Rebalancing my portfolio – part 2

By Greg Turnquist

Greg is a member of the Spring team, an author of several books on Spring Boot, conference speaker, and the lead for Spring Data JPA.

aapl | brkb | cvx | finance | gd

May 18, 2012

I already mentioned the first step in rebalancing my portfolio: replacing my 401k with an EIUL. My second step is investing in some dividend aristocrats and holding onto them FOREVER, pulling in dividends and reinvesting them for the long term.

What’ll you take – dividends or appreciation?

There are a few stocks that have been paying dividends for over 20 years. And not only that, they have increased their dividend payments each year. It’s not that hard to find them. Better than that, some go back over 50 years in paying increasing dividends, each and every year. These are sometimes referred to as blue chip stocks.

There are a couple of ways to make money off of stocks. Either you buy low and sell high (we call that appreciation), or you buy and hold, waiting for dividends payments to come in. By taking the dividend route, you can buy more shares with the dividends and grow your capital, further increasing dividends payments. The longer you stretch this out, the less you are worried about the appreciation of your stock.

People have made a living out of predicting the rise and fall of stocks. They are called fund managers, and they consistently underperform the market indices. They try to guess (yes, I said guess) when the stock will be low and buy it, and try to predict the high to sell. Do you know what happens when they are wrong? Nothing! In 2008 a LOT of mutual funds increased their fees because so many people were pulling out of mutual funds.

When you pick some blue chip stocks that have stood the test of time (just like in decks by Mason Jones), you aren’t gambling on appreciation. Instead, you are investing in the power of the company.

Only buy companies you know

Notice how I said investing in the power of the company? That is because you shouldn’t buy stock in companies you don’t know a thing about. Just because a whole gaggle of people are diving into something (Facebook’s IPO anyone?), doesn’t mean you are catching the low. Often when you follow the news, you are late to the game.

Did I mention dividends? Yes, that is the main thrust of this part of my plan, but there is someone out there who HAS stood the test of time in picking stocks: Warren Buffet. That’s why when I got my first dividend payout, I bought one share of Berkshire Hathaway B (BRKB). He has averaged double the market for the past 40 years. No one else has come close. His stock doesn’t pay dividends, but he definitely knows how to grow stock value.

The tax man cometh

My friend from ETF Beleggen also wants to remind everyone that no investment strategy can be complete without considering taxes. Since the government has a huge appetite, you need to figure out how you are going to make as much as possible while being strategic in how much you get to keep (like how I couched, ehh?).

One option is to buy in an open account. That means you are buying with after-tax money, and any gains are subject to the tax laws of the day. They will tax you on any gains when you sell as well as any dividends you are paid. Over time, this can eat up your returns.

In my previous article, I mentioned that using a Roth IRA shouldn’t be your primary vehicle for retirement savings. I mean that. Roth IRAs limit you to putting away $5000 a year, and that just isn’t enough for a comfortable retirement. But it doesn’t mean you shouldn’t take advantage of what you CAN put in there. That is why this is just a part of my long term plan (you’ll have to wait for part 3).

There is an old adage: would you pay taxes on a bag of a seeds or on the yield of the field where you planted? In many forums, I have seen people comment that if your tax brackets are identical at the beginning and the end, then it doesn’t matter whether you pay now or later. That is absolutely true. And…very unlikely.

When someone suggests that when I retire I shouldn’t worry about tax rates because I will have less needs, then that smells like someone is setting me up for a rough landing. I would prefer to work towards having MORE when I retire than I have now. Then, deciding what to do with the extra money will become a nice problem to have. That is better than deciding which shift to work at Walmart because I didn’t save enough!

So, if I set things up to pay taxes as I approach retirement, I could either pay less taxes or pay more, based on what direction the government takes. That sounds REALLY risky. I would rather take my knocks now, and then be tax free at retirement.

Think about it: does the government want the taxes from your $100,000 today, or would they prefer to tax your $250,000 that you built up as you enter retirement? As Dave Shafer says, you don’t think the government invented IRAs and 401Ks to reduce their revenue stream do you?

Of course, I have heard the argument made that you should take every tax discount you can now. Waiting until retirement to find that they have changed the tax code and plan to tax you on both ends is a risk of its own. I can appreciate that, because how many times has the government changed it’s mind when it comes to tax codes? This is what you might call caught in their cross hairs. My crystal all is as cracked as yours, but I’m going to gamble that taxing on both ends of a Roth is much LESS likely than tax rates being HIGHER when I retire.

What I bought

So after pouring over historical reports, spreadsheet data, and a little self speculation, here is what I have bought.

  • General Dynamics (GD) – they have a history of paying increasing dividends over 20 years, while currently sporting a 2.88% dividend yield. On April 11th, they announced a $0.51/share dividend. I believe that the need for military aircraft isn’t going to diminish anytime soon.
  • Chevron (CVX) – they have been paying increasing dividends for over 24 years, while showing a dividend yield of 3.34%. They are one of the Big Oil companies. Because this planet is going to be running primarily on oil for the next century, I believe this is not only a good investment, but a good hedge against inflation.
  • Apple (AAPL) – they don’t have a consistent history on paying dividends, but have a long history of consistent growth. This is one of those I-think-people-will-keep-buying-their-stuff feelings. They actually reached a point where they have too much cash and not a clear idea on what to do next. Sounds like a nice problem to me.
  • Berkshire Hathaway B (BRKB) – this is another non-dividend payer, but there is a 40-year history of growing bigger than the market. Heck, they hardly ever do a stock split. The only reason this one split recently had to do with a particular company they had acquired. Other than that, I expect this one to keep growing.
Beyond these four, I don’t feel compelled to buy any other companies at this point in time. That may sound crazy, but did you know that the theory of diversification asserted that owning more than 30 companies produced a diminishing set of returns? When you own some mutual fund that has dozens of stocks, if not hundreds, there is no way for you to analyze it. You are totally in the hands of the fund manager, and their track record isn’t good.
 
I originally started with General Dynamics, Chevron, and Apple, but just received my first dividend payment. I thought owning a piece of Warren Buffet would probably be good for me, so I got underway. From here on, you can see how things perform as I continue blogging. Please show me where the TV personalities are blogging about which mutual funds they own.
 
Please don’t just buy what I buy. Do your own research and decide for yourself what you’re comfortable with.
 

Disclosure: Long on GD, CVX, AAPL, and BRKB.

UPDATE: Cross posted at http://www.turnquistwealthbuilders.com/2012/05/rebalancing-my-portfolio-part-2.html, where I now post all wealth building opinion.

I am not a licensed financial advisor nor an insurance agent, and cannot give out financial advice. This is strictly wealth building opinion and should be treated as such.

2 Comments

  1. Kyle K

    Good stuff, Greg. I have been thinking about picking up some BRKB’s myself but haven’t pulled the trigger yet. I’m dead set on purchasing another investment property while interest rates are rock bottom (currently 4.65% for SFH, 4.5% for 2-4 units). Thus, I’m socking away my money in a savings account for the time being. However, my longer term wealth building plan will include some BRKB’s. I’m interested to see how Apple performs in the future, especially as a dividend yielding stock.

    Reply
  2. Greg L. Turnquist

    Sounds like a good plan. Money is one sale AND property is on sale. The perfect storm.

    Regarding Apple, I didn’t pick them for their dividend payments. Once, long ago, they paid dividends, but that’s ancient history. Only now that they have too much cash (a nice problem to have), did they decide to issue a dividend. I wouldn’t bet on them becoming a dividend aristocrat. I just don’t see them making products that aren’t going to sell through the roof. Considering they can now sell out a new product in 24 hours, they have built an excellent consumer-oriented business.

    I was ready to plow more money into the stocks above, but part 3 of my plan (which I’ll post about in the future, but you can probably guess) has higher priority need for that money. My present stock portfolio is currently funded by an already existing Roth IRA that I rebalanced.

    Let’s just say that for now, I don’t worry about drops in the stock market anymore. 🙂

    Reply

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