Thursday, August 29, 2013
Interview With Derek Foster, The "Idiot Millionaire"
While some of you may not have heard of Derek Foster before, he's fairly well known in Canadian circles as someone who escaped the rat race extremely early in life, and became "Canada's Youngest Retiree" by retiring at 34 years old. He then went on to write a number of books that showcase his early retirement strategy - investing in high quality dividend stocks. He's been espousing this strategy ever since. He now spends a lot of his time running a newsletter and also produces a video series that highlights changes to his stock portfolio.
Derek started saving money right out of college and started rolling this surplus cash flow into dividend-paying stocks. Derek had some luck on his side along the way, as retiring that early in life almost requires it. But he also worked incredibly hard and stayed persistent.
Derek recently contacted me and we exchanged a few emails and he was kind enough to answer some questions I've always wanted to ask him. To be quite honest with everyone, Derek was actually an inspiration for me right from the start. I read his story early on when I was first researching dividend growth investing and early retirement after his name came up from a Google search. I thought if he could retire at 34 years old on a modest income, there was no reason I couldn't retire early as well (even though I was starting at almost 28 years old).
Derek has been retired for years now, even with a large family to support (he has six kids). So, Derek definitely knows a thing or two about early retirement and investing.
What you see below is what I believe to be a great interview with someone who shares my vision on what life should be and how one best gets there. While he lives in Canada and had some high-yielding trusts to propel him early on, the basic premise is still the same. I hope you readers enjoy!
Q: Tell us a little about who you are and how you got started. What got you interested in investing? How young were you when you began saving and investing in dividend stocks?
As a kid I played games like Monopoly a lot and was interested in investing in general and I gradually became interested in the stock market. I started out investing in mutual funds when is was a teenager, but quickly realized that the fees were reducing my returns so I started looking at buying stocks directly. I started by saving $200/month while in university as well as any additional money (such as income tax returns, etc). Even when I could not get a good job in the early 90s (the Canadian economy had a long recession, sort of like the US recently) I still made saving money a priority. So when I spent a year travelling in Australia and New Zealand, I made sure I first put aside $2,400 ($200 x 12 months) for savings before taking off -all saved from a crappy retail job I had at the time.
Q: I believe that one's ability to save outweighs their ability to get outsized returns on their investments, meaning living below your means is much more important than seeking big returns in the market. Do you share this view, and if so how is frugality a part of your life?
I think there are three important variables to escaping "wage slavery". First (and agreed most important), spending less than you earn. I went to university in the same city I lived in, so I stayed at home and kept costs down and graduated without any debt (and debt is really the chains that keep people financially enslaved). I worked some really crappy jobs which I hated, which made me really focus on creating a passive income stream through investing in dividend-paying stocks. I was very frugal, only splurging for travel. I did backpack in Europe one summer and travelled (and worked) in Australia for a year (life should be fun, especially in your 20s), but I ALWAYS saved some money along the way.
The second variable is to become an investor instead of just being a saver. If you work and save and then just stick all your money in the bank, it will be VERY HARD to become financially well-off because although you might have the discipline to work and save, your money is not working for you (it's working for the bank making the bank money)!
Third, it's important to invest that money properly. When I started, mutual funds were all the craze and I followed the crowd. But after some research I realized the fees were stealing from me so I decided to invest for myself. And with investing for yourself, I found one should look for QUALITY companies that are stable with long histories and dividends. Too many investors treat the stock market like a casino trying to earn huge windfalls quickly - but that approach tends to wipe out your efforts of saving because in many cases you simply lose your money!
Q: I understand you've been retired for about nine years now, living off the dividend income your investments provide. And you also have a fairly large family to support. Have there been any major surprises along the way? A lot of naysayers say it's impossible to retire young and live off dividend income. Do you believe you've proved that theory to be wrong?
My wife and I have 6 kids, so that's a pretty big family these days. I left the rat race at 34 and so far things have been great. The biggest surprise was that I had to tweak my investment approach a little bit. Back in the late 1990s, everyone wanted to buy the proverbial "lottery tickets" in the stock market - dot-com stocks! This insanity led to certain investments being very cheap because investors were only focused on high tech stocks and ignoring the boring stuff which drove down their stock prices creating an opening for investors.
In Canada, there were investments that paid very lush (and safe) dividends called income trusts (I think these are similar to your Master Limited Partnerships in the US, but I could be wrong). Anyhow, I bought some REITs, Pipelines, Utilities which were yielding between 10-13%! (and the yields were in many cases growing at 4-5% per year)! But most investors did not care about these high dividend because they were more interested in hot IPOs which could gain 100% in a single day! This was like manna from heaven (cheap stocks with high yields), until the government altered the tax rules as they related to income trusts in late 2006. For a while I simply held on, but over time I began to understand the impact these changes would make on these investments and had to shift more into dividend-growing stocks. For the naysayers, I still get people who tell me it's not possible (even after I've already done it), but that is the way the world works - there are some people who disagree with everything so you just ignore them. I had a lot of determination, but a dash of luck helped too - but without the luck component, I still would have retired early, just not quite as early...perhaps by 40?
Q: You are a Canadian citizen, correct? Are there any major differences that Canadian investors face when approaching a dividend investing strategy?
I think Canada and the US are similar in a lot of respects (rule of law, mostly capitalist economies, high standards of living). The difference is the size of the economies and global growth potential. In Canada there are some industries with cozy little oligopolies (banking, integrated oil, pipelines, railways, communications) which make a lot of money for shareholders and offer returns similar to the best US companies, but with mostly growth only within Canada. They can make good profits because their margins are higher in many cases, but their growth is somewhat limited. This is a big reason I own a lot of US companies such as Coke, P&G, JNJ, etc - I have been in many countries and have also spent time in Asia and these brands are growing there! So I have to ante up a 15% withholding tax on the dividends to own these shares (regardless of my annual income), but that "entry fee" still seems worth it to me even though the Canadian taxation on dividends is more advantageous for Canadian investors.
Q: You hold a fairly sizable portfolio, and quite a bit of it is invested in American stocks. Do you have any particular favorite U.S. companies for the long haul? Any U.S. stocks that you're interested in right now at current prices?
It's hard to pick one "favorite" stock. In my book, "The Idiot Millionaire" I listed 50 or so "idiot-proof" stocks that have great histories. I look for companies simple enough to be explained by any 6-year-old using a crayon because I am not smart enough to understand some companies (like tech stocks) so I simply avoid them. But something like Colgate (which has paid dividends since the 1890s) makes sense to me. I mean what would have to happen to encourage you to stop brushing your teeth? I look for companies that have a competitive "moat" as Warren Buffett has explained.
So for example, I own shares in UPS - what a great moat. A few years ago a huge package company (DHL) took a run at the US package market but pulled back a few years later because they weren't as successful as they thought they'd be (even though they dominate the European market). If an already huge package company can't move into UPS's turf, how in the world can an upstart? How long would it take a company to build up the trucks, routes, distribution centres, etc to match a UPS or FedEx? How much money would they have to lose while building up their networks and operating at a loss as the cost of the infrastructure is HUGE? Their main competitor is the USPS (post office) which is in decline where UPS can gradually take business. Talk about a moat! Also think of this, most of UPS's cost are fixed costs. The infrastructure. So if a truck carries one additional package and charges $40, almost the entire $40 moves to the bottom line (revenue becomes income) once they have the volume to cover the fixed costs. This is how companies can increase revenue by let's say 2% but increase earnings by 10-12% at the same time! Companies like that will do well for investors over time!
Right now I don't see huge value in the market, but I do an online video series where I detail my portfolio and explain why I bought certain companies and the price I paid. I also offer free updates from time to time. So for example, in my first update back in January a company that dominates the Canadian coffee market (Tim Hortons) was cheap so I bought some shares. This company has opened some stores in the US with mixed results, but even if they only operate in Canada, coffee is an addictive product that is cheap to produce which generates large profits. Since that time, the dividend was increased almost 24% but the shares are up over 20%. It's still a great company, but not cheap like it was...so I will slowly wait for opportunities which will probably be company-specific.
Q: I remember reading that you sold your house and bought an R.V so that you, your wife and your six children could travel for a year. How was that? That sounds really amazing. That's the kind of adventure that a lot of us still stuck in the rat race dream of, right?
It was a lot of fun. First we went out west in Canada and then headed south into the US as the weather got colder. We stopped in Las Vegas of all places and then headed gradually east through Arizona (the Grand Canyon), New Mexico (Roswell for Halloween), then into Texas where we settled for a few months. I have never met friendlier people in my life!!! It was great! And it beat the snow and cold we get in Canada during winter. As a cheap guy (oops, I mean frugal), it helped that the Canadian dollar had risen to parity over time (a number of years ago it was hovering around 60 cents, so a HUGE difference, which is another reason I have gone shopping for US stocks over the past few years). It was a fun trip and it's nice to have had the freedom to do it (which is the point of creating a passive income). I try to buy US stocks when our dollar is strong. US investors might to the same thing when their dollar is strong with Canadian stocks.
Q: Finally, can you share some advice for any readers who are just starting out? Are there any particular mistakes you've made that you'd like to see others avoid? Any strategies that you can particularly recommend to beginners?
I've made so many mistakes I could write a BIG book about those alone. The biggest mistakes I've made is when I focused on cheap stocks which were crappy companies. Some people are smart enough to be true "value investors" , but I'm not. The funny thing is that if you accept the fact that you are never going to be Warren Buffett or Ben Graham, you can avoid a lot a grief. If you stick to quality stocks, the whole system is rigged in your favor (yes, you read that right)! For example, go to the Proctor and Gamble website and look at dividend history going back to 1970 (coincidently the year I was born). If you simply bought enough shares in 1970 to give you $1,000 of dividend income, and then NEVER DID ANYTHING ELSE, you would be doing well. If you had spent all that dividend money every year on bubble gum and jelly beans, (and the only thing you did was not sell your shares), today you would be earning over $60,000 per year in PASSIVE DIVIDEND INCOME! Anybody can do this and this is how I retired at 34 and became "The Idiot Millionaire" (which you can Google to find out more).
There you have it. Let me know what you thought! Hopefully Derek will be kind enough to stop by and answer some questions.
Thanks for reading.