Shifting perspectives: Profiting from the proliferation of shortermism

Never has there been a time where so much information is readily available than now. Not only is more information available it is available faster than ever before. Photos don’t need a week to develop; you don’t have to wait until morning to read the newspaper to find out what happened in the world yesterday. Instant news and results are the new normal.

Business and investing is no exception. There are dedicated business news channels, websites, blogs, podcasts, books, magazines, newsletters, twitter feeds, seminars and pundits, all offering their opinions (this blog included!). Mass media headlines sway the market, stocks prices and the sentiment of investors. Analyst upgrades and downgrades trigger knee-jerk reactions, compounded by high frequency trading, stop losses, short positions and the heard mentality.

But access to all this information should make investing easier. As an investor, you consider oil prices are down, the Canadian dollar is down – consumer staples should do well. You can buy iShares S&P/TSX Capped Consumer Staples Index ETF (TSX:XST). Sound logic, wrong perspective. Here is the problem – you missed the boat. With a P/E (price to earnings) ratio of 24, now is not the time to buy consumer staples, but to consider selling them. In 2011, the TSX Consumer Staple index was 13.9 (historical P/E ratio of the TSX is around 15). This is what I call shortermism. Shortermism, is a natural progression of today’s society in general and is the companion of a get-rich-quick mindset.

Let’s look at this from a different perspective. Stocks prices follow supply and demand principles. When demand increases, prices go up. When demand decreases, prices go down. You can buy the latest smart phone the day it becomes available to market but you will pay a premium. You can buy the same phone a year later, when demand has gone down for much less. Same phone, same functions, huge savings. Your retirement fund doesn’t need the newest phone, or the hottest stock. You need to make money, not show off that you own the latest trends.

Stocks are shares in a company (physical assets, people, intellectual property etc.). I don’t think the intrinsic value of a company changes as much as the stock prices change. Here lies the opportunity.

1)    Invest in the Long Term

Long term isn’t 6 months or a year from now. I invest with a 5, 10 or 25 year horizon. I won’t be 65 for more than 20 years, so why wouldn’t I invest for the future? I can’t tell you what will happen tomorrow on the markets, but I believe the price for useful materials that have limited supply will ultimately go up (real estate, oil, uranium, metals, etc.). Invest in areas (via ETFs) or specific stocks that you believe have long term potential. Look at the big picture, ignore the noise.

2)    Look for Value

Find companies and ETFs that are trading below their average P/E ratio and/or have huge potential. I like companies that are profitable and pay a sustainable dividend, even when times are rough. You don’t need to do complicated technical analysis. Quickly look at long term trends, history and averages.

3)    Find the Sweet Spot

When you can marry long term potential and value, you have hit the sweet spot.

Last October I bought Agrium for $94 (TSX:AGU) . I had been watching the stock price for many months. Good long term prospects – check, good value – check, profitable – check, pays dividend – check. I bought ½ my intended position. I was planning to buy the other half if it dropped to $90. It didn’t. Agrium is up about 50% in the last 5 months. I was lucky it did well in the short term, but I still hold it for the long term.

I like (and have a long position in) PrairieSky Royalty (TSX:PSK). I recently bought it below the original IPO price. Good long term prospects – check, good value – check, profitable – check, pays dividend – check. I am not worried about this investment. Another investment that I have held longer but has not appreciated is Cameco Corp (TSX:CCO). I’m not sure what will happen in the next year or two, but Cameco is still profitable, it pays a dividend and I believe they are very well positioned for the future.

If you look at long term trends and buy stocks/ETFs when they are cheap – you can forget analysts’ recommendations, market fluctuations, short term trends along with the rest of the noise and have peace of mind. You might just beat “the market” while you are it…

Be happy, live long and prosper! Farewell Leonard Nimoy and thank you.

My biggest investing blunders

I have made so many investing related blunders I am truly embarrassed. I used to joke I would stop “playing the markets” and develop a drug addiction to save money.

So I’ve learned a few lessons, expensive lessons, the hard way.

At the risk of looking like a complete fool and my wife taking her RSP out of my care and back to her old mutual fund advisor, I will reveal some of these painful lessons.

Get rich quick mentality

If there is one thing that has slowed (and many times reversed) my accumulation of wealth more than anything else it is a “get rich quick mentality”. The thought of hitting the jackpot and getting 10x or more returns on stocks is a temptation, like a forbidden fruit, especially once you have experienced this elation. It is something I still struggle with.

My fix

I have read at least twenty investing and personal finance books. I now understand gambling and speculating is not investing. Investing requires a get rich slowly mentality. Although difficult, I’ve learned to ignore my emotions and the evil, get-rich-quick whispers in my head. The majority of my investments now are in profitable companies that pay sustainable dividends as well as ETFs. I still follow a few speculative stocks that I think have huge potential and that I believe are undervalued. If I succumb to temptation I buy a small amount say 5% or 10% of what I would invest in a dividend stock or ETF and never in my wife’s account! Speculative stocks account for about 2% of my portfolio and I am comfortable with that.

Margin Accounts

I opened a margin account in the late 1990’s. A margin account lets you borrow against equity in your portfolio, much like a line of credit lets you borrow on the value of your home. My unrealized gains in my portfolio of stocks were much higher than my interest rate. Being young and clever, I borrowed to invest more and my portfolio grew faster. I had investing all figured out, I would cash-out before too long, extremely wealthy for my age. Then the market dipped. I wasn’t worried, I understood technology and I was invested in technology. The dip turned into a crash. I was forced to sell my stock holdings at the worst possible time. My losses were compounded by my margin buying and I had lost money on interest payments. I lost close to one year’s salary in just days. My hard earned money had vanished completely and I had nothing to show for it. Like the old Nortel joke, if I had bought beer instead of stocks, at least I could return the empties and have a few dollars left in my pocket…

My fix

I never buy any stocks on margin. I am adverse to debt, so much so I am debt free just as interest rates are around an all time low. Also with TFSAs, RSPs, and RESPs I have no need (yet) for unregistered margin accounts and their additional tax burden.

Bubbles

It is hard to know when you are in a stock market bubble, particularly the first time. I define a bubble as when stock prices lose correlation with value of the small piece of the company you own. Bubbles typically form slowly. In the technology bubble around the turn of the millennium, I knew wireless technology was going to be huge in the future. I invested in the top wireless chip makers. I wasn’t concerned about P/E (price/earning) ratios, in fact I didn’t look much at earnings or forecasts at all. My investments did very well and I continued to buy as their stock prices rose. Was I right about wireless technology? Yes, the number of wireless devices on the market now, 15 years later, is mind-boggling. Did my investments pay off? No.

My fix

As an engineer focused on continuous improvement, I rely on quantitative data and analysis to help identify issues and prove they are resolved. I now use simple quantitative analysis for investing too, focusing on P/E ratios, earnings and earnings forecasts, and dividend payout ratios. I also use Moringstar’s Quantitative Rating (offered free through my online brokerage) as a sober second though, like Canada’s senate. If a stock gets overvalued based ratios compared to historical trends, I will sell some of my holdings if I still like it long term, otherwise I may sell the position entirely. The inverse also applies. If a stock price drops very low and its value and long term fundamentals are good I’ll buy it or buy more.

Pump & Dump

When I first started trading on the markets I often bought penny stocks. I read and received information from investing bulletin boards and related email distributions. I would read some great news about a stock, the stock would take off, and typically as fast as it went up, it went down. The majority of these holdings ended up delisted (zero). I’m not sure how much of this has changed over the years. But in hindsight it appears I fell for the classic pump and dump scheme. Watch the movie The Wolf on Wall Street.

My fix

I don’t invest in speculative penny stocks anymore. The odd speculative stock purchase I may make is in Canadian companies I have heard about from reputable sources, or seen interviews with CEO and followed the stock price. I will look at the company’s website and I consider financial health, growth and take over target potential. If I have any doubts I do not make the purchase. If I do buy the stock it is a very small fraction of my overall portfolio. I do not partake in any stock related chat rooms.

Leveraged Products

A few years ago I purchased 2x leveraged natural gas ETF. It tracked the commodity price, not industries. This product was designed that for every 1% change in the natural gas price it would move 2%. I was confident natural gas prices had bottomed. As luck would have it, natural gas prices continued to fall for an extended period of time. The leverage, relatively high management fees (> 1%), combined with poor index tracking was like adding salt to an open wound.

My fix

My days of short term commodity speculating are done. I would rather buy a related and profitable industry leader, ride out commodity cycles and collect dividends while I wait. I don’t pretend to understand exactly how leveraging works and right now, I don’t need to know. But leveraged products, like a margin account, coincide with the dangerous and often expensive get rich quick mentality.

Stock Tips

I have invested blindly in stocks suggested by friends or relatives. Why? Because I thought they were successful investors. Who better to follow? In hindsight, the adage past results are no guarantee of future returns is true. I lost big on few tips. Stocks that went to zero. I lay no blame on the person who provided tips. I asked for tips and the tipper full heartedly believed they were worth the risk (and lost too).

My fix

I now know getting lucky speculating and being a good investor are not synonymous. I admit I still love stock tips. I might listen to BNN and hear the top picks and I will look at the stock. If I like it I might put it on my watch list. I like to date a stock for while before committing to it. Sometimes a stock runs away in price before I can buy it. I no longer fret when this happens. There are plenty of stocks in the markets, and more than likely there will be awesome buying opportunities in the future.

I’ve done a few things right too

Just so you don’t think I’m a complete idiot, I have learned from my mistakes and I’ve made some good investments. I saw value long term value in nanotechnology/rare earths, pipelines and energy infrastructure when these were not popular investments.

Since January 2009 (the oldest data available from my brokerage) to the end of October 2014 I have outperformed the Toronto Stock Exchange cumulatively by about 70% (166.46% vs. 96.99%) and I have even outperformed Berkshire Hathaway (124.84%) in this relatively short period of time – although I am no Warren Buffet!

I am sure I am still making mistakes, but I am optimistic the frequency and the cost of these mistakes are decreasing.

Don’t make the same mistakes!

I could have saved a lot of money (and embarrassment) if I had just done 2 things:

• Read about personal finance and investing before investing in the markets, or
• Invested with a strategy like the couch potato or my ultimate portfolio.

The good news for millennials is there has never been more choice of low cost investment products and free information available. Grow and protect your money, don’t learn the hard way if you don’t have to.

Be happy, live long & prosper. Best wishes for 2015!

Revisiting the Ultimate Portfolio

Statistically the Ultimate Portfolio has been my most popular article on my blog. It has been about 5 months since I published the article, maybe it is a good time to see how this portfolio is doing. Just a quick recap, the Ultimate Portfolio is composed of 3 Exchange Traded Funds (ETFs) trading on the TSX: XTR (40%), CDZ (20%), and CYH (40%).The chart, compliments of Google Finance Canada, shows the Ultimate Portfolio (blue), compared to the S&P TSX (red), the S&P 500 (orange), Dow Jones Composite (green) over the last 5 months.

The Ultimate Portfolio has fared reasonably well. The portfolio has returned 4%, including dividends. This has (just) outperformed the S&P 500, the Dow Jones composite, but it has lagged behind the S&P TSX.

Interestingly, while U.S. and Canadian indexes have recently dropped 2% or more, the ultimate portfolio has only given up 1%. This supports the viewpoint that having a well diversified portfolio helps decrease volatility. Stay tuned.

Be happy, live long and prosper.

The markets are due for a correction, or are they?

Is it time for a market correction?

The Canadian and US stock markets have done very well over the last year. As of market close July 18, 2014, the S&P/TSX Composite Index is up 20% for the last year and the S&P 500 is up 17%. The PE (Price to Earnings) ratio is above historic norms.

The markets are due for a correction, or are they?

Interest rates are extremely low. Interest rates on savings accounts and GICs are negligible. The threat of rising interest rates has made bonds unattractive. What’s left? The stock market has momentum, corporate earnings are good. The North American economy appears to be improving slowly, primarily lead by the US.

I have talked to a few people who are waiting for a correction, before they invest more in the stock market. This is the reason why I believe a correction is not coming anytime soon. I don’t think the markets are going to climb much further either, with the stock market crash of 2008 still in people’s minds. There will be some volatility in the coming months, maybe a big one day slide perpetuated by stop losses, but other people will immediately jump back in the market. Also with interest rates this low, if there was a correction in the markets would it not make sense to borrow money to invest in the markets? Interest paid for investment loans are tax deductible and capital gains and dividends are taxed at a preferential rate. The case to borrow to invest in blue-chip companies on a correction is logical. Again, this is another reason a correction is not imminent.

Markets will essentially move sideways or slightly up, while interest rates remain low.

What do I do now?

I can’t predict the markets, but my thoughts haven’t changed much since my article: So, you feel like an investing Rock Star? back in February 2014. Here are some suggestions:

• Keep looking for value and growing dividends.
• Diversify your portfolio, look for cheaper markets outside North America (I typically use low fee ETFs to do this).
• Try contrarian investing and buy blue-chips on bad news. E.g. look at Potash Corporation (TSX: POT) it dropped 20% last July and has climbed back up while continuing to pay dividends.
• Hold some cash. Cash doesn’t pay dividends but it is incredibly versatile.
• Add some gold or silver to your portfolio. Last I heard the cost of mining gold is about $1,200/oz so buying gold at this price or less is a good deal. I like silver at $18/oz. You can buy ETFs backed by physical bullion in registered accounts, but for non-registered accounts definitely buy physical gold or silver; any gains are tax free and it’s handy if a doomsday scenario actually occurs.
• Do nothing. Sit back, relax and enjoy the ride…

be happy, live long and prosper

i think i have left the matrix

I think I have left the matrix; at least for now, hopefully forever.

stuff (the blue pill)

Recently I was fortunate enough to have won a ticket to MoneySense magazine’s 15^th anniversary event. David Chilton, Dragon and author of the Wealthy Barber was the guest speaker. He was very entertaining and extremely funny. He made an important point about stuff. We are obsessed with buying stuff (reminds me of George Carlin’s rant about stuff). And stuff has never been cheaper or better. We buy fancy cars, big houses or expensive renovations, the latest techno-toys. Stuff our parents could not have even dreamed about when they were our age.

My new wireless, bluetooth enabled speaker. It’s a cool toy and I got a great deal, but it was something I didn’t really need…

Our houses have never been worth more and interest rates are at an all time low. With the proliferation of credit cards, debit cards, lines of credit, micro payments, tap-and-go, pay-pal, and internet shopping it has never been easier to spend money. Your neighbour buys a new car and subconsciously (or maybe consciously) you think my car is getting old, it is starting to show signs of rust, repairs bills are starting to go up, I need a new car! But you don’t think of getting the same car or a model down – you look at a newer car, with more features or more horsepower or an upmarket brand. Looking into it you can get a 6 year payment plan – this lowers the monthly cost and makes it more affordable – I can afford the special edition! Wait until the Joneses see this…

A house being built on my bicycling route. I wonder what the property taxes, utilities and maintenance costs will be…

Expensive cars, big houses (to put more stuff inside); these are things we think we want. It is symbolic of success and we all want to be successful. But it is not just stuff, we spend money on cable TV, Hollywood movies, professional sporting events and paraphernalia, perpetuating and supplementing the extravagant and excessive lifestyles of the rich and famous, at our own expense.

you’re not as rich as you think

Unfortunately increasing household debt has become a Canadian pastime. We are working to support our spending habits and while giving a higher percentage of our income to the banks to pay for the privilege of thinking we are richer than we actually are.

Many Canadians are working longer and longer hours and now thanks to technology you can carry the office in your pocket. You can be reached at anytime anywhere. Your cubicle has followed you home. But you think to yourself, I am lucky to have a job, there would be a line up of people to replace me (although they wouldn’t be able to do the job as well as I can). Everyone is replaceable. Working for the same company all your life has gone to the same place as guaranteed pensions, to a privileged few government employees. We work harder to get ahead, get the raise and get the promotion. Yet the more money we make, the more money we spend.

the red pill

At a company I worked for, the richest guy at the office drove a beat up, old rusted Honda. Why? It got him to work and back every day. It was reliable. It wasn’t that he couldn’t afford a new car, he simply didn’t need one yet.

A few weeks ago I went to the local park with my kids for a hike, we brought leftovers, some snacks and water. We stopped at a picnic table under a giant maple tree. After our picnic, my kids asked me if they could climb the tree. “Of course” I replied. The park was free, climbing the tree was free. No admission, no line ups, no overpriced concession stands. The kids had great time and without realizing it, got some good exercise too. It was a beautiful day and we were in no rush.

real problems can’t be solved with money

A close friend of the family recently lost their daughter to cancer. It is hard to imagine something worse than burying your own child. Their daughter also left behind a husband and two young children, one with special needs. It was absolutely heart breaking to be at the funeral. The family was well off, but real problems can’t be solved with money. Money “problems” can always be fixed.

i am grateful

I have been in the fortunate position to reflect on life recently. I am extremely lucky and grateful to spend more time with my happy, healthy, supportive and loving family. I am happy I am able to assist with little things that I didn’t have time to do before. I am exercising regularly and feeling better every day. I am volunteering with the local engineering chapter, working with a great group of people. I have been reading insightful books, learning new things, expanding my thoughts.

If it is obvious already, I love money, like Kevin O’Leary loves money. And like Kevin O’Leary, I like money because it can help buy freedom, to do more of what I want to do. I have started my own business and I want to travel more with my family, exploring the world’s small and large wonders. I am saving so my kids have a chance of graduating university or college without feeling burdened by debt. I would like to do more projects around the house: build a new deck, finish the basement, create a waterfall, stream and pond in the back yard.

you don’t need to win the lottery

In recent Lotto 6/49 commercials they asked people what would they do if they won the lottery. I found it interesting that in more than half of the responses; it was to do things they probably could already afford. You don’t have to be a millionaire to start your own business, go fishing, or put fresh linens on your bed everyday.

What do you want to do?

What are you working for?

How do you want to be remembered?

Work, spend and save with these goals in mind. Take care of your health. Remember the big picture. And as always…

be happy, live long and prosper

Simos beach, Elafonisos, Greece

 

5S your finances

5S is a fundamental of lean manufacturing derived from the Toyota Production System. It is a great place to start to improve any process. The 5S’s are:

(1)    Sort

(2)    Straighten

(3)    Shine

(4)    Standardize

(5)    Sustain

The first 2 steps are the most critical, if done properly the remaining steps are easier.

Chances are your personal finances could use a 5S. The areas where this is very useful are documents (electronic and/or paper) and accounts.

1)    Sort

Sorting typically involves sorting everything in the area into 3 groups:

                     i.            Necessary

                   ii.            Garbage

                  iii.            “Red Tag” area: things you might need, but aren’t sure

Documents

The Canadian Revenue Agency recommends you keep supporting income tax documents for 6 years. You may want to keep documents longer if you think you will want to calculate rates of return on your investments. Throw out envelopes, old proxies etc. and anything that has expired or has redundant information.

Accounts

Most people I know have various accounts here and there like RSPs or pension plans from previous employers. You might have some investments with one advisor, other investments somewhere else. You may have multiple bank accounts or redundant savings/chequing accounts. Sorting is taking a critical look at all your accounts. Figure out what is necessary, what is redundant. Identify accounts that you are no longer contributing to.

For documents or accounts that are red tagged, specify a date to review the items. Write that date on your calendar. If you haven’t used or needed it by then and it is not required for anything else close it or put it in the recycling bin.

2)    Straighten

Straighten involves setting everything required in its designated place.

Documents

Create 3 hole binders with labelled dividers for paper documents or electronic folders that are organized first by account then by year. This will allow you to find any financial information quickly. If you have many different accounts organize by account type (non-registered, RSP, TFSA etc.) first then account and year. The important thing is to create an intuitive system that works for you and stick with it.

Accounts

You can transfer registered accounts to other registered accounts without penalty (and without cost). Consider transferring small, abandoned defined benefit plans into locked in retirement accounts. Centralize your accounts so they are easy to see. Accounts that you are no longer contributing to should transferred to active accounts and then closed. Keep in mind any fees you are paying and try to minimize them. Simplifying your finances will make them easier to manage.

3)    Shine

Shine is the process to clean the working area completely. You should be able to clearly see the changes made in the first 2 steps.

Documents

For electronic documents make sure your financial records and directories are located in a logical and intuitive part of your hard drive. For paper documents, your binder(s) should have a designated place on bookshelf ideally easily accessible from your desk or close to where you sort your financial papers. The binder should have a label on the spine, a cover page clearly identifying the contents, and dividers inside.

Accounts

For investment or savings accounts that you frequently deposit into, these should be linked electronically to accounts that pay cheques are deposited into. Most online services allow you to nickname your accounts. These names should follow the same standards as your document organization.

Try to eliminate or reduce any fees. If you have consolidated account keep in mind the larger your investments, the more benefits you may be entitled too such as reduced commissions, reduced regular fees, etc. Banks and investment companies want your money. It is worth your time to call the company holding your investments to see how they can lower or eliminate any fees you may be paying. Register stocks accounts for DRIPs.

4)    Standardize

Standardizing is always following the first 3 steps. Create a cleaning/organizing schedule if required, or create process documentation.

Documents

Now that your documents are organized, as soon as new documents arrive or are available review the statement and put it in its place immediately. Don’t put it down or leave it sitting on your desk (or sitting in your inbox). Create new binders, new tabs, new folders as necessary or prepare them for the entire calendar year in advance.

Accounts

If you are transferring money on regular basis, or even making lump sum deposits into savings or investment accounts – automate this process. Most online banking services allow you to setup automatic deposits or transfers that can coincide with regular paycheques. Take 10% straight off your paycheque and put it directly into savings/investments (start with registered accounts first), budget with the remainder. This is one of the secrets to building wealth. Take a percentage of every paycheque, even if you have debt, even if it is only 2% of your earnings, do it. It is a good habit to get in to. Learn to live with spending less.

5)    Sustain

Sustain is the self discipline to keep your process in working order. Once you have a standardized process in place, regular repetition will lead to good habits.

Documents

Record all account balances in a spreadsheet at least quarterly. You can summarize, and create statistics for your account. Just like baseball, creating and tracking statistics make finances more interesting. There is truth in the saying: what gets measured gets done. By tracking your investments, debt and savings you will be more conscious of spending and savings. Keeping your finances in order will become second nature.Create a backup system to backup all important financial information regularly, preferably off site.

Accounts

Stay on top of your accounts. Review all accounts at least annually. Is the account active? Can it be consolidated with another account? Make sure you keep up with life changes.

Summary

The 5S’s: sort, straighten, shine, standardize, and sustain are a powerful when used together. It will eliminate clutter and may reveal issues you didn’t know you had. By dealing with these issues sooner you can save a lot of money. If you run into difficulties you can always start back at step 1. The same steps can be used to 5S the holdings in your portfolio.

The most important thing is to take action. 5S your finances! It will provide you peace of mind and you likely become richer by doing it.

be happy, live long and prosper

All-Star Stock: Enbridge Income Fund (TSX:ENF)

“Diversified Energy Infrastructure Company Designed to Provide Attractive and Predictable Cash Flow to Our Investors.”

• Ticker Symbol: ENF (Toronto Stock Exchange)
• Price: $26.64
• Yield: 5.18%
• Market Cap: $1.5B
• Initiated Position: 2004
• Current Sentiment: Hold, slightly overvalued at this price, but enjoying the dividends and DRIP
• 5 Year Return: 139% or 27.8% annualized (with a fractional share DRIP)
• Website: http://www.enbridgeincomefund.com/

Data based on April 30, 2014 closing price

Why I own it

I love energy investments and I love infrastructure investments. Enbridge Income Fund is a sweet spot of the two.

ENF is diversified in green power (wind mills, solar, waste heat) and natural gas/liquids storage and transportation (pipelines and soon rail). 67% of ENF is owned by Enbridge Inc. Long term contracts, limited competition, consistent money maker, good strategic growth, DRIP eligible with a stable and growing dividend – what’s not to like? It doesn’t matter how bad the economy is or if you lose your job, chances are come winter you will heat your house. This makes ENF ideal to accumulate during recessions and market corrections.

This stock has managed to fly under the radar. No one talks about it and you rarely hear any news about it. It is a boring stock; no flash, no glamour. But this stock delivers. It is one of my largest and my longest holding in my portfolio. I usually recommend this stock first for people looking to get in the markets, but without get-rich-quick appeal few have taken my advice.

No doubt this stock will help fund my retirement when I stop the DRIP and use the dividends as income.

Put Enbridge Income Fund on your watch list. It is a great long term hold, that hasn’t received the recognition it has earned.

be happy, live long and prosper!

A DRIP that pays

When it comes to investing, DRIPs (Dividend ReInvestment Plans) are a good thing. It is a great way to use the magic of compounding for your investments. Most major banks and brokerages offer “synthetic” DRIPs at no charge. These plans reinvest your dividends. They buy whole shares (sometimes at a discount) from your dividend distribution, with the balance deposited as cash. Sometimes you have to ask to be part of the program. Do it, it is free money. A few key points for this to work:

• Each stock dividend distribution must be greater than the current stock price

• The stock must be eligible for the DRIP with your brokerage (ask your brokerage, if they do not have a list posted)

DRIPs are dependent on the distribution frequency typically: monthly, quarterly, or annually and the distribution amount. The yield is annual distribution total as a percentage of the current stock price. So, the higher the yield and the slower the frequency of dividends, the smaller the investment required to compound your shares. But stock price is another variable to consider. The higher the stock price, the larger the investment required for the DRIP to work. It is the number of shares that is critical. This is something to consider when purchasing new dividend paying stocks. I created the following table that shows the minimum number of shares (for eligible stocks) for a DRIP to work. You should always buy more shares in case the stock price goes up.

Minimum Number of Shares for Stock/ETF DRIPs

Yield	Frequency
	Monthly	Quarterly	Annually
0.50%	2400	800	200
1.00%	1200	400	100
1.50%	800	267	67
2.00%	600	200	50
2.50%	480	160	40
3.00%	400	134	34
3.50%	343	115	29
4.00%	300	100	25
4.50%	267	89	23
5.00%	240	80	20
5.50%	219	73	19
6.00%	200	67	17
6.50%	185	62	16
7.00%	172	58	15
7.50%	160	54	14
8.00%	150	50	13

 Simulations

Thinking about DRIPs it is fairly obvious that if the stock price rises, DRIPs will increase the value of your investments. If the stock price stays the same, DRIPs are also beneficial. But what if the price drops? I created a random what-if analysis in Excel using the following variables: Initial stock price: $20, initial number of shares: 500, initial yield: 5%. I randomized the stock price over a 5 year period. I left the dividends unchanged throughout at $1 total per year (the frequency is shown in legend).

Scenario 1: Falling stock price

The first chart, Scenario 1, chart really shows the power of dividend investing. Even though the stock price declines by 15% over a five year period, the returns are still positive. The distribution frequency (monthly or quarterly) made little difference. But if you did not participate in the DRIP you would have lost about 2% of potential returns.

Scenario 2: Slowly increasing stock price

In the second chart, Scenario 2, you can see that as expected, the gap between DRIP and no DRIP increases steadily over time.

Scenario 3: Sudden 25% price drop

In the last chart, Scenario 3, shows a sudden 25% stock price drop and 5 years for the price to go back to where it started from. You can see that with dividends (no DRIP) after 5 years the total value is up 25% (5% annualized return). With DRIPs the returns are over 30%. Looking at the data, the quarterly DRIP outperforms the monthly DRIP because a higher percentage of the dividends are effectively used to buy more shares, thus the compounding effect is quicker.

It is also interesting to compare Scenarios 2 and 3. In Scenario 3, with the significant correction and no net change in the share price in 5 years, the returns are very close to scenario 2 where there is a 7% increase in share price and no correction. Looks like dollar cost averaging really works!

Key points to remember

• If haven’t already done so, sign up for dividend reinvesting with your broker
• When purchasing dividend stocks/ETFs make sure they are DRIP eligible and you have enough shares to make it work. Refer to the Minimum Number of Shares for Stock/ETF DRIPs chart for a quick reference.
• Look for stocks/ETFs that have a history of raising dividends. If the stock price falls with a market correction, your dividend will mostly likely not be affected. No need to worry, with dollar cost averaging and DRIP on your side you will catch-up quickly…

be happy, live long and prosper!

 

Engineering Wealth

To date, I’ve talked a lot about personal finance, and very little about engineering. Time to balance the scales. I am engineer. I’m an engineer at heart. I’ve always liked to build things, take things apart, break things, and fix things. As a professional engineer not much has changed. I still build, break, take apart and fix things, except now I pay more attention to the process around the things I build, break, take apart, and fix. I look at how things are interconnected, where there are problems, and how things can be improved (by building, breaking, taking apart or fixing).

I learned the theory of constraints many years ago and applied it to my work. Identify slowpokes, put them in front, and then speed up the slowpoke. When I learned about the Toyota Production System (TPS) it was a natural extension of this logic. TPS is the foundation of Lean Manufacturing. Lean/TPS is all about removing waste and improving process flow. There are many tools and tricks to accomplish this type of process engineering.

Like anything that you do for long period of time it becomes second nature and starts creeping into your personal life. You might start with a designated place for your wallet and keys (that you use), then your dishwasher utensils holder gets grouped by spoons, forks, knives, and others utensils, soon your sock drawers become categorized by function and then by colour and eventually you even start to look and process your finances differently.

Any lean practitioner will tell you lean can be applied to just about anything. Building wealth is no exception. You want to remove waste: money not going to or leaving your possession; and improve process flow: money going into your possession. Simple.

Lean was once described to me as the application of common sense. When lean is applied correctly, changes made seem obvious, but typically only in hindsight. Why didn’t we do that before? Lean is a journey of continuous improvement, made one step at a time, with no end (thankfully as this increases my chance of regular meaningful employment).

So begins a series of articles where we apply tools and tricks of lean and process engineering to build wealth – engineering wealth. We’ll take the first, logical step next article. Until then…

be happy, live long and prosper!