At some point in life, I realized I didn’t want to work the daily grind forever. I knew I wanted to quit the soul-sucking job I had at the time as soon as possible and not work another hour that I didn’t want to work. That’s when I discovered the powerful concept of financial freedom.
What is financial freedom?
Financial freedom can be anything you want it to be, so long as it involves having the kind of money you need in order to live the life you dream of for yourself. It means not compromising, living within your means, and getting rid of financial sources of worry.
In today’s post, I will be focusing on helping you create a sound, functional plan for financial freedom, and also offer a couple of simple tips for beginner dividend growth investor. Finally, I’ll leave you off with some of my favorite inspirational quotes on financial freedom. Trust me, it’s not that hard to achieve. If I can do it, so can you!
7 easy steps to financial freedom
We’ve just barely come out of a period in human history when everyone and their grandmother seemed mired in debt. Credit card debt, mortgage debt, you name it. With the increased prevalence of college debt, it’s not like the world at large is successfully out of the red. However, if you’re already lucky enough to be (relatively) debt-free, this might be a good time for you to consider a road map to financial freedom.
You might be planning to purchase a new home or car. You might be dreaming of an early retirement, or planning for a family. Whatever your goals are, make sure they are clearly laid out and sitting at the top of your mind. They will be the corner stone of your plan. Now, here are the XXX steps you ought to take, in order to bring that plan to fruition.
1. Find a place to start.
Alright, so you know your goals and you know they need to be made a priority, if you want to see them come true. Now’s the time to learn where you stand. You need to determine your net worth, by subtracting your liabilities from your assets.
This net worth statement should be a document that stays with you through the years and helps you accurately chart your progress. If you find that your net worth is eroding, this should be enough of a warning sign to understand that you’re driving yourself further away from attaining your goal.
2. Track your cash flow
Keep a journal of how much you spend. It will help you get a very clear picture of each tax year. Do you typically end them with a surplus or a deficit of cash? A surplus is a good reason to cut back on expenses or increase your income. Don’t forget to track everything, from bills, rent, and utilities, to benefits, wages, and interest.
The easiest way to start tracking your cash flow is to look at your money after tax and subtract the amounts for the bills you pay every month. You’ll find that some of those bills are easy to predict (mortgage, utilities), while, for others, you’re going to be using approximations. Don’t forget to also add expenses that only come up a couple of times per year (traveling, gym subscriptions, etc.).
3. Live within your means
The first thing to do, if you realize you’re creating a deficit, is to cut your costs. Perhaps there are some things, like dining out or taking expensive vacations, that you could do without. Maybe you can even save some dollars off your monthly mortgage payments. The point is to create a cash surplus, which would help you achieve your goals quicker.
4. Develop your action plan
Ok, so now you know:
- Where you stand financially;
- What your life goals are;
- How close/far you actually are from achieving those goals.
Now’s the time to start making progress toward achieving those goals. The simplest way to do this is to spend less, save more, invest, and eventually get to the point where you want to be. Easier said than done, right? Here are some actionable pointers worth bearing in mind for this step:
- Take care of any outstanding debt first.
- If you’re in a relationship and one of the partners is only working a part-time job, perhaps increasing the household’s income with a full-time job would be a viable way to go about it.
- Make sure to identify any potential obstacles standing between you and your goals and determine strategies for addressing those goals.
5. Review your taxes
You’re probably already doing a lot to minimize your taxes—but managing an investment portfolio will mean that you’re going to have to look into a completely different category of tax shelters. You’re going to have to look into how each type of bond and dividend is taxed and how the taxation system treats your capital gains.
Possibly the best step you can take at this point is to discuss your situation with a tax accountant. Then, depending on your income bracket, you need to decide what to do with your capital gains. If you’re in the low to moderate revenue bracket, then the best approach is to pay off any form of debt you might have, starting with your mortgage. For anyone earning upwards of $85,000, investing in a couple of hours with a tax accountant can take you from there to the next point.
6. Figure out what you want to invest in
I advise you to draw up as much of a professional financial plan as you can afford to. All such plans come with an Investment Policy Statement (IPS), which is basically a detailed account of how you are going to spend your money. If you’re a beginner investor, you’re going to need this kind of a plan to stick to your guns and hold your ground even in more volatile market conditions.
Investment policies are drawn up by taking into account your time horizon and risk tolerance. A good starting point is 60-40% ratio of stocks to fixed-income investments. For investors with more time and tolerance for risk on their hands, equity might end up playing a bigger part. Those closer to retirement age, who need more stability and safety, are better off divesting a larger part of their investment money into bonds.
Also included in the IPS is your ROI for a long span of time, along the lines of two decades or more. This margin is usually placed at around 5-6%. The IPS also allows for market volatility and factors in a potential 10% loss for the short-term around once in every 10 years.
7. Write up your plan
Now, this might sound daunting, but it’s actually not all that complicated, once you break the plan down into the following 5 distinct sections:
- Your current financial situation;
- Your main financial goals;
- Your net worth statement;
- The steps required of you, in order to reach your goals—complete with details on income, expenses, insurance, retirement and estate planning;
- The Investment Policy Statement.
All sections are important, but, for the purposes of this post, let’s focus on what an Investment Policy Statement should contain:
- Current financial status;
- Objectives & Constraints: what is your risk tolerance? What about your time horizon? How much time do you want to allot to portfolio management activities?
- Investment Strategy Guidelines;
- Security Guidelines;
- Location Guidelines;
- Risk Control, Monitoring, and Review.
5 tips for investing dividends from the pros to the newbies
Dividend growth investments are something we discuss at length on this blog, so I’m not going to get into an excess of details this time. Instead, I’m going to assume you might have landed here because the term ‘financial freedom’ piqued your interest and you want to find a safe way of achieving it. So, for this post, I’m only going to assume you’ve never partaken in dividend growth investment.
Why should you? Because it works, it’s less risky, and it’s profitable. Unlike playing the market itself, stocks that pay dividends can wind up growing your wealth for years, if not decades to come. You won’t have to watch the market all day long. And you can make a hefty profit just by playing on your very own.
Need more proof that dividend-paying stocks works? Here are some facts for you: from 1972 onwards, stocks that don’t pay dividends have been yielding annual 2.6% returns, whereas stocks that do pay dividends have been producing total returns of 9.2% per year. The average ROI for dividend growers and initiators over that span of time stands at 10.1%.
Image source: Sure Dividend
So, gear up and read up—you’re only a couple of minutes away from deciding that you, too, want to stick your fingers into this dividend-paying stock pie.
Tip #1: This game is about total returns
Forget high yields. If you’ve been playing the stock market, you may have gotten it through your head that it’s all about that yield. Since total returns equal capital appreciation and dividends, high yield is completely irrelevant in this sense. In fact, analysis has revealed that stocks in the highest yield quintile actually generate smaller total returns that those in the 2nd highest yield quintile.
It’s not that dividend yield doesn’t matter. It does: in fact, if you come across two completely identical stocks, which are only differentiated by their dividend yield, go for the one with the higher yield. But the odds of this actually happening, in real life, are pretty small.
In fact, what you should be looking for are stocks with high yields and low payout ratio. Historically, they’re the best performers in terms of total returns. However, stocks of the high yield, high payout variety are far more common. So, why should you prefer those in the former category? It’s because businesses with low payout ratios are typically quicker to grow—and a solid growth rate is your ultimate grail here.
Tip #2: Check for dividend history
The rule of thumb is simple here: the longer a business has been paying out dividends, the better. Why? It’s a matter of consistency from the point of view of management. A company that has only been awarding dividends for a couple of years can more easily cut them than one which has been paying them to investors for 5 consecutive decades.
There’s research to back up the above statement. Companies that had been increasing their dividend payoffs consistently for 25+ years were far less likely to reduce them than those with a history of only 10 to 24 years. In 2013, for instance, only 1.90% of companies in the former category took to cutting their dividends, as opposed to 4.37% in the latter category. The same had held true for the previous two years: 3.06% versus 10.8% in 2011, and 3.92% versus 7.53% in 2012.
Tip #3: The more boring the industry, the better
It’s not about being boring, as much as it is about being predictable. Of course, stocks in newer, more exciting industries get more lip service and are far more hyped. Social media, biotech, and every company that was associated with the Internet bubble around the year 2000 is proof for this.
However, a more ‘boring’ industry like insurance has the advantage of predictability. Take insurance, for instance. The process of awarding premiums, investing the float, and paying claims to policy holders has literally stayed the same over the course of the past several centuries.
The same applies for banking, food and beverages, household goods, and more. There’s very little reason to believe that companies in these industries are going to become obsolete any time soon. From a dividend investor’s point of view, stability is essential in deciding whether or not it’s a good idea to place their money in one particular business over another.
Tip #4: Look for friendly management
This is not about whether company management would take you out for a pint. It’s about shareholder friendliness, the first sign of which is the sheer fact that company management values shareholders enough as to pay out dividends. But you need to look for more than just dividend payouts. A long history of dividend awarding is also a very good sign—and there are many others, too.
Here are some other positive signs that management values shareholders:
- Spin-offs and divestments of non-core or underperforming assets. Some CEOs out there will do their darndest to artificially conflate the size of their business, because the more business they’re in charge of, the bigger their paycheck is. However, if you notice that management is shrinking the business to make it more profitable for shareholders, this is usually a good sign.
- Some share repurchases are a positive sign, too. Whenever a company buys back shares that are trading at or below fair value, value is returned to the shareholders. This, however, can be a trickier aspect to assess, because it is sometimes difficult to figure out if a share is trading at or below fair value. If repurchases occur when the stock is overvalued, share value is actually ruined for shareholders, because they should be getting that extra cash in dividends.
Tip #5: Patience, grasshopper
In value investing and day trading, it’s all about how much time you can dedicate to your endeavor. Not the same applies to dividend growth investing, where you buy stock and then hold on to it for a long span of time. In this game, the best asset is patience. You will likely need to ride out bearish markets, with faltering stock values. You need to hold on to the faith that your dividends will be paying off, even during harder times.
Patience is, indeed, the most valuable virtue, in dividend growth investing. A business with a year-on-year total return of 10% will double your wealth every decade. Provided their growth stays strong and solid, you’ll be increasing your assets by 10x every quarter of a century. If patience is not your strong suit, or if you’d rather buy and sell in a fast-paced market, perhaps you should consider investing in something else, rather than dividend growth.
The 5 best financial freedom quotes
To finish off this post, I’ve lined up my five all-time favorite, most inspiring quotes on financial freedom. Each one teaches an important lesson on money-making and enjoying life. Don’t hesitate to add your own favorites in the comments!
Image source: Quotesgram
Image source: Quotesgram
Image source: HippoQuotes
Image source: Empower Your World
Image source: Quotesgram