Sunday, July 14, 2013
Which Is Riskier - 1 Paycheck Or 50 Paychecks?
There is a lot of confusion and fear over investing in the stock market. Although I consider myself an intelligent investor these days, there was a time not long ago that I was a total idiot with money and I certainly thought there was some mysterious voodoo surrounding the stock market. Fear holds many of us back, even when the reasons for fear aren't really based on facts, but rather self-contrived notions.
One particular notion of fear that I hope to dispel today is that investing in a large basket of high quality dividend-paying companies is somehow riskier than continuing to rely on one source of income for all of your needs - your day job.
As always, I like to use myself as an example. Perhaps this is anecdotal in nature, but I'm a regular guy with a middle class job and I think that's easy to relate to for many. I work a little over 50 hours per week, earn close to $60,000 annually and although I've now saved and invested my way to a six-figure portfolio, this job still provides me with most of my income. However, what I'm attempting to do is replace the necessity for this income by investing the excess capital my frugal living skills allow into high quality income-producing assets via dividend growth stocks. This plan will allow me to then own all of my free time for myself, with which I can spend how I please.
But isn't it extremely risky to rely instead on a basket of high quality companies to send me money so that I can pay my bills rather than just continue to work at my job so I can earn a paycheck? Umm, in a word, no.
If you rely solely on your job for your income needs you're actually putting yourself in a high-risk situation. Your income comes from just one source. What happens if you can no longer work due to an unexpected life situation or illness? What happens if your employer decides your services are no longer required? What happens if your employer goes out of business? Well, in these cases you lose your only source of income. Unless you have other income sources, you'll be in a bad financial situation in a hurry.
However, my plan doesn't rely on one source of income. By the time I'm done, I'll likely own a piece of 50 different high quality companies, and these companies will send me out quarterly or semi-annual "paychecks" which will very likely rise annually over the rate of inflation (more than I can say for many jobs I've had in the past). Why do they send out these checks? These dividend payments are a percentage of the profit these companies generate, and they send me this portion because, well, I own a piece of the company. It's great being the owner!
The great thing with my plan is that risk itself, and fear along with it, is spread out among many companies, rather than just one. If your day job decides to discontinue your employment you're out 100% of your income if this is your only source of cash flow. However, if one of the 50 companies I'll eventually be invested in decides to suspend the dividend or otherwise runs into financial hardship, I'll only lose 2% of my income (assuming equal weights). 100% vs 2%. Which is riskier? Not only that, but because of the dividend raises I was talking about earlier, I'll likely not even see a 2% loss of income. 49 dividend raises will quickly erase whatever pain I might have felt.
There was a time just a few years ago I couldn't imagine investing in the stock market because of the perceived risk it entailed. Now I can't imagine NOT investing in high quality companies that pay out rising dividends, because of the risk it entails to have all of my eggs (my income) in one basket (my day job). Spread those eggs out, reduce your risk and conquer your fear. You'll be better off for it!
How about you? Have you conquered your fear? Enjoying the freedom of reduced risk?
Thanks for reading.
Photo Credit: David Castillo Dominici/FreeDigitalPhotos.net