What’s Your Magic Number? Retirement Planning Anyone Can Do By Mark Ford

How much money do you need to retire? A hundred thousand dollars? A half million dollars? Ten million dollars?

It is a very important question. Getting the right answer can determine how soon and how well you can retire.

In his book The Number, former Esquire editor-in-chief, Lee Eisenberg talks about why “the number” is so important. He says that for most people, it represents a free pass to a great life without financial stress.

That’s what it always meant to me. When I was in my thirties, I had a number in mind. I figured that if I could achieve a certain net worth, I could quit work and live comfortably for the rest of my life. I hit that number when I was thirty-nine years old. But I quickly discovered that amount was not the number I needed… it wasn’t even close.

Your net worth includes your house, your toys, and all sorts of other assets you may not be willing to give up in retirement. But your retirement “number” is the amount of money you have to save specifically for retirement. It is a fund of assets that will eventually replace your active income and pay for your expenses… after you’ve quit your nine-to-five job.

Because I didn’t calculate my number correctly, I had to go back to work. I picked a new number–a real number–and worked another ten years to hit it. When that day arrived, I felt fantastic. I was able to change my priorities. I devoted the lion’s share of my money to non-financial goals. I never worried about money again.

Reaching your number is a great feeling. If you haven’t yet experienced it, what I’m about to say will put you on the right track…

Most people fail to achieve their retirement dreams, Eisenberg notes. There are two common pitfalls that stop them, he says:

Many people enter their forties and fifties are “ensconced in a cloud of avoidance and denial about the years ahead of them.” They spend their early years not doing any serious retirement planning. They sense they are far behind from where they should be, but they don’t want to face the truth. These are the procrastinators, Eisenberg says.

Other people do retirement planning, but they’re sloppy about it. They don’t know how to calculate their numbers correctly, so they pick arbitrary numbers and hope for the best. This is the mistake I made when I first retired. Eisenberg calls these people “pluckers,” because they pluck numbers out of thin air.

You don’t have to be either one of these people. You can begin to realize your retirement dreams today by discovering your retirement number.

Let’s do that now. Let’s figure out how much money you have to save in order to quit work and enjoy retirement.

To calculate your magic number, you need to know five other numbers:

1. How much money you have saved.

2. How many years you have to save money before you retire.

3. How much money you will need in order to enjoy the retirement you want.

4. What rate of return you expect to get on your savings.

5. The average rate of inflation.

Take These Five Steps and You’ll Have Your Magic Number!

I am going to give you five calculations. Each one should take just a few minutes. The entire process, including all five steps, should take no more than half an hour. Please do it now. In terms of your future wealth and happiness, it may be the most fruitful thirty minutes you ever spend.

But before we begin, I want you to write down two numbers: 8 and 12.5.

Step 1: Write down how much money you have already saved towards retirement. This should include not only liquid assets (such as cash, stocks, and bonds) but also any illiquid assets (such as an auto collection or a second home) that you plan to sell prior to retiring.

Sell the house you own (if you own one) for a less expensive house more suitable for retirement and add any profits from the sale into your retirement savings.

For example, if your house is worth $350,000 and you will be happy in a smaller house that will be $100,000 cheaper, you can add $100,000 to your retirement savings.

Step 2: Write down how many years you have before you hit your retirement age. If you are thirty-five years old now and plan to retire at sixty-five years old, that number is thirty. If you are fifty-five years old now and want to retire at sixty-five years old, that number is ten. But be realistic. If your retirement fund is small right now, you might have to work another five years to reach your goal.

I told you above that I hit my number before my fiftieth birthday. That allowed me to start writing fiction and poetry several hours a day… and take lots of vacations. Since I still liked my line of work, I continued to spend some time every day as a consultant to publishers. And that turned out to be lucrative.

Keep that in mind when you hit your number. Like me, you may decide to keep working on a part-time basis. If you do, you’ll be making more than you need. Enjoy it. Don’t increase your spending.

Step 3: The next step is the one most people start with: deciding how much money you will be spending each year in your retirement to enjoy the lifestyle you want.

A good way to do this is to start with how much money you are spending now on your current lifestyle. I told you how to make that calculation in an essay I wrote a few months ago, titled Three Numbers that Are Essential to Your Wealth. I called that your lifestyle burn rate. What you are doing now is figuring out your retirement lifestyle burn rate (RLBR).

Take your current lifestyle burn rate and add to it any “extras” you want to enjoy. Let’s say, for example, that your current lifestyle burn rate is $80,000 a year. To make your retirement more fun, you want to own an extra car–a sports car–and join a golf club. This will cost you an extra $10,000 a year. Add $10,000 to the $80,000 and you have $90,000.

Now subtract from $90,000 any expenses that you currently have but will no longer have when you are retired. This commonly includes expenses for your children and other expenses related to having a family with children. If those expenses are currently $15,000, then you will deduct that $15,000 from the $90,000 and you will be left with your true RLBR of $75,000 a year.

Got it?

One caveat: In determining your retirement lifestyle burn rate, you have to be realistic. If you are already fifty years old, have only $300,000 in your retirement savings account, and are currently spending $80,000 a year to live… it’s unlikely you will get your RLBR up to, say, $500,000.

Step 4: Subtract from that number (RLBR) any income you are confident you’ll be getting during your retirement.

For example, if you trust that Social Security will still be around when you retire, you can find out what your projected yearly Social Security income will be and subtract that from your RLBR. You can do the same with any pension income you expect. And finally, if you intend to work part-time during retirement, you can deduct that, too.

Working with the same $75,000 RLBR number, you deduct $15,000 a year you expect to get from Social Security, another $5,000 a year you expect to get from some pension, and another $5,000 a year you expect to get by working as a golf ranger two days a week. This reduces your RLBR from $75,000 to $50,000.

This is your net retirement lifestyle burn rate. Save this number.

Step 5: Now it’s time to figure out your magic number, the amount of money you need to save in order to retire.

Using the same example, what we are looking for is an amount of money to invest that will generate $50,000 a year in after-tax income.

So how much money is that?

Again, that depends. It depends on the return on investment you can expect to get on your retirement savings.

If you expect to get only 5% on your money, then your number–the amount you’d need to save before retiring–would be $1 million. (One million dollars generates $50,000 a year at 5%.) If you could get 10% on your retirement funds, you could retire much sooner… since you’d need only $500,000 at 10% to generate $50,000 in annual income.

So what rate of return should you plug into this equation?

That depends on what kind of investments you use. If you put all your money in municipal bonds, you could be making 3%. (Municipal bonds are yielding only 3.13% today.) You could earn about 8% by putting your money in stock index funds (since 1970, they have returned 8.14% after taxes of 20%), but I don’t like the idea of having my retirement fund in an index fund because the stock market can fluctuate greatly from year to year.

There are stocks that might give you–at minimum–an 8% after-tax return. But I wouldn’t want all my retirement funds in stocks, because even the best of them are still subject to annual fluctuations.

To compensate for the temporary low yield of municipal bonds and the volatility of the stock market, I’ve designed a simple three-asset portfolio that should give us 8% reliably and steadily. Or as close to that as one could possibly hope for.

A Sample Retirement Portfolio Strategy

I’m thinking of a portfolio consisting of high-quality dividend stocks, high-yielding bonds, and rental real estate.

Specifically, I would recommend an allocation of 50% rental real estate, 30% dividend stocks, and 20% high-yielding bonds.

In future essays, I’ll talk in more detail about how I came up with these calculations, but I feel confident that you can expect the following after-tax minimums from each of these portfolios: 3% from bonds, 6% from dividend stocks, and 12% from rental real estate.

A portfolio that gave you 3% on 20% (your high-yielding bonds), 6% on 30% (your dividend stocks), and 12% on 50% (your rental real estate) is a portfolio that will give you just over 8% overall.

The Final Step: Now we are ready for the number. To figure out your number, take the net RLBR and multiply it by the reciprocal of the expected rate of return. These are the numbers I asked you to remember in the beginning of this essay: 8 and 12.5.

Using the same example, you would multiply the $50,000 (net RLBR) times the reciprocal of 8%, which is 12.5. Fifty thousand dollars times 12.5 is $625,000. That is your magic number!

So if your net RLBR is $100,000, then your magic number is $1,250,000. If your net RLBR is $300,000, then your magic number is $3,750,000.

Get it? Just multiply the income you will need by 12.5.

In case you are lost, let me break it down for you again using the original example. The following is just an approximation…

You need $50,000 a year from your retirement savings. Knowing you can expect to get an average yield of 8% a year, you do the math and determine that you need a total of $625,000 in your retirement savings portfolio. Twenty percent of that amount ($125,000) would be in bonds yielding 3% after taxes. That would give you $3,750 a year. Thirty percent ($187,500) would be in dividend stocks yielding 6% after taxes. That would give you $11,250. And 50% ($312,500) would be in rental real estate yielding 12% after taxes. That would give you $37,500 per year. The total of $3,750, $11,250, and $37,500 is $52,500.

Now remember, that is the minimum. If you got higher yields–even moderately higher yields–you’d do better. You will have more income than you need that year. You will have a choice: either save it for a rainy day or spend it. You won’t need to save it, as your retirement fund will continue to produce 8% yields.

I’d like to end here, but there is one final number we haven’t looked at yet… And that is the rate of inflation.

When planning for your retirement, you have to consider the effects of inflation on the value of your portfolio. That’s because in most cases, inflation makes future dollars less valuable than they are today. The $80,000 a year we’ve been using in this essay, for example, will still be $80,000 in ten, twenty, or thirty years… but it will buy far fewer things than it can buy today.

So how do you account for that in your planning?

One way is by owning businesses that keep pace with inflation because they are able to raise their prices to match inflation. Many of the stocks we recommend in our portfolio are of that kind. Having 20% of your portfolio in such stocks will definitely help.

Bond yields should increase in the years to come as well. Today, they are low… and our plan is based on a 3% yield. But these are likely to increase in the years ahead. So that will be some help, too.

But the main inflation hedge you have in the portfolio I recommended is the rental real estate portfolio. Real estate, as a tangible asset, appreciates during inflationary times. According to The Case Shiller Index, which has tracked real estate sales of existing homes since 1987, the average annual increase for real estate is 3.6% over this 25-year period. Compare that to the reported Consumer Price Index during the same period at 2.9%.

I didn’t count this appreciation into the mix when we went through the numbers. That means that half of your portfolio will likely increase by 0.7% above inflation, not counting the positive effects you might get from your stocks and bonds.

More importantly, as a landlord, you should be able to increase your rent to match with inflation. I’ve been doing that with my rental real estate portfolio for more than twenty years.

These factors should go a long way towards protecting the validity of your “number.” But if you want to be extra sure, you can simply use a multiplier of more than 12.5–just to be sure. In the case of our existing example, you would multiply $50,000 by, say, 14, which would increase your number to $700,000 rather than $625,000.

Again, I feel safe using 12.5 as a multiplier (for the reasons I mentioned)… but if you have twenty, thirty, or forty years to go before retirement, then you might want to use 14.

I know this may not been the most exciting essay you’ve ever read. But in terms of your retirement planning, it may be the most important.

Please take the time to do your calculations today. The moment you have your number, you’ll be motivated to begin the journey of achieving it. The sooner you begin, the sooner you can retire.

How I Avoided the Investment Mistakes That Crippled My Friends and Colleagues By Mark Ford

Maybe I’m lucky.

Or maybe it’s just common sense.

I’ve been involved in the investment advisory business for thirty years. And except for a few early mistakes buying real estate, the big financial hoaxes and bubbles that devastated so many investors never burned me.

That made a huge difference over time. It allowed me to grow my net worth year after year without a single year of loss. In this essay, I want to identify several lessons I learned, and how to avoid the biggest mistakes average investors make.

The financial life of the typical investor is marked by a plethora of hopeful speculations. Only a few dozen, at best, achieve their promise. My investment history is less exciting but more profitable. I get into trends only after they are proven, I get out as soon as they don’t make sense, and I turn my back on nine out of ten opportunities that come my way.

In the 1980s, I worked for a publishing company that produced, among dozens of other financial publications, two publications that promoted penny stocks. Penny stocks were the rage back then. The financial press was full of stories about investors who got rich by buying little-known companies at fifty cents a share. My boss invested in one and tried to convince me to do the same. I was tempted. But something inside of me told me to let this bus pass me by.

I’m glad I did. My boss, a very savvy investor, lost 100% of his money on that deal. It turned out to be a scam. I remember thinking that if a sophisticated investor can be fooled by one of these cheap stock deals, I’d stand no chance.

Five or six years later, technology companies were hot. Again, the press was filled with exciting stories about all these great little companies going public. The technology sector was bigger and more legitimate than the penny stock market. And that turned out to be a problem. The success of early investors led to millions of ordinary people climbing on board. And many of them were making big profits. I remember my brother-in-law coming over on weekends and telling me, over a beer, how much money he was making.

Again, I was tempted. When you see people–people who know next-to-nothing about business–making profits month after month, you think, “Hell, if they can do that then so can I!”

I remember one deal that my brother-in-law recommended. It was a company that had a “patented” method of expanding some gizmo related to computer memory. He showed me the newsletter story about it. It explained how every major computer manufacturer in the world would soon use this new technology. It hinted that a “major deal” was pending with one of them.

I asked my personal assistant to get me the prospectus. And although I was a novice at reading them, I could tell right away that it was hardly a sure thing. Other than the president, whom they appeared to have recruited as a figurehead (and who had only a small stake in the business), the rest of company’s honchos were brokers and dealmakers, not proven entrepreneurs. The “use of proceeds” was actually scary. There was too much money allocated for offices, employee salaries, and “consulting fees.” What I wanted to find was a believable marketing plan–something to make me believe they knew how to sell their product at a profit. If you have had any experience in buying businesses, then you know one thing: a start-up business must devote 80% of its resources to creating the first profitable sale. That means it must be frugal with office expenses, salaries, and other non-essential start-up costs.

This company clearly had another plan. It was to make and spend a lot of the funding on everything but investing. I didn’t need to know more than that. I decided not to invest and warned my brother-in-law to sell his shares. I don’t think he did, because when the company went bust six months later, he never said anything to me. Investors love to brag about their winners, but they keep their losers hidden in the closets of their minds.

Flash forward another five or six years. My brother-in-law was back again with exciting new stories about making money from the internet boom. Again, he told me amazing stories. And again, I looked into a few of them, hoping to find something I could believe in. But the prospectuses for these dot-com companies were just as fishy as the high-tech offerings I had seen earlier. No, they were worse. The valuations were based on a method of selling that had never existed before: advertising fees based on “eye balls.”

Do you remember that?

Forgive my skepticism, but I can’t get myself to put my money down on business ideas with selling strategies that have never worked for anyone. The idea that you could invest billions of dollars attracting people to websites and then profit by selling ads in those websites seemed positively bizarre to me.

As it turned out, most of the investors in the internet boom fared no better than investors in the high-tech frenzy. There were some exceptions, but they were few and far between. My skepticism may have blinded me from a few good opportunities, but it prevented me from losing big money on hundreds of deals that went bust.

And then finally, five or six years later, we were in a real-estate bubble. By that time, I had been investing in real estate for more than ten years. I knew the game. I had made a lot of money.

But by 2006, the houses I had been buying were selling for twenty times their yearly rentals. (A single-family house that could fetch $15,000 in a yearly rental was selling for $300,000-plus.) I knew it was time to get out. I stopped buying and advised my friends to do the same. They thought I was crazy. I’m sure they wish they had listened to me now.

I don’t want you to think that I kept my money in the mattress during these bubbles. In fact, I made millions by investing in private companies that I could understand and control. I got in when the economics were good. And I got out the moment they were bad.

I’m telling you these stories not to brag, but to illustrate an important point: you don’t have to be a sophisticated investor to avoid making big investment mistakes. You can do so by applying a little bit of common sense.

Looking back on these experiences, I can see now that the biggest mistakes most investors make are simple ones–ones that any person with a modest amount of business experience should be able to avoid.

What follows is a list of the five biggest mistakes most ordinary investors make:

Mistake #1: Being swept away by exciting stories.

The business my boss got suckered into had an amazing story. A company in Central America was turning beach sand into gold. The company had “proof” of their success in the form of audited financial statements, geologist reports, and endorsements from investment experts. My partner even went down and saw the operation. He saw the sand going in and the gold dust coming out.

I didn’t invest because the story sounded so fantastic. I remember telling him, “This sounds like alchemy.” I didn’t know anything about geology or gold, but I didn’t need to. The story itself was just too crazy. When I hear stories like that nowadays, I am totally turned off. One part of my brain might get excited, but the smarter part tells me, “Stay clear!”

Mistake #2: Investing in businesses you don’t understand.

My boss was a sophisticated investor. He had his own seat on the stock exchange when he was in his twenties and had been successfully investing since that time. But he knew nothing about gold mining. Nothing at all. His ignorance allowed him to be duped by the reports and by the fraudulent factory tour. The scam was exposed by a few people who were in the mining business. They understood the industry and they knew how to read reports with the sophistication of experience.

If you don’t understand the business you are investing in, then you are investing blind.

Mistake #3: Allowing yourself to be bullied by good salespeople.

I mentioned that early in my real estate career, I made some bad investments. Those were due to a combination of the two mistakes I just enumerated, plus I buckled under pressure from a real estate broker who also happened to be my landlord and, I thought, a friend.

I agreed to make the investments even though I had a hunch they wouldn’t work out. I ignored my instincts because she was so good at manipulating me emotionally. Nowadays, whenever someone tries hard to sell me something, I take that hard selling to be a signal: stay away!

Mistake #4: Investing in trends too late–when the only chance of making money is to find “the bigger fool.”

I got into real estate investing at a good time, when prices were already going up but also when the values were still very good. I made a lot of money as the market rose, but when I could no longer buy properties at eight or ten times yearly rental… I realized the only way to profit was to ride the bubble to the top.

But riding a bubble when the economics are bad is a fool’s game. Your only chance of winning is to find someone else willing to buy you out, who knows less about the market than you do. Insiders call this “the bigger fool theory.” You would think anybody with common sense would not fall victim to this impulse, but millions of Americans (including bankers and brokers) did.

There is a time to get into a trend and a time to get out. Neither is that difficult, so long as you pay attention to the fundamental economics of the deal and ignore the excitement caused by the bubble.

Mistake #5: Investing without a way to limit your losses.

Sometimes, even if you use your common sense and avoid the four mistakes I’ve already explained, you can lose money because something entirely unpredictable happens. To avoid this, I have a rule that I never get into an investment unless I have a way out.

When you are investing in a business deal, that way out might be a buy/sell agreement. When you are investing in real estate, it is the income you can get from renting it if you can’t sell it for any reason. When you are investing in stocks for yearly gains or income, it is the trailing stop loss. There is always a way to limit your downside–so long as you identify what that is before you make the investment and stick to it, even if you feel like you shouldn’t.

So those are the five biggest mistakes ordinary investors make. As you can see, they are all pretty obvious–the kind of mistakes that you can avoid by applying common sense.

David Nicholson Queensbury

My last year in High School was 1974 and one of my friends then was Frank Reay, Esq. Frank and I still keep in touch today and he often sends me poignant emails. The following passages are from one Frank sent about Regina Brett who is 90 years olde and her philosophies about life. Regina once wrote…”To celebrate growing older, I once wrote the 45 lessons life taught me. It is the most requested column I’ve ever written. My odometer rolled over to 90 in August, so here is the column once more”:

1. Life isn’t fair, but it’s still good.

2. When in doubt, just take the next small step.

3. Life is too short to waste time hating anyone. Change the way you think.

4. Your job won’t take care of you when you are sick. Your friends and family will. Stay in touch.

5. Pay off your credit cards every month.

6. You don’t have to win every argument. Agree to disagree.

7. Cry with someone. It’s more healing than crying alone.

8. Release your children when they become adults, it’s their life now

9. Save for retirement starting with your first pay cheque.

10. When it comes to chocolate, resistance is futile.

11. Make peace with your past so it won’t screw up the present.

12. It’s OK to let your children see you cry.

13. Don’t compare your life to others. You have no idea what their journey is all about.

14. If a relationship has to be a secret, you shouldn’t be in it.

15. Everything can change in the blink of an eye.

16. Take a deep breath It calms the mind.

17. Get rid of anything that isn’t useful, beautiful or joyful.

18. Whatever doesn’t kill you really does make you stronger.

19. It’s never too late to have a happy childhood. But the second one is up to you and no one else.

20. When it comes to going after what you love in life, don’t take no for an answer.

21. Burn the candles, use the nice sheets, wear the fancy lingerie. Don’t save it for a special occasion. Today is special.

22. Just because you believe you are right, doesn’t mean you are. Keep an open mind.

23. Be eccentric now. Don’t wait for old age to wear purple.

24. The most important sex organ is the brain. So keep it working

25. No one is in charge of your happiness but you.

26. Frame every so-called disaster with these words ‘In five years, will this matter?’

27. Always choose life.

28. Forgive everyone everything.

29. What other people think of you is none of your business.

30. Time heals almost everything. Give time.

31. However good or bad a situation is, it will change.

32. Don’t take yourself so seriously. No one else does.

33. Believe in miracles.

34. Your job is to love your children, not choose who they should love.

35. Don’t audit life. Show up and make the most of it now.

36. Growing old beats the alternative — dying young.

37. Your children get only one childhood.

38. All that truly matters in the end is that you loved.

39. Get outside every day. Miracles are waiting everywhere.

40. If we all threw our problems in a pile and saw everyone else’s, we’d grab ours back.

41. Envy is a waste of time. You already have all you need.

42. The best is yet to come…

43. No matter how you feel, get up, dress up and show up.

44. Yield..

45. Life isn’t tied with a bow, but it’s still a gift.”

David Nicholson Queensbury

2. When in doubt, just take the next small step. Written by Regina Brett, 90 years old.

David Nicholson Queensbury

1. Life isn’t fair, but it’s still good. Written by Regina Brett, 90 years old.

Your New Year’s resolution in 12 steps – not 12 months

Change is hard. Unlearning a bad habit or practicing a new one takes time, patience, self-kindness, and a plan.
Every January, gyms and yoga studios overflow with well-intentioned folks trying to make their New Year’s resolutions reality. Soon enough, though, the crowds dwindle, and many a resolution has been snowed under by stress or crazy-high expectations.

But it might not be the resolution that’s to blame: it might be your approach. Change is hard. Unlearning a bad habit or practicing a new one takes time, patience, self-kindness, and a plan.

Pick one. People resolve to change habits. But it’s hard enough to change just one, let alone 3 or 5 or 10. We should resolve to change one habit. Picture or list your priorities and put a big circle around the one that matters most to you right now.

Pick small. A big-picture goal is good but tough to achieve. Shrink your ambition to a size you can visualize clearly.

Visualize it. Begin at the end, not the beginning. See where you want to be at the realization of your goal, who you want to be and what you want to do once you get there.

Ask yourself why. Why do you want to lose weight? Is it so you’ll feel more energy? Why do you want to cut out caffeine? Is it so you’ll have fewer headaches? Why do you want to spend more time with friends? Is it because you need to laugh more often? Give yourself an answer to your question. A goal finds its meaning in the tangible effects it causes, not in the goal itself.

Map out obstacles. Know that bumps rise up on any road. How will you keep trucking? Take a new route to your goal? Repave the road? Drive right over it? When you resolve to exercise more, a day will come when you’re forced to skip your workout, for whatever reason. When that happens, don’t hit the brakes. Sneak in a walk around the block. Go to the very next session you can make it to. Or say no to the other commitment and head to the gym.

Name your muse. Think of someone or something that inspires you in a way that relates to your resolution. If you want to get more writing done, think of your most admired author. If you want to organize your home, think of your best friend from university who had the super-efficient 10×10-foot dorm room.

Train. Enlist an expert to help you rehearse your resolution. If fitness is your goal, sign up with a personal trainer before you try it on your own. Before you toss out your last pack of cigarettes, talk to your doctor or to your friend who quit smoking last year.

Start. Think like a baby: First steps are the hardest, but you take them because what else are you going to do? Toddle, fall, pull yourself up on the coffee table – just start!

Make it public. Now that you’ve begun, tell someone. It might be your partner, your kids, your best friend, or the readers of your personal blog. Tell the world you have a goal in mind and they’ll support you when you need a boost.

Do swaps. Faced with the challenge to change, you can replace an undesired habit with a new, healthier one. Swap a smoke break for a walk with a coworker. Switch off that reality TV show and spend time with your kids before bed. Type an email to a friend instead of biting your nails.

Play up positives. Give yourself permission to celebrate small victories. Notice when you get it right. Let your support system know, too. It’s less fun giving yourself a high-five, after all.

Pace yourself. You’re on a path with its own distance and its own twists and turns. Just because it’s called a New Year’s resolution doesn’t mean you have to complete it ASAP or even by the time the calendar turns to December.

Source(s):© McNeil Consumer Healthcare, division of Johnson & Johnson Inc. 2010

Choices

Sometimes there’s just nothing better than a Dilly Bar or a Coca Cola Float for Saturday Morning Breakfast…today I’m gonna have both!

Great Quote

“The best way to keep money in perspective is to have some.” – Louis Rukeyser

Lessons From The Trenches

The First-Ever Dividend

Peter Hodson

This is my first article for Canadian MoneySaver. I recently left my position as chairman of Canada’s largest hedge fund company to start up an independent stock research company called 5i Research Inc., which provides company research for individuals, not institutions. But enough about me, this column is about investing.

For my first contribution to MoneySaver, I thought that I would highlight some of the major investment lessons I learned over almost 25 years as a portfolio manager and analyst. Pushing 50 now, I don’t think I’ve yet “seen it all”, but it’s hard to imagine what else the markets could possibly throw at investors to surprise us. I’ve survived: the 1987 market crash, the 1991 real estate crash, the 1997 Long Term Capital hedge fund crisis, the 1998 Asian crisis, the dot-com boom and bust, Y2K worries, the 2001 recession and terrorist attacks, the cheap-credit bubble, the 2007-08 credit crisis, Lehman Brothers’ bankruptcy, the Flash Crash, numerous wars, epidemic scares (SARS, H1N1, bird flu and countless others), the U.S. housing collapse, Japan’s decline and China’s growth.

Through all of these events I’ve learned that a crisis is indeed bad, a crisis always ends, investors panic unduly, and good companies are always good companies, good times or bad. Every time there is a crisis, investors re-discover the fear of the unknown. As investors, of course we do not know when the current crisis – whatever it may be – is going to end. The problem, though, is that investors act as if the crisis will NEVER end. They sell on the belief that prices will keep going down, wars will keep going forever, or a small flu scare will run amok and take over the world like in the new movie Contagion. Twenty-five years in the business, though, has at least taught me that a crisis always does end. It is painful, sure, but end it does. In the 2008 credit crisis, for example, S&P reported than more than 1,100 companies actually traded below their net tangible cash balances. Investors were so scared, effectively, that they were willing to give away cash, literally. At the time though, because of money market problems, it looked like cash wasn’t even worth anything. When the next crisis hits – and there most certainly will be one again some day – keep in mind that it will end, either sooner or later. If you have some time and some liquidity in your portfolio, then hang on to your good companies, or buy more shares of the good companies. Stay calm, and let the other investors panic into giving away quality companies.

The Single Best Idea

The single best investment theme I can provide after 25 years is this: When a company declares its first-ever dividend, pay attention. Buying first-dividend payers has provided me and the portfolios I ran so many gains that if I were to do only one thing in the future, it would be to scan the world for companies initiating dividends. A first dividend tells you so many things: the company is doing well, the company has excess cash, and the company’s board respects shareholders and probably owns lots of shares themselves. In addition, a first dividend is only done after careful consideration by the board of directors, and its initiation likely means many years of steady, if not rising, dividends. Two companies that recently initiated their first dividends are: Primary Corporation (PYC on TSX, yielding 5.5% right now) and DSW Inc. (DSW on NYSE, yielding 1.3%). DSW also decided to pay a special $2 per share dividend at the time it declared its initial $0.15 quarterly dividend. The result: the stock is up 89% over the past year.

Another lesson learned over the past two-and-a-half decades is to try to avoid listening to the mainstream financial media, especially if you are trying to act rationally. As you know, bad news sells more newspapers and gets more viewership on TV. When the stock market plunges, it always gets more attention than when it goes up. TV commentators, in particular, get all excited and breathless in a market decline. Thus, as a reader (or TV viewer), you might think that a market drop is more important than a market gain. It’s not, though, unless you are a buyer. A market decline typically only represents an event in the macroeconomic environment. It is often due to portfolio managers simply changing their asset allocations, and has absolutely nothing to do with a strong company’s performance. In other words, good companies stay good companies, despite a 2%-5%-10%-20% market drop. Don’t let the media convince you to sell a good company.

It Pays to Be a Cynic

A similar investment lesson involves brokers and research analysts. In my cynical viewpoint, changes in brokers’ recommendations and target prices are designed to do only one thing – generate trading activity. For the life of me, I don’t know why an analyst would put out a price target on a fast-growing company. If the company keeps growing and/or the market simply goes up, your price targets are meaningless. Let’s look at a few laughable analyst targets from the past: RBC Capital Markets had a $31 target on the Bank of Montreal stock in 2009, during the last stage of the financial crisis. With BMO stock at $28 at the time, you as an investor might have sold at the $31 target, missing out on an additional $28 per share gain to today’s price, and more than 5% annual dividends along the way. Or how about Netflix – Credit Suisse told investors to sell the company, with a $31 target price in January 2010, well after the financial crisis ended. Eighteen months later Credit Suisse’s target price was $310, and they wanted you to buy it. I don’t want to pick on analysts, but this does highlight the limitations of recommendations and target prices.

Rather, instead of acting on recommendations or target prices, I’ve learned you should try and buy good companies, and keep your shares until you need the money or they cease being good companies. Finally – for this piece at least – the last lesson I can share with you is to watch out for conflicts. Everyone, it seems, makes money in the investment business, except the individual investor. Advisors earn fees, investment bankers earn fees, fund managers earn fees, traders earn fees, and analysts get bonuses. Whenever someone is paid, the potential for conflict exists. I can’t tell you how often I met a company management or research analyst who extolled the virtues of the company, only to get a phone call a few days later asking me if I wanted to participate in a financing for the company. Now, was the management team or analyst saying good things so I would buy the deal? How much does the broker make in commission off the deal? What’s the investment bank charging the company? How much is the analyst’s bonus? With such a conflict of interest, I basically learned never to trust anyone. It was a cynical environment, but saved me and my investors tons of grief. Anyway, I’ve discovered over the years that the best companies to invest in are those that need no money, and get no attention. But that’s an article for a different day.

Peter Hodson, CFA, Head of research at 5iResearch Inc, an independent stock research company, research@5iresearch ca, www.5iresearch.ca Canadian MoneySaver z https://www.canadianmoneysaver.ca z october 2011

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