Measured in sales the Bad Daddy segment is much larger than Good Times.  Sales for the 10 restaurants that were open all year over the trailing twelve months was $26 million or $2.6 million per restaurant.  Management’s claim that the locations earn a 15% operating profit seems consistent with operating profit numbers from the company’s previous annual report.  I, therefore, estimate total sales of roughly $50 million from the Bad Daddy’s segment.  A 15% operating profit indicates $7.5 million in profits, we then need to remove the corporate tax, we’ll say roughly 35%, giving us just about $5 million.  I value this stream of profits at $50 million (again applying a 10% discount rate).

Last we have to subtract out the value of corporate expenses.  From the most recent quarterly report I estimate about $600,000 in ongoing corporate expenses. Discounted at 10% this works out to be a value of -$6 million.  Subtracting this from the Good Times Burgers locations and Bad Daddy’s Restaurants we get a total valuation of roughly $49 million for the entire company.

Worth more Dead or Alive?

The company’s balance sheet is $37 million.  I can’t seem to find any reason to believe that the real-estate Good Times holds is worth substantially more than it is being held on the books for.  This is about the only reason I can think of that the company’s assets, if liquidated, would be worth more than book value.  It’s entirely possible, given that much of their expansion took place over 10 years ago.  That might merit further study but as a first pass, I’m guessing that Good Times is better valued on its profits than its property.

Comparison to Good Times’ Market Value

Now we get to check our valuation against the valuation the market gives, or the market cap.  This is relatively straightforward as Good Times doesn’t have a very significant amount of debt. The current market cap of Good Times is about $39 million.  Our valuation indicates that Good Times could possibly be undervalued by 25%.  This isn’t a screaming bargain, but rather indicates that the company merits a further look.  It looks like Good Times is a misnamed company at this point, and the investment really comes down to whether the Bad Daddy Burger locations can achieve 15% operating profit and sustain $2.6 million in sales, the Good Times locations probably won’t make a massive difference in the value of the company, assuming nothing fantastically bad happens.

Given that I live in the area, I’ve opened a starter position and am headed to try Bad Daddy Burgers, we’ll see how it is.

Disclosure

I am long GTIM (Good Times Restaurants) I wrote this article myself, and it expresses my own opinions. This is not a investment recommendation. I am not receiving compensation for it (other than from the owner of the blog District Media Corp). I have no business relationship with any company whose stock is mentioned in this article.  Always do your own research before making any trade, buying or selling any stock mentioned.

Join the Thousandaire newsletter

Screen_shot_2017-04-25_at_1.36.50_pm

Subscribe to get our latest content by email.

Powered by ConvertKit
Dec 82016

Own Rental Property? You Better Have Insurance

By |December 8th, 2016|General Personal Finance|Comments Off on Own Rental Property? You Better Have Insurance

apartment-building-1082094_640Passive income is a type of investment many people want in their portfolio.  There are three main types of passive income: dividend income, real estate income, and business income.  One of the main ways people create passive income for themselves is through investing in rental property.  This investment can add to your net-worth and put money in your pocket each month. With this investment comes a certain amount of risk.  That risk can be lessened with the proper insurance coverage.  Here are the three types of insurance every property owner should secure.

General Liability Coverage

A General Liability Insurance Policy attempts to protect the investor from losses due to fire, storm, tenant or employee injuries, tenant or employee theft and even discrimination lawsuits filed by tenants or employees.  A few examples of where the need for this type of coverage exist include:  A tenant or visitor are injured due to the landlord’s negligence, when a maintenance issue results in a tenants’ injury or loss of personal property, or when a tenant is injured as a result of the landlord’s failing to keep the property in safe working order.

(more…)

Join the Thousandaire newsletter

Screen_shot_2017-04-25_at_1.36.50_pm

Subscribe to get our latest content by email.

Powered by ConvertKit
Nov 292016

Budget Percentages

By |November 29th, 2016|Blog|Comments Off on Budget Percentages

“I decided that a part of all I earned was mine to keep” ~ Richest Man in Babylon

Budget PercentagesThe typical view of budgeting is to figure out how much money you “need” to spend, add some for wants, and save the rest.  This tends to result in ever more elaborate justifications for what qualifies as a “need”, and keeps the focus on maximizing spending, for good or for ill.  Surviving is really just about avoiding dying, and that can sometimes be had at a price of $0, and sometimes it can’t be had at all.  Furthermore, correct estimations of the amount of money required to prevent your death are fortune-telling at best.  The best solution for your financial health is to set the percentage of money you will save first.

Focus on the percentage to save, rather than percentages to spend

What percentage of your income do you need to save?  The answer to that question can be determined by asking yourself what you are saving for?  The only sensible answer to that question is financial independence (you are financially independent once your investment earnings can fully cover your spending).  If you’re saving for anything else, like a fancy television, you’re simply deferring spending.  There’s nothing wrong with spending money on a fancy television, but that should be marked as an expense in your budget as well, money you save is money you keep.

Therefore, in order to determine how much money you should save you first need to know when you want to become financially independent.  Financial independence allows you to retire, so many choose a date at which they would like to retire.  My recommendation is to set this date as early as you can stand, keeping in mind that the following calculations assume your spending after financial independence and before financial independence will be the same adjusted for inflation:

I can only assume that you decided to mouseover for the equation to this plot. Very well, I'll give it to you: M=ln[1+i(28.5)*(1-r)/r]/log(1+i). Where i is the rate of investment return, and r is the savings rate.

Equations taken from Jacob Fisker’s nifty book: Early Retirement Extreme.

Keep in mind these are after inflation rates of return.  While stock market returns have been quite high over the last 5 years, I find it safest to assume a rate of return of 4%.  You’ll find that the difference between assumed rates of return become less important as your savings rate approaches 1 (100% that is).  Therefore if you’re 35 and want to be financially independent by 50 you have 15 years, this requires a savings rate of roughly 55%.  If you’re 20 and want to be financially independent by 50 then you only need a savings rate of 35%, as always starting early helps!  This plot assumes that invested capital equal to 28.5 times your annual expenses will sustain you indefinitely.  (Why 28.5? Well, that’s math for a later post, but for now it is an amount which has been safe for the vast majority of market scenarios over the last 100 years in the US).

Once you know the savings rate you need then you can worry about how to spend the rest of your money.  Suppose I make $4,000 per month after taxes and I have determined that I want to be financially independent in 15.  My savings rate needs to be 55%, so I have the other 45% to allocate as I see fit, this works out to $1,800.  You then need to split out your monthly bills and your other expenses.

Monthly Bills – Fixed Expenses

This is anything you have to pay every month to avoid a service interruption.  For example, your rent.  If you don’t pay rent, you will be kicked out of your house.  (Same for a mortgage).  These are characterized by little variability and are hard to avoid paying in the near-term.  It’s important to make sure that your income covers these expenses with plenty of room to spare. This isn’t complicated, usually you know the values of these in advance.  They’re also pretty important to pay, no one wants to be without health insurance.  As a rule of thumb I want to make sure that my income after taxes and savings covers my fixed expenses by a factor of two at least, most of which will be housing costs.  In our example the remaining 45% should cover the fixed expenses twice, therefore the percentage of your budget spent on fixed expenses ought to be roughly 20%.  If you make $4,000 per month after tax that means $800.  That’s not much when you consider it has to be split up among rent, utilities, health insurance and so on.  This likely means that you don’t want to be spending much more than $500 for your housing.  That doesn’t get you a lot in some places in the country.  Hopefully a high cost of living area means you can pull more income in.  If not, get a roommate, or double your working life, doesn’t matter to me, if you intend on waiting 30 years to become financially independent then you can spend 30% of your income on fixed expenses, making $800 for rent more reasonable…seems like not very much benefit when you consider it means working for twice as long.

Other Stuff – Variable Expenses

The stuff here is important too.  Food is in this category.  You want to be able to eat, it’s bad if you can’t.  Fortunately, it’s also a pretty flexible category.  Most people can save money on food simply by going out to eat less frequently.  The typical cost of eating out is 2 to 3 times greater than eating at home on a per person per meal basis, that creates a lot of wiggle room for most people.  Your automobile will probably account for half of the remainder of your budget, 12.5% from the remaining 25% of your after-tax income.  This means that you eat, entertain yourself, and cover everything else that comes up in life on $500 for a person making $4,000 per month, intending to be financially independent in 15 years.

Putting it together 

You should keep in mind that savings or retirement accounts count as working years.  If you save $25,000 per year and your net worth is currently $75,000, you get to count that as an additional three years.  Thus, if you want to be financially independent in 12 years and have three years worth of savings you can use the savings rate of someone who desires to retire in 15 years.  Keep in mind however that you have to continue to live on the same amount of money post financial independence if you lose your original source of income.

Example Budget:

15 years to financial independence

After-tax income: $4,000

  • Savings $2200 — 55%
  • Fixed Expenses $800 — 20%
    • Housing $500 — 12.5%
    • Health Insurance $150 — 3.75%
    • Car insurance $50 — 1.25%
    • Utilities $40 — 1%
    • Internet $30 — 0.75%
    • Cell Phone $30 — 0.75%
  • Variable Expenses $1200 — 25%
    • Car $500 — 12.5%
    • Food $300 — 7.5%
    • Entertainment $100 — 2.5%
    • Books $50 — 1.25%
    • Gifts $50 — 1.25%
    • Haircuts/Clothes/Home supplies (other) $200 — 5%

This is an example budget and simply represents a baseline.  Surely you’ll find that you want to spend less money on a car and more on housing, or vice-versa.  (Keep in mind to account for depreciation as part of your car expenditure). Maybe your health insurance is covered by your work.

I realize this isn’t the standard 15% savings rate that is often advocated by personal finance experts.  They assume retirement at 65, a fixed social security payout and then they assume death.  Part of the benefit of financial independence is simply having to worry less about what happens.  Depending on social security being unchanged in forty years sounds about as fun as hoping that I don’t accidentally outlive my money at 85 (that being said, I’ll happily choose outliving my money over the alternative). Seriously, boo to having four years left on the actuarial table, and having four years of savings left, there is nothing fun about that math.

Join the Thousandaire newsletter

Screen_shot_2017-04-25_at_1.36.50_pm

Subscribe to get our latest content by email.

Powered by ConvertKit
Nov 182016

Mailbag: Should I Stop Investing, Because Trump Won

By |November 18th, 2016|Blog|2 Comments

You can email me at adamwoods137@gmail.com

You can email me at adamwoods137@gmail.com

Hi Adam,

I’m just starting out in my career and I think I’m ready to start investing.  I really expected Hillary to win the election. Now that it’s Trump I don’t know if I still should.  It looked like when Trump started winning the market dropped a lot.

Thanks,

Melanie

Well, when you boil this down, what this question seems to really be is: “Should politics impact my investing decisions?”.  Short answer, no.  If you owned a successful car-wash would you sell it because Trump was elected?

My Bias

I voted against Trump.  Specific to the matter at hand, I think Trump’s economic proposals are bad ideas.  The main planks of his economic platform seem to be a mercantilist view of the global economy, that trade agreements make winners and losers of countries.  This is coupled with a restrictive view of immigration.  The global economy would like roughly double in size (Clemens, 2011).  This would likely double average real incomes. (That’s an after-inflation doubling folks!)  Yes, the middle class in the US has not seen a lot of the benefit of free trade, in part due to increasing healthcare costs, and in part due to competition from foreign workers.   If Trump does not approve the Trans-Pacific Partnership, if he cancels NAFTA, or if he reduces incoming immigration, I expect the economy to suffer.

My Bias and My Investing

I have not changed anything about my investing process to take this into account.  It is very important not to let your political bias effect your investing.  The fact that my above bias is based on, what I believe to be, sound economics, doesn’t make a difference.  When you’re investing you want a mechanical and rational process, or a process that is based on analyzing individual companies for obvious mispricing and exploiting it.  There is very little rational and nothing mechanical about politics.  The vast majority of people should put 20 to 50% of their income into an appropriate asset allocation split between bond and stock index funds.  They should do it every month, rain or shine, and wait.

That means each month that you’ll accumulate a growing share of the world’s productive assets, this means that you own a larger and larger share of the world’s businesses.  These businesses will probably make profits in the future, and you’ll have a right to an increasing portion of those profits. The important thing is that you don’t sell your share of the businesses for any reason except that you need the money.

It might be appropriate for some people to take a more active approach to their investing.  Here you analyze a companies, balance sheet, income statement, and other financial documents to determine it’s intrinsic value. (The value of all of the money that can be extracted from the business ever, discounted at a fair interest rate to the present).  You then compare the intrinsic value to the market value, and buy shares of the business if the market value is substantially less than the intrinsic value.  This is much harder than it sounds, as it involves some prediction of the future.  It’s easier if you look at businesses that are simple and easy to analyze, crucially the market also has to be dumber than you about analyzing them.

An example

The best investment I ever made was probably in Sitestar, the dying dial-up company.  The reason it was a good investment is that it owned a bunch of real estate, and you could buy shares in the company for less than the value of the real estate.  Shares were cheap because to the casual observer, it simply looked like a dial-up company, and who wants to invest in a dial up company?

Nowhere in that story did it matter who the president was, nor did it matter what the economy was doing (frankly I was probably helped by the poor economy if anything). So there you have it.  If you’re a mechanical investor, keep doing the mechanics as normal.  If you’re an active investor your investments probably have more to do with your research than who is in the White House.  Everyone’s politics are tied very tightly to their emotions.  Emotion is an investment killer.

There’s an old investing joke:  Tell me tomorrows news, and I’ll still lose money trading on it.  That seems to apply strongly with politics! If I had a crystal ball that told me in advance Trump would win, I would have bet a bunch of money that the stock market would go down after his election (assuming that Trump’s impending win wasn’t generally known already).  Stock market went up the day after his election.  The stock market is still up since his election.  I would have been very wrong, I would have lost a lot of money.  The reason I didn’t place such a bet is that I didn’t know who would win the election, but I assumed my reasoning would turn out correct.  Trump fans shouldn’t think the lesson from this is just that my politics is wrong, and that you’re safe trading on your politics if you’ve just got the right politics.

The bottom line is that you should probably go ahead with your original investing plan

brokeGIRLrich

Join the Thousandaire newsletter

Screen_shot_2017-04-25_at_1.36.50_pm

Subscribe to get our latest content by email.

Powered by ConvertKit
Nov 102016

Should I invest in a Dividend Reinvestment Plan (DRIP)

By |November 10th, 2016|Blog|Comments Off on Should I invest in a Dividend Reinvestment Plan (DRIP)

Thanks to Andrew Magill for the image.

Thanks to Andrew Magill for the image.

The answer to this question is complicated and gets to the root of psychology and money.  If you’re about my age, probably the best thing for you to do is to set your money in a total market index fund and ignore it until roughly retirement.  This is very probably the best effort-to-reward ratio.  The problem is that most people are not psychologically prepared to watch half their money evaporate in the stock market.

Why a Dividend Reinvestment Plan could be worth it

Let me give you a hypothetical.  You have a retirement account.  If you want to spend $40,000 per year when you retire you’ll need $1,000,000 to do so safely.  Include inflation and both of those numbers are potentially much larger by the time you retire.  So let’s say you’re 50, still 15 years left until you plan on retiring, your retirement account has more money in it than it has ever had (if you’re contributing constantly, most years should be record setting years for your retirement account balance).  You have $2,000,000 in your account.  One month later the market has taken a nose dive, you’ve just lost $1 million dollars.

Try to imagine that.

What it feels like over the course of a month to lose 40 to 50 thousand dollars day after day.

Sure, there are occasional up days, even days where you make $60,000, but you’re still down 100K overall, then 200, 300.  The financial news is calling this the worst stock market crisis in 15 years, and things seem to be getting worse.  Really try to imagine how you feel at the end of the month.  You’ve lost a million dollars, does your spouse know?  Does losing a million dollars of your shared retirement cause any marital strife?

Really close your eyes and try to imagine the stress and the fear.  Then suppose that there is another big up day.  Seven days where you’ve made $40,000 or more have happened in the last month.  Every one of them has been followed by even bigger losses, it’s put your account just a little ways above a million dollars again.  Be honest, what do you think the chances you sell your stocks to prevent more losses are?

If you tell me that the chances you sell are less than 20% and you’ve never been through a bear market, you sir, are a liar.  People have extreme levels of difficulty predicting how they will react when they’re emotional state is different from the one they are in now, this is a type of hot-cold empathy gap.

So where does a dividend reinvestment plan come in?  While an index fund might be optimal if you really would buy it and sit on it for 40 years, it might be easier to buy and sit on a dividend reinvestment plan instead.

How does a dividend reinvestment plan work?

Company’s sometimes offer DRIPs (Dividend Reinvestment Plans).  The deal is that you buy some of the company stock from the company rather than a broker.  The dividends are then paid either to you (often by direct deposit or check) or reinvested in fractional shares of the company’s stock.

For example, with the Exxon Mobile dividend reinvestment plan you fill out a couple forms, buy some starting stock, and you’re off to the races.  For the Proctor and Gamble DRIP you can set any number of whole shares worth of your dividends to be reinvested vs direct deposited to your checking account.   For example, when I had a XOM DRIP I had roughly half of the dividends reinvested and the other half direct-deposited to my account.  It wasn’t super simple to see the current balance of the P&G shares I had, this meant that there was only one thing I could focus on: the income stream coming from my P&G shares.

The DRIP plan

The theory is this, rather than buying an index, instead invest in 15-20 DRIP plans of megacapitalization blue chip companies in various sectors of the economy.  Probably your money won’t grow as fast as in an index fund.  Your money will probably experience volatility similar to the index fund (perhaps it will be somewhat better).  However, since your focus is on the number of shares you own and the profits generated by those shares, rather than their quoted market value, you are somewhat less likely to make a serious mistake, you just slowly accumulate ownership of these companies over time and collect steadily growing quarterly dividend checks from them.

Why do I worry so much about mistakes rather than just explaining the optimal strategy?  The return of a total market index fund is about 10% annually.  The return of the average investor is about 3% annually.  Typically the gap between an investor’s return and the return of the funds they invest in is 6.5%.  Basically this comes down to investors buying and selling too often and at exactly the wrong times.   If losing out on a few percent of possible gain can keep you focused on the right things, and avoid the much more common 6.5% drag, it’s money well spent.

My Favorite DRIPs

Exxon Mobile – No comment about the future of oil, or if the stock is reasonably priced, but this is my very favorite DRIP. Oil can be very volatile.  Hiding this volatility from yourself behind incoming reinvested dividend checks seems good. The Exxon Mobile DRIP is delightfully cheap as far as fees go.  They only hit you when you’re trying to sell, but the plan here is that you never sell.  If you’ve got a long time horizon this goes from being good to being very good.  If you think oil is going to die a painful death, then maybe not, probably shouldn’t be your only investment.

GE (General Electric) – A relatively low fee DRIP. There is a $7 or so initial purchase fee, and a small fee for automatic investments. However, there is no fee paid for dividend reinvestment.  There is a fee if you’re trying to sell, but you aren’t trying to do that, right?

DRIPs with fees

Coca-Cola – Minimum manual purchases are $500.  This isn’t terrible, but note the dividend reinvestment fee of 5% up to a maximum of $2.  In order to hit the maximum fee and therefore for the reinvestment to stop sucking you need to have a quarterly dividend of $40.  The current dividend on Coke shares is 35 cents per share, so you need about 100 shares.  That requires about $5,000, really though you want to get the effective fee down to 1%, that means an investment of $25,000.

Proctor and Gamble – Same deal as Coke, more or less, only the fee caps at $3.

Honorable Mention

Tradeking – If you look at anything with a reinvestment fee, you’re probably just better off shoving it into a tradeking brokerage account.  If you intend on reinvesting your dividends this is probably the way to go.

Loyal3 – This would be my favorite solution to the high-fee DRIPs, however the selection of stocks is very limited, and they don’t currently allow for reinvestment.  Psychologically, it seems like one of the best options.  No fees (more or less at all) and the default view doesn’t show when you are losing or making money.  You just focus on the cash building up in the account from the incoming dividends. This is a good way to pick up positions in available companies with expensive DRIPs like, Coke, Disney, and Intel.

Join the Thousandaire newsletter

Screen_shot_2017-04-25_at_1.36.50_pm

Subscribe to get our latest content by email.

Powered by ConvertKit

Join the Thousandaire newsletter

Screen_shot_2017-04-25_at_1.36.50_pm

Subscribe to get our latest content by email.

Powered by ConvertKit