Sleep Well At Night Stocks

Years ago I started planning my retirement, I tend to become almost obsessive over these things. I calculated that after I started receiving my Social Security at age 70 and a few small pensions that I would need about $30,000/yr. to fill my “income gap”. The “income gap” is the difference each year between my guaranteed income and my life-style income.

I also decided that I only wanted to use my IRA and never touch my taxable account that would someday go to my loved-ones. My taxable account is the result of years savings, good investment choices and the sale of a business.

As I got closer to retirement I wanted to make sure that my IRA could easily generate my “fill the gap” income AND let me “Sleep Well At Night”. I wanted to invest in SWAT stocks and ETF’s.

Here is a great example of one of my long time holdings, Reality Income, ticket symbol “O”. Reality is a commercial REIT, it pays about $2.54 per share in annual dividends.  This represents a dividend yield of 4.67%, a fair bit above the average dividend yield of 3.27% in the general financial sector.

The company just announced its 568th consecutive monthly dividend! Even during the Great Recession, the company paid its dividend! Furthermore, it has increased its dividend 93 times since going public in 1994. Pretty good track record.

This is what I call a SWAT stock.

Reality Income has about 5,000 freestanding, single-tenant properties located in 49 states and Puerto Rico, leased to 251 different commercial tenants, and doing business across 47 industries. I would say that this is pretty well diversified. These properties are leased under very long-term, net lease agreements with the average remaining lease term of 9.6 years.

Here is how Reality Income has done as compared to the S&P 500, see the chart below. It has outperformed the market for at least the last 10 years, and that Does NOT include the dividend!

This stock represents about 2.5% of my well diversified IRA portfolio. The portfolio generates about $38,000 a year in dividends and about 6% in total annual returns (dividends and price growth). I’ll publish more of my SWAT stocks in my IRA later.

First I’ll tell you why I’m celebrating the stock market crash, then I’ll celebrate the President!

Ten years ago in 2007 the stock market peak, then proceeded to tank 40% and the economy went into the Great Recession. On March 9, 2009, the QQQ traded at $25.74, the bottom. QQQ is an ETF representing the NASDAQ top 100 stocks.

Many panicked, sold at the lows and vowed to never again risk their hard-earned money in the “casino” called the stock market.

However if you weren’t recently retired and forced to take out distributions and just stayed invested in good quality company’s your have done very well. Fidelity Investments just published information comparing retirement plan savers who stayed with stocks grew their investments by an average of about 240%, that’s about 50% more than investors who bailed out of stocks at any point in 2008 or the beginning of 2009.

What did I do in 2008-2009, when many of my friends thought I was totally crazy? Here is a list of things.

1. I felt just as bad and went sleepless like everyone else. But I didn’t panic.
2. I did sell off some speculative stocks as they kept going down. This was to me just good housekeeping. Even today, as a buy & hold investor, if the story changes on a stock I own and I don’t like it anymore I sell immediately!
3. I knew that some day top companies would rebound. I kept all my core holdings both stocks and bonds. Many of these I still own today.
4. I didn’t have to check because I had always maxed out on my contributions to my work 401K plan. Unfortunately because of income restrictions I couldn’t contribute to an IRA (pre-tax). Many people were cutting back on their contributions
5. I started buying as much blue chip stock as I could afford, GE for under $8, Microsoft at $16, etc.  It was very painful at the time and I didn’t catch any of the lows. But by 2010 or so I was already up HUGE. Then as I re-balanced my portfolio I got wacked with significant capital gains taxes.
6. Oh, by the way today the QQQ ETF trades for $151, an 600% increase over the bottom, not including all the dividends it paid.

So why celebrate, because I survived the 2nd worse recession ever, chances of another one like this in the next dozen or so years is pretty remote. Secondly, I didn’t panic and invested wisely. Today I use that same lesson to deal with the normal market craziness.

How did my business RainMaker Software do during this time? Actually pretty good. Early on in the downturn I clearly communicated to my employees, they were all afraid we’d have to cut  back head count or reduce salaries, that unless we had a real catastrophe I wouldn’t lay-off anyone. If some one resigned or retired we would not replace them. I then told them that they (the employees) had to find ways to reduce some expenses so that we still made our profit share numbers for the year. Free daily breakfast at the deli next door would get reduced to Friday only, etc. The bottom line was that my team really stepped it up, so much so that we had record profits in 2007 and thereafter. We never missed a single management bonus or employee profit share payment. Happy employees do wonders for a business, I always knew they had the answers to all of our problems, many CEO’s would just never listen. I listened closely.

A Message to President Donald Trump
Dear Mr. President,

I voted for you, I wanted a business man to be president for once. So far I’m not happy with you being on Twitter (I’m not).

However, I couldn’t be happier that since you have become president my investments are up over 25%! This is with all the crap that is going on in Washington and all the fake news.

I’m also hopeful that if you can get a tax reduction bill through Congress, lower corporate tax rates, allow corporations to bring home about $3 trillion in cash my investments will compound by another 25%. That too would make me very happy.

Keep up the good work Mr. President as dysfunctional as it may appear.

A Buy & Hold Investor,

Jim Hammond

At our community Investment Club meeting last week a member asked for a description for how DRIP programs work for dividends. Answers were provided and I thought this would be a good topic to write on since there are some misconceptions. 

If you are an investor you should understand what a DRIP is, an automatic “dividend reinvestment plan”. Let’s take a look at your choices in dealing with stocks, ETF’s or mutual funds when it comes to dividends.

Dividends offer long term investors with the opportunity to improve their total returns over time. How important are dividends, check out this chart showing “returns” from 1997 to 2017, for the S&P 500 index.

When dividends of the S&P 500 were reinvested back into the index the power of compounding took over and increased the total return from 190% to 321% over 20 years.

A DRIP (dividend reinvestment plan) will allow you to automatically have your brokerage provide you with new shares of stock, instead of a cash dividend deposited into your cash account. 

Let’s look at a simple example of how this works. Let’s say you have a stock with a current price of $40/share and this quarter you get $150 in dividends. Most of the time, the amount you receive as a dividend won’t divide evenly to buy only whole shares with nothing left over. Therefore your dividend reinvested will buy 3.75 shares. The brokerage adjusts the number of shares you own in whole numbers and shows a 0.75 fractional share. At the next dividend date, if the same thing happens you will be credited with another 0.75 share. It will look a little strange to see that you own 103.75 shares of Apple, but your broker will handle all of this.

Now, behind the scenes it isn’t your broker doing all of the work, in fact the company/fund/ETF you own shares of must have a DRIP program in the first place. Most do. Your brokerage just makes it easy for you to participate, most not charging any fees or sales commissions on the new shares.

How difficult is it to set up a DRIP for your stocks, funds or ETF’s, it should be very simple. Here is an example on my Fidelity account:

In Fidelity just go to Accounts/Trade – Account Features – Brokerage & Trading – Dividend and Capital Gains. This will show you, by each account which stocks are eligible for DRIP’s.

After selecting a stock, just choose “Reinvest in Security” and choose Update. As you can see in the above example, on NXP stock I have DRIP turned off, therefore all dividends are just deposited into my cash account.

I noticed that the majority of my dividend stocks and ETF’s had DRIP capabilities. I also noticed that none of my preferred stocks allowed it and a few BDC’s did not allow it either. 

Benefits of DRIP’s:

1. It helps buy more shares of an investment.
2. Compounding dividends may help you reach your investing goals.
3. Your brokerage house will track your “costs basis” on all new shares for determining tax treatment (in a taxable account) when you sell any shares.
4. Most brokerage houses, like Fidelity do not charge any fees or commissions on this transaction. If you have a lot of dividend stocks, over a period of time this is a substantial costs savings.
5. Company’s save cash by providing dividends as shares of stock. 

Why You Might Not Want To DRIP:

1. By using DRIP you give up the ability to reinvest dividends in another stock or fund, for example you may already have a full allocation in Apple and want to use the dividends to buy something else.
2. You may need the cash, for example in your IRA you’ll want to maintain a cash balance to handle your RMD (required minimum distribution) withdrawals.

Tax’s:
There is no free ride on dividends held in a taxable account. When dividends are awarded to you, whether in cash or as additional shares you will owe taxes on them. If you are sensitive to paying taxes on dividends and capital gains for mutual funds in a taxable account you may want to consider receiving your dividends in cash and reinvesting yourself into a more tax friendly investment. For example, a mutual fund or ETF may provide a high percentage of its dividends as regular dividends (not Qualified Dividends), these regular dividends are taxed at your ordinary income level, vs. the special rate for “qualified dividends”.

In any case a conservative investor may want to hold a sizable portion of their portfolio in dividend generating stocks and reinvesting the distributions to enhance the Total Return.

There are some really simple reasons why “High Net Worth” people get richer faster than middle or lower net worth people. Much of this disparity has to do with the tax system we’ve had for years now. In addition we continue to get confirmation that, “high earners” save a much higher % of their earned income and are less effected by inflation over the years. Those still working that earn more today will probably earn much more tomorrow, those down the income scale will see flat increases.

Conclusion – the faster you build your net worth to a higher level, the better off you are in having that net worth increase faster than people with lower net worth. Also being a high income earner isn’t necessary enough!

High Net Worth is defined as having $1 million – $10 million in liquid assets, we won’t include home equity is this definition since it is anything but “liquid”. Notice I’m also differentiating between “high income earners” vs. “high net worth”.

Let’s first look at some anomalies in our tax system and understanding how to build wealth. Here is an example.

A CEO makes $300,000 in annual income, a retired high net worth person shows $300,000 in income. Do they pay the same amount of tax this year? Absolutely not, the working person’s income is taxed based on normal brackets and pays over TWICE the amount of tax on the same amount as the retired person. Why, the retired person is holding his money is tax beneficial vehicles. His income is a combination of Social Security (only taxed at 85% max.), capital gains, qualified dividends, muni-bonds, inheritance, etc.

Right after World War II the top dividends tax was between 70 – 80% (wow!). Then President George W. Bush’s tax cuts dropped the top rate on dividends by half.

See the table below to see how taxes on Investments has drastically changed over the years. Today we have a pretty good thing going.

The old adage “the more you make, the more you spend” isn’t true for everyone. The richest American’s save a far higher % of their income than the bottom 90% of our population. As a matter of fact, 90% of our income earners by and large don’t save anything at all.

In mid-September the Census Bureau released its annual report on household income data for 2016. Last year, the median (middle) household income rose to $59,149, a 4.1% increase over 2015 and a record high. The mean (average) household income set a new high of $83,143.

So, you would think that we are all doing pretty well then, everyone is getting “richer”, these are all time high’s. But wait, let’s adjust for inflation using the Consumers Price Index based on 2016 dollars. Now we see a much different picture of wage earners in different quartiles. Even if your household is in the 2^nd Quartile, making $95,000 in 2016, your after inflation “income growth” has been flat for many years. If you are in the $200,000 – $400,000 income range you have seen much higher growth!

No wonder Warren Buffett, CEO of Berkshire Hathaway said, “Through the tax code, there has been class warfare waged, and my class has won”.

So what is the bottom line? Earn more money, save more money, smartly invest more money and get to High Net Worth as early as possible. The 1^st million of Liquid Net Worth is much harder to reach than the 2^nd million, 3^rd million etc.!