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Sunday, April 23, 2017

Buying Income

Posted by Robert on June 28, 2010

I’ve always been interested in money. Even before I became a financial advisor, I started reading all the financial books I could get my hands on. I was able to find the first edition of Your Money or Your Life (1992 edition). (It was a long time ago; if my summary is of a different book, please correct me in the comments.) It presented a very simple, two step financial plan. Step one was to reduce spending. Step two was to increase investment income. Now that I am a Certified Financial Planner, I know that this is the very essence of a successful financial plan. The author, Joe Dominguez, suggested putting a chart on the wall, and charting two lines. The line that represents monthly spending should be decreasing, while the line that represents monthly investment income should be increasing. The month they cross is when you are financially independent. At the time, bonds provided the safety and income that the author recommended.

Later, I found and read Rich Dad Poor Dad. Although the author didn’t present a well-developed financial plan, he recommended accumulating passive income. Although he doesn’t address the very important idea of risk, his thinking intersects with that of Joe Dominguez in the idea of building up investment income. Realistically, having a source of passive income is the only way a person could retire from active work. Otherwise, they’ll have to work to support their lifestyle.

Besides the ultimate payoff of financial independence, acquiring passive income has other advantages. For example, this approach suggests a simple investment strategy. In my opinion, buying income is the best definition of investment. Any strategy that bets on increasing values is speculative by definition. If a person is focused on accumulating passive income, they are most likely to focus on investments that provide an attractive current yield (such as interest or dividends). This mentality of buying income will also affect one’s attitude toward risk. The prevailing academic viewpoint¬†is that stock market returns are random and risk is equivalent to variability. However, when buying income, risk represents the possibility of cash flow (interest or dividends) being reduced.

Further, using this approach makes tracking progress relatively simple. Each time I buy more income, I make progress toward my goal. If, for example, the goal is $2000 per month of income, and my investments produce $1000 per month of income, I know that I will be financially independent after I buy another $1000 per month of income. This strategy also puts market value fluctuations into perspective. The market value of the investments may rise or fall, but the income is likely to remain relatively consistent. That allows the investor to avoid emotional reactions. Market increases aren’t cause for celebration. Market crashes aren’t cause for panic. Better yet, market crashes provide good opportunities to buy income at relatively low prices. Focusing on yield helps keep this in perspective.

There are various strategies that can all move a person closer to retirement. The strategy that seems the most reasonable to me is to buy income. This approach makes tracking progress a simple matter and keeps the true value of investments in better perspective. It also simplifies investment decisions. Do you think this simplifies investing, or do you feel it takes a professional to make investment decisions? Do you have a bad experience or a lesson learned that you want to share? If you can, please share your own investment strategy, and why you chose it.

Comments

7 Responses to “Buying Income”
  1. moneyxyz says:

    I currently make just over $3200 net income per month in months where we receive 2 pay cheques. I calculated that to make $3200 in dividend income I would need a $500,000 portfolio of dividend stocks. I am 31 so nowhere near this. But bit by bit, we are getting there by DRIP-ping and making purchases periodically.

  2. Dave says:

    I’m kind of at step one right now, attempting to reduce my expenses. I’m doing this by paying off my mortgage as quickly as possible. I would like to be building income at the same time, but feel in the end I would rather have lower monthly expenses (permanently) than higher income.

    Once the house is paid off, I look forward to “Buying Income”

  3. Jon Snow says:

    After years of having no indentifiable early retirement strategy (other than LBYM etc.) I’ve recently decided to embrace dividend investing as my means to quit the rat race at 45. Quite simply the plan is to invest 60-70k per year in dividends and hopefully, in seven years my investment income will hopefully equal my company salary and I won’t have to work anymore.

  4. Robert says:

    Thanks to everyone for sharing. I’m unclear about one point. You’ve said that you’re investing in dividends until it equals your salary. I think that’s a great plan. What it should actually equal is: gross salary – taxes – benefits – savings – debt repayment. As an example, if a person earns $100,000, pays $30,000 tax, pays $25,000 on their mortgage and invests $10,000, they’re really only spending $35,000. That’s all that needs to be provided by dividends.

  5. deegee says:

    You have to look beyond one year when it comes to replacing wage income with dividends. When I was first working up my ER spreadsheet a few years ago (I retired in 2008 at age 45), I saw that my expenses would rise more quickly than my dividend income would. I saw that I needed to run a surplus in these early years of ER because at some point the expense line would cross the dividend income line, causing a deficit and forcing me to use some of my principal.

    However, my projected income is based on only my taxable acounts while my IRA grows until I can access it at age 60. a few years later, I will gain access to my frozen pension, SS, and a reduced health insurance expense with Medicare kicking in at 65.

  6. Robert says:

    We’re lucky in Canada that we can access an RRSP or TFSA at any time, which seems to be different from an IRA or Roth IRA. Our equivalent to SS, CPP + OAS, are relatively inflexible and don’t start before age 60 and 65.

    I agree that it’s better to run a surplus of income… at any time. I don’t think it would be wise to have just enough income to cover necessary expenses, whether it comes from dividends or salary. The nice thing about dividends is that you can still collect them, even if you work. So a shortfall means making the choice to sell principal (which reduces monthly income), or work temporarily or part-time.

  7. George says:

    > Do you think this simplifies investing, or do
    > you feel it takes a professional to make
    > investment decisions?

    I’m an IT analyst in the US, so researching & making information-based decisions is second nature to me. Financial decisions do not require a professional until you get to large sums (e.g. annual incomes over $150k, $2+ million estates) and possible tax consequences.

    > Do you have a bad experience or a lesson learned
    > that you want to share?

    Make use of stop losses when you don’t understand why a security is going down. If you’re certain you know the reason that it’s going down and you’re okay with riding it down, then fine, stick with it. But when you have no idea why it’s steadily dropping, it’s time to believe the market is telling you something! Exit before the party is over and you’ll have more fond memories (and a fatter bank account).

    > If you can, please share your own investment
    > strategy, and why you chose it.

    Currently I’ve focused on a consistent income. My goal is 6.5% yield from dividends and distributions and royalties. This is the yield that will pay off the house in 4.5 years from now and was selected because my mortgage is 3.85% for the next 9.5 years after I refinanced from 4.95% back in Dec 2009.

    I also trade in/out of selected securities when I find them relatively cheap/expensive, thus building up a portfolio of high-yielding assets by the percentage gained on the trades.

    So far this year, my yield is over 7% and I’ve outperformed all the major indexes by 9-10% with my additional capital gains.

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