Note from Daily Trade Alert: This is the third article in an exclusive four-part series that reveals how Jason Fieber went from below broke at 27 years old to retired at 33. If you haven’t already, read Part 1 and Part 2 first. In today’s article, Jason discusses how he invested his money in order to be able to retire so early in life. His primary objective was the generation of reliable and growing passive income that could cover his low expenses. Once his expenses were covered with passive income, he was financially free. But he also had to be mindful of inflation over time, which is why it’s so important that the passive income can regularly grow….
So I revealed in the last article how I was able to save such a high percentage of my net income.
But saving is just one piece of the “blueprint” to early retirement. An important piece, no doubt, but not the whole picture.
As someone who was aiming to achieve early retirement at a very young age, it was imperative for me to use the money I saved to build a passive income stream that would exceed my expenses and outpace inflation.
Exceeding expenses is obvious.
Outpacing inflation is less so, but still important. $1 today will very likely be worth much less in the future.
So I needed to find a source of income that isn’t just passive (so that I can enjoy life), but one that’s growing so that my purchasing power is increasing at least in line with inflation, but preferably in excess of.
But where could that kind of income stream come from?
I’ll tell you in a moment.
But first, let me back up a little…
Up until just before turning 28 years old, I had never invested before in my life.
I barely had a bank account!
Investing seemed intimidating.
Guys in suits on Wall Street know what they’re doing.
Rich people with yachts know how to invest. Millionaires have all the inside tips.
How could a broke auto service advisor have any chance?
Well, knowledge is power, folks.
So I started reading. A lot. Book after book. Article after article. I read voraciously… and I learned how to analyze companies and read financial statements.
After researching how some of the world’s most successful (and wealthy) investors went about allocating their capital over their careers, I noticed a common theme.
Great investors routinely invest in great businesses. And they hold these shares for the long term.
It seems intuitive in hindsight, but that’s what actually creates a fairly easy learning curve when it comes to investing. One can and actually should keep things very simple when investing their money. Intelligent investing comes natural once you’re on your way.
Once I learned the secret of sticking to great businesses over the long haul, I set about discovering exactly what high-quality businesses look like.
This, too, is somewhat intuitive.
When I think of how a great business operates, I hearken back to how I started to operate when I started thoughtfully exploring my own personal finances as I became fixated on the idea of being able to retire very early in life.
I was spending less than I was earning. I was taking care of my debt. I was taking the idea of capital allocation very seriously. I was lowering expenses while simultaneously increasing my income.
Well, great businesses do this, too.
When I look for a great business, I want to see excellent fundamentals.
I’m looking for a lengthy track record of increasing revenue and profit. A balance sheet without too much debt but plenty of cash. Strong profitability metrics (margins, return on equity, return on invested capital, etc.). Competitive advantages, like recognizable brand names, robust distribution networks, cost advantages, pricing power, and patents.
And perhaps most importantly, I’m looking for growing dividends, because growing dividends can be a great litmus test for quality.
How so? Because a company is only able to increase its dividend for decades on end if its underlying profits are rising in kind.
A dividend is paid in cash from cash. It can’t be faked – a dividend is basically the “proof in the pudding”. Don’t tell me how profitable you are; show me.
So after researching just about every possible investment strategy out there, I settled on Dividend Growth Investing (DGI) as the strategy to get me to financial independence.
In my opinion, owning a portfolio of high-quality dividend growth stocks is the most reasonable, sensible, and intuitive investment strategy available.
What’s a dividend growth stock?
Put simply, a dividend growth stock is a company with a proven track record of raising its dividend (a cash payout to shareholders) year after year.
High-quality dividend growth companies typically dominate their industry, realize steady profits, and generate massive amounts of free cash flow.
As a result, they’re able to pay their shareholders a portion of that cash in the form of a dividend that increases every year… often rising faster than the rate of inflation.
The beauty of owning a stock like this is that no matter what happens to its share price, as long as the company continues to grow its dividend, we — as shareholders — stand to collect larger and larger payouts each and every year.
That’s why these stocks are so compelling: you buy them when they’re trading at a reasonable price, hold them, and then get showered with growing cash payouts for potentially decades to come.
Even in economic downturns, recessions, bear markets, periods of war, etc., these high-quality companies have the ability to continue paying increasing dividends.
How is this possible?
Consider a few of my favorite dividend growers…
Johnson & Johnson (JNJ), Wal-Mart (WMT), Target (TGT), Procter & Gamble (PG), PepsiCo (PEP) and Coca-Cola (KO) have increased their respective dividends each and every year for over 25 years in a row!
Many of these (if not all of them) are boring companies that don’t necessarily come to mind when you think of making a lot of money.
But by their very nature, “boring” companies like these have the potential to generate enough cash to pay shareholders throughout practically any kind of market environment.
That’s because they sell the kind of ubiquitous products and/or services that people use every single day.
These companies provide the food you eat, the beverages you drink, the gas you put in your car, the toothpaste you use to clean your teeth, the power you use to light up your home, and the hardware and software necessary to power the device you’re probably using to read this article.
Selling products and services that billions of people around the world use every single day is precisely what protects these businesses from recessions and allows them to expand even in times of distress. Even if you’re unemployed you’re still going to eat, drink, and brush your teeth!
You can see how that worked out during the financial crisis and ensuing Great Recession that started back in 2007 (shaded area in chart below).
Each of the “boring” companies I mentioned above actually increased their respective dividend payments to shareholders right through the worst financial calamity my generation has ever witnessed.
Here’s my point:
The growing dividend income offered by high-quality dividend growth stocks can be a fantastic source of growing passive income… no matter what’s going on in the global economy or stock market.
And it’s truly passive income: I’ll likely collect over $11,000 in dividends from my portfolio in 2017… and I don’t have to do ANYTHING to collect this cash.
I don’t have to wake up at a certain time. I don’t have to clock in. I don’t have to call a 1-800 number. I don’t have to report to anyone. I don’t have to sell any stock.
I literally do nothing… other than continue to hold shares in these great businesses.
Now, dividends aren’t the only way to extract income from a stock portfolio.
In fact, many people take a completely different approach.
They invest in index funds or stocks that don’t pay dividends and then perform a controlled sell-off of assets in order to meet expenses and maintain a certain lifestyle once income is necessary.
This would usually involve building up a large portfolio over your working years and then drawing down income from the portfolio by selling off stock once you’re retired.
You would determine a safe withdrawal rate, based on your expenses and asset base, and then start to slowly bleed your portfolio dry.
This makes no sense to me.
If you build out a portfolio of stocks that do not pay growing dividends, but you need passive income to pay your expenses, you’re going to have to slowly and methodically sell off shares of these companies.
I realized very early on that I don’t want to be in that situation. It’s just nonsensical to me.
If I have 100 shares of a wonderful business, why would I want to slowly sell off shares? Why would I want only 95 shares next year? 90 shares the following year? All the way to the point where I potentially have zero shares?
I prefer a different approach: dividend growth investing.
In short, I sleep soundly at night because I’m generating income without having to sell ANY of my stocks.
That’s right, as dividend growth investor, I don’t plan to sell ANY of my stocks. I want to own them for the growing dividends they’re paying me each and every year.
Again, dividend income is what’s funding my early retirement. Not the selling of any shares.
I hope you can see how this all works by now, and that it’s really starting to make sense.
At the end of the day, I’ve relied on my savings and dividend growth investing strategy to get me to where I’m now at.
And where I’m now at is financial independence.
I’m essentially retired in my early 30s, living the life of my dreams.
And you can get here, too.
Nothing I did is particularly hard. I shared with you my “blueprint.”
I simply took my excess savings and invested it intelligently, like many of the most well-known and successful investors have done for years.
I stick to high-quality companies with histories of paying out higher and higher dividends. And I buy into these companies when their stocks appear undervalued.
The fact that the growing dividend income I’m now collecting from my portfolio is used to pay for the bulk of my real-life expenses makes dividend growth investing a clear winner, in my opinion.
I’m waking up to fresh dividends in my brokerage account almost every single day. No work on my part. I just sit back and collect.
Now that you see what I’ve done, how I’ve saved, and how I’ve invested, there’s only one more article to come.
In Part 4 of this series, I will wrap things up and tell you about a resource I think can help investors, especially those aiming to live off of their growing dividend income at a very early age.
– Jason Fieber
Note from DTA: If you’re interested in building your own dividend growth portfolio, but you’re not sure where to start, there are several resources right here on Daily Trade Alert (and they’re all free). One of them is something we call our Undervalued Dividend Growth Stock of the Week, which is written by Jason and published every Sunday. As the name implies, the companies featured in this column typically offer sound fundamentals, reasonable levels of debt, strong balance sheets, rock-solid histories of increasing their dividends, and of course, attractive valuations. Click here to access Jason’s latest pick – a stock he recently bought more shares of for his own portfolio, that pays a higher-than-average yield, and that’s potentially 30% undervalued right now.