Last week, the second edition of my book Get Rich With Dividends was published. Those of you who read it (or the first edition at least) should be familiar with my three-year rule.
In a nutshell, it’s this: If you need the money within three years, it shouldn’t be invested in the market. That’s it.
If funds are going to be required to pay rent, tuition, living expenses or anything else in the next three years, that money should not be at risk. It should be in CDs or other safe investments.[ad#Google Adsense 336×280-IA]While we know that markets go up over the long term, in the short term, anything can happen.
And if you need your cash that’s invested in the market right in the middle of a bear market, you’re going to have less than you expected.
Obviously that’s a problem.
Like I said, the rule is pretty simple.
But I wanted to address it in Investment U because I recently received an email from Norm, a reader, asking about it.
Here’s his question:
“I should hopefully be retiring in 2015. What is wrong with holding dividend-paying stocks for the income? If they go down 20%, so what? It’s the income I’m interested in. Those CDs, etc. just don’t cut it. The three portfolios in The Oxford Income Letter imply that the positions listed are proper investments for retirement.”
There are a few things at play here. When Norm says he doesn’t care if the stock goes down 20% because he’s invested for the dividends, it sounds like he may have a large enough nest egg to live off the income.
If that is the case, and he doesn’t expect to have to touch the principal, then I agree with him 100%. The goal for every investor should be to have enough capital to live off the income generated by their investments.
So if that’s Norm’s situation, then he’s right about not worrying if the stock goes down 20%. That is, as long as the dividend continues to get paid and increases every year.
More Income Every Year, Throughout Retirement
The increasing dividend is a key component of my 10-11-12 System. It’s the system my book and The Oxford Income Letter are based on. It was designed to ensure you receive more income every year from your investments. That way, your buying power actually increases on an annual basis.
The stocks held in The Oxford Income Letter’s portfolios can all be held in retirement. However, if an investor is not in the situation I described above and will need some free capital, the required funds should not be in the market. It doesn’t matter how low interest rates are in other investments or how high a particular stock’s dividend is.
For example, let’s assume an investor has a $500,000 portfolio. If he or she has followed my system for several years, investing in Perpetual Dividend Raisers (stocks that raise the dividend every year), the portfolio should generate a yield of 11% and spin out $55,000 per year in income.
However, let’s say the investor needs $75,000 per year for living expenses. In that case, the investor should take about $100,000 out of the market and put it into a CD or other account where the principal is guaranteed. The remaining $400,000 will still yield 11%, generating $44,000 in income. And the $100,000 will make up the difference over the next three years.
The following year, the investor should put some more money in a safe account and continue to do so every year.
Let’s look at what happens if they don’t…
Put Your Money Somewhere Safe
If the entire $500,000 is invested and, in two years, the market drops 30%, that $500,000 will suddenly be worth $350,000. Should the investor need money at this point, he or she will have to sell shares, reducing the income generated each year.
So not only will the nest egg decline significantly, so will the income. You never want to be in a position where you have to sell low or react emotionally to volatility. Having a plan for when your money will be in or out of the market makes these decisions easier.
Thanks to the rock-bottom interest rates being paid by banks, it’s tough for investors to generate any kind of meaningful yield on their near-term money. But it’s better than losing 25% when you have to sell in a bear market.
Take any money you need over the next three years out of the market and put it somewhere safe. If your time horizon is longer, then the market – in conjunction with my 10-11-12 System, of course – is one of the best ways to reach your financial goals.
Source: Investment U