Tag: simplicity

The Simplicity of Living off Dividends

Some people have made comments that many of my posts on this blog are not finance related, so I will make an effort to post more about ETFs and other financial topics in the future. Perhaps the reason why there are few finance topics on this blog is because living off dividends is such a simple technique that I rarely think too much about finance. The whole point of making money is so you do not need to think about money. You do not need to stress about making ends meet when you have few obligations and multiple streams of dividends flowing into your bank account.

Budgeting, tracking net worth, trading, and rebalancing are not worth it

While most people maintain spreadsheets to track expenses and net worth, living off dividends only requires you to invest all your work salary and spend your dividends. If you end up spending more than dividend income, simply “borrow from yourself” by maintaining a few thousand dollars in cash in a separate savings account that you borrow from but pay back with dividend income. Either use a spreadsheet to keep track of how much you own to yourself or ensure that this savings account has a fixed amount e.g. you have $2000 in it, run out of dividends to spend, so you “borrow” $500 to have a balance of $1500 and then when your next dividend payment comes in, put $500 into this savings account to top it back up to $2000.

I don’t recommend tracking your expenses or tracking your net worth because it is time consuming and because the information you get out of it is not valuable. If you track expenses, you can see where all your spending goes, but what matters is not what you spend your money on but how much you spend. If you spend such that your expenses are equal to dividend income, this ensures you don’t spend too much, and one of the benefits of living off dividends is that dividends increase over time as you invest more and as companies become more profitable, so there is a gradual increase in standard of living, which I think helps overcome the feeling of deprivation many feel when they are frugal. If you only spend e.g. $10,000 per year for the rest of your life, you are stuck on that level and do not feel as if you are growing or making progress, but if you live off dividends and your dividends grow, you feel a sense of personal growth. As for tracking net worth, when you diversify across multiple areas (e.g. retirement accounts, managed funds, ETFs, cryptocurrency, etc) then it becomes a huge burden to log in to each of these accounts to check the balance. What matters to financial independence is not net worth per se but passive income. You live off passive income, not net worth, and if you live off passive income then you’ll be able to assess automatically whether you have enough based on whether you are satisfied or not with your standard of living.

Because living off dividends is simple, there are only two things you need to consider: how to spend your dividends and what to invest your work salary in. Most people have no issue with figuring out how to spend their money (e.g. holidays, books, smartphones, and coffee). What to invest in is more complicated, and generally I recommend buying broad and diversified ETFs with a slightly heavier allocation towards high dividend paying ETFs (or LICs). However, more important than what you invest in, in my opinion, is the “buy and hold” mentality. You should buy with the intention of holding these investments for a long time, if not forever. I also do not bother with rebalancing. For example, in recent years the Australian stock market has underperformed whereas foreign stocks (particularly US stocks) have done very well. There are those who rebalance by selling off US stocks to buy Australia stocks to maintain a certain amount to certain countries. This is far more effort than necessary, adds administrative burden by triggering capital gains tax, and does not add much value because if you feel you have too little Australian stock, rather than sell US stock, you can simply buy more Australian stocks. For example, in recent years, as US equities has gone up, I have purchased more high-dividend paying Australian stocks and ETFs e.g. CBA and IHD.

Age in VDCO

For most people who ask, I recommend Vanguard’s diversified ETFs. You cannot beat the simplicity of these ETFs. Whatever your age is, hold that amount in VDCO and the rest you hold in VDHG. For example, if you’re 30 then hold 30% VDCO and 70% VDHG. These Vanguard diversified ETFs diversify across just about all asset classes (e.g. Australian shares, international shares, emerging markets, small caps, property, bonds, etc) so you don’t need to worry about mixing and matching. The reason why you hold your age in VDCO is to broadly follow the “age in bonds” rule, which is insurance against retiring just after a huge market crash. There are many people who are anti-bond and claim that they are a drag on performance, that stocks always go up on the long run, etc, but this is not true. In fact, this is dangerous advice. There is no guarantee that stocks go up in the long run as the value of stocks merely represent company profits and there is no guarantee that company profits will go up in the long run. Even if stocks do go up in the long run, there are huge market crash (e.g. 50% decline) that emerge, not just normal business cycles but debt supercycles that can take centuries to materialize. You do not want to be in the position of being in 100% equities and then losing 50% just before you retire as this can really set you back and impact on the quality of your retirement. Broadly following “age in bonds” (government bonds, specifically) is insurance against such a scenario. In fact, of all the rules of personal finance, “age in bonds” is, in my opinion, the most important. You can pretty much invest in any exotic high-risk asset class (e.g. emerging markets, tech stocks, robotics ETFs, cryptocurrency, etc) but if you own your age in government bonds, you are safe.

When markets go up, it is very easy to rationalize why defensive asset classes are poor quality. It is when markets go up that people easily covert to the cult of equity, but when there is a market crash or when there is a prolonged economic depression that lasts many decades or centures, many will understand and appreciate the wisdom of “age in bonds.” The reality is that when markets are booming, it’s easy to convince yourself why 100% equities or high leverage is a good idea, and the opposite is true when there is a market crash. It goes back to Warren Buffet’s quote about being fearful when others are greedy but also thinking about Ray Dalio’s idea that you must stress test your ideas because you are never be too sure in yourself  because it is easy to be moved by your emotions as well as other psychological biases.

 

 

Why I Use ETFs

I am not the only dividend investor on the internet. It turns out there are plenty more. Through Twitter alone I have found many other bloggers who blog about dividend investing, which I think is great because it allows us all to learn from each other.

What I have noticed from reading the blogs of other dividend investors is that most of them seem to invest in individual stocks, and lots of them. They may hold shares in thousands of different companies.

Most of these bloggers give monthly updates where they break down how much they receive from each share. Most even go further and report on how much they spend. They divide their spending into categories such as groceries, mortgage payment, repairs on the house, gas bills, etc.

I thought for a second maybe I should do the same, but honestly I don’t really know how much I spend, and I don’t really know how I spend it.

I also personally don’t think it’s necessary to record everything you spend down to such a minute detail. It may be great to know that for one month you spent $500 on groceries but more important than knowing what you’re spending money on is knowing how much you’re spending overall.

I believe in keeping things simple, and for saving money I recommend the David Bach recommendation, which is “pay yourself first.”

In other words, talk to HR and have them send, say, 20% of your salary into your normal bank account and then set up another bank account where 80% of your salary goes. For the bank account that gets 80% of your salary, leave it alone. Let the cash accumulate. Meanwhile, try to simply live off the money in the bank account with 20% of your salary coming into it.

By doing this, you don’t need to worry about calculating whether you have spent $x on entertainment or $y on groceries. You just know that you’re spending 20% (or whatever percentage suits you). At the end of the day, it’s how much you spend that matters, not what you spend it on.

Every once in a while, access the money in the bank account where 80% of your salary is going and then use that money to buy ETFs.

Why ETFs? Why not research and buy stocks in companies that pay high dividends?

Personally, I believe it’s much easier to invest in ETFs. There are many ETFs in the market dedicated to paying high income. These are the ETFs I recommend for dividend investors. You could do your own work, but it’s much easier to let a fund manager do the work for you and let him or her take a small fee.

In Australia, there are actively managed ETFs that use options and futures to generate more income and to manage risk by lowering volatility.

Many people believe that low cost index funds are best, and I used to believe the same, but I have noticed over time that low cost passive index funds simply don’t produce much income.

It is certainly more risky to invest in an actively managed ETF because you are relying on the skills of the fund manager, but this problem is easily fixed by simply diversifying across different income-focused actively managed ETFs.

Most importantly, I believe in keeping things simple. We don’t need to make things complicated. Having your savings automated and then simply investing your savings in high-yield ETFs is a very simple plan that allow you to build passive income from dividends without much effort. All you need to do is stay employed and maintain your 80% savings rate.

This is exactly what I did. I aimed for an 80% savings rate. However, when I started working I invested in normal Vanguard low cost index funds but was disappointed in the sporadic and low income I got, so I slowly started to put money into funds that were more tailored for income investors.

Over time, I noticed that I had enough money coming in from my investments to cover my living costs, so I instructed HR to send 100% of my salary to the bank account earmarked for savings. All my investment income is send to my normal transaction account for spending. I am therefore literally living off dividends. Hence the name of this blog. All my salary is invested and all the income from investments is spent.

Why live like this? Simply, if you learn to live off dividends, you condition your mind to live a standard of living that can be maintained even of you lose your job. This means that regardless of whether you work or not, your standard of living is exactly the same. Your life is unaffected by work, which means you don’t need to worry too much about sucking up to the manager. This takes away a lot of stress.

Most people, if they start earning more, automatically start spending more. They’ll let the money get to their head, think they deserve to spend more because they earn more, and then they become addicted to the spending and must therefore keep working, even if their enthusiasm for the job wanes over time.

If you live off dividends, you have the freedom to quit or move jobs, or take time off work to pursue other opportunities, knowing that you are capable of simply living off your investments because that’s what you’ve even doing for many years.