Lazy Man and Money

Introducing the Lazy Man Rule of 20

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At the start of 2020, I took a fresh look at the stock market and realized that it was up about four times from 2010. Many people who had $250,000 in the markets in 2010 are now millionaires. My wife and I started working before 2000, so we had already saved up a lot in our 401ks and Roth IRAs before 2010.

I was excited by all this progress. The plan was working to perfection. I had a fear… I didn’t want to lose all these gains. However, we weren’t 45 years old, so we still had a decade or two before we started to access these retirement accounts. I wanted to stay invested, but I didn’t want to take the big risks that I did when I was 25. At that time, not only was I young, but the market had collapsed with the Dot Com bust of 2000. It was the perfect time to buy growth stocks.

In 2020, it looked like technology dominated the stock market. The world’s biggest companies were not GE, Walmart, Citibank, and Exxon like they were back in 2000. Instead, we have GAMAF: Google, Apple, Microsoft, Amazon, and Facebook. (I’m substituting Microsoft for Netflix in the popular FAANG acronym.) To reduce tech risk I replaced much of the major total market index ETF I had (VTI) with a high-dividend index ETF (HDV).

I may have lost out on some gains as the pandemic was great for tech stocks. Alternatively, many companies cut their dividends. However, vaccines came out and the boring companies that are in the high-dividend index are thriving. Those boring consumer staples and energy companies are in-demand as they are generally inflation-proof.

There was one other way that I tried to protect our money in 2020. I added more bonds. I haven’t been a big fan of bonds because historically, the best returns come from stocks. I’d rather have 60 years of 10-12% returns than 60 years of 4-6% returns. However, with stocks in a 10-year bull market, I felt it was best to move some money to bonds to diversify with a lower-risk asset. I slowly started to buy Vanguard’s major bond ETF (NASDAQ: BND).

Fast-forward to today and I was either smart or very lucky. I think maybe it was a little of both. HDV is only down about 5% from its highs. VTI is down around 20%. The tech-heavy NASDAQ index has been off of its highs by about 30%. Bonds haven’t been great as they’ve been down about 11% – but they are at least better than VTI.

One of my good friends has an Investment Policy Statement (IPS) that she loves. An IPS puts down in writing how you are going to invest in advance of any market conditions. The beauty is that once you have your philosophy in black and white you simply have to just execute it. I’ve been thinking about creating one for some time, but I’ve been living up to my Lazy Man moniker on that one.

With the market going down and possibly heading further down, I’ve started to think more seriously about what might be in my IPS. One thing I know for sure would be a valuation-based asset allocation. I know a lot of people stick to one asset allocation and change it to be more conservative as they grow older. One old rule of thumb is that you should subtract your age from 100 and have that percentage in stocks. Thus, at age 45 now, I would have 55% in stocks (100-45). I’m an aggressive investor so that rule of thumb doesn’t sound great to me. (It may work beautifully for you though.)

While I do believe that age should be important in asset allocation, I also believe that the market’s valuation should be considered. Here’s a chart of the Shiller P/E:

The Shiller P/E is an indicator of how expensive the market is. The higher the number, the higher the price you are paying for the earnings. One thing that you’ll notice is that for 125 years until the last decade, when the P/E is above 25 there’s been a crash. It can stay up there for a little while. It almost always crashes at 30 until the last ten years or so. It’s crashed down a bit from 37, but could still have some way to go.

That’s why I came up with…

Lazy Man Rule of 20

The Lazy Man Rule of 20 says that my bonds should be around the Shiller P/E minus 20. When the Shiller P/E was 37, I should have had 17% in bonds. In reality, I had around 15% of my money in bonds. (This is a new rule that I’m implementing now, but it would have been nice to have been at 17% bonds.) Now that the Shiller P/E is at 30, I should have around 10% in bonds. I have been selling off bonds and buying stocks (including the NASDAQ at 30% off), but I still have about 11.25% of my money in bonds. The next day that stocks go down, I may sell 1% of my bonds and buy stocks.

Let’s look at how this may have worked in big market bubbles and crashes in the past. I’ll start with my first year out of college in 1998:

  • Bubble of 1998

    At the top of the market in 1999, the Shiller PE hit about 45. Using my rule of 20, I should have 25% of my money in bonds (45-20=25). In hindsight, it should be 100%, but 25% bonds for an aggressive investor at age 25 is a lot. I may have missed the run-up in 1997 and 1998 as I sold stocks to buy that 25% in bonds.

  • Crash of 2000

    As the market starts to crash in 2000, I allow myself to sell the bonds to buy stocks. Bonds performed well from 2000 to 2003, but the stock market was down 9% in 2000, 12% in 2001, and 23% in 2002. By the time it recovers in 2003 the Shiller PE was 23, which means that I only 3% bonds and 97% stocks. That goes to about 7% bonds (Shiller P/E of 27) until we get to 2008.

  • Crash of 2008

    When the crash of 2008 hits, the Shiller P/E goes to 15%. Suddenly, I was allowed to have -5% bonds. Realistically, I can’t do that, so I get to 100% stocks while the market recovers.

  • Bull Run from 2010 to 2020

    During this time, I’m gradually selling stocks and buying bonds. In 2013, I only have 2% bonds. By 2014, I’m up to 5% bonds. In 2015, I’m up to 6.50% bonds. This continues… in 2017 I had 8%, in 2018, I had 13%, in 2019, I have 8%. Finally, in 2000, I’d be back up to 11%.

One of the keys to my Lazy Man Rule of 20 is that I stay invested. I’m not pulling money in and out of the market. Some people claim that you can’t time the market. Is valuation-based asset allocation timing the market? I think it depends on who you ask. I think it is, but I’m using the market itself to tell me what to do.

Make Your Own Rule

I picked my Rule of 20 out of thin air. It was based on my gut feel and I’ve acted when the stock market is up and down. It was only recently that I made the connection that I tend to have bonds that are Shiller P/E minus 20.

If you are a more conservative investor you might want to choose to keep bonds that are equal to Shiller P/E. Or maybe if you are in retirement, you want to have twice the Shiller P/E in bonds. As I get older, I may move from my Rule of 20 to go through all these valuations.

What do you think? Are you going to explore valuation-based asset allocation? If so, let me know what your rules might be in the comments.

Portfolio Potential – One Trick To Keep Your Head in a Down Market

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Portfolio Potential

How are you doing with this stock market lately? Have you looked at it? Most experts recommend not paying attention if you hear bad news about the markets. I look at the markets a few times almost every day. It doesn’t matter if things are going well or very poorly. It’s a combination of a habit and a hobby.

If you are like me and look at your portfolio often maybe this trick I use will help you.

One of the numbers I keep track of is what I call Portfolio Potenial.

What is Portfolio Potential?

Portfolio Potential is not about what your portfolio value is today, but what it could potentially be… if the Vanguard Total Market Index matches its all-time high. I picked Vanguard’s VTI ETF as my market benchmark. I suppose you could choose something different if you like – I simply wanted a broad index that is well-accepted as a sound investment benchmark.

Let me give an example to illustrate.

Let’s pretend that I have a $10,000 portfolio of stocks, bonds, mutual funds, ETFs, REITs – whatever is in your brokerage account. If that portfolio drops 15% it is only worth $8,500. However, instead of looking at that $8,500 number, I take that number and divide it by how much VTI is off of its all-time high. As I’m writing this on the morning of May 12, 2022, VTI is down 20% from its all-time high… or it has retained 80% of its value. The Portfolio Potential number I look at is $8,500 divided by 0.8… or $10,625.

Essentially, I’m celebrating that my portfolio has “beat” VTI by not losing as much. How did I do that? I had bought more bonds than I would normally have and removed some tech risk from my portfolio a couple of years back. I might have given up some potential gains then, but I slept well and I was still fully invested in the market. In fact, my high-dividend ETF (HDV) is only down 6% from its all-time highs. Since it has been paying me dividends during the last couple of years, it has held its ground in the latest sell-off.

Over the last few days, I’ve seen my Portfolio Potential go up about 5%. Diversification is paying off. Psychologically it’s very calming. It also helps that this money is in a retirement account that I don’t plan on touching for quite a while. If I needed to draw down from this account, I would be more concerned about the portfolio’s actual value than its potential.

I keep track of this in my Google Spreadsheet. It automates all the math, so I just have to know which cell to look at for the Portfolio Potential.

Bonus Trick

I know I promised one trick, but here’s a bonus one. This is a good time to focus on accumulating shares of stock.

Over the last couple of days, I’ve been selling off very small amounts of bond allocation and my high-dividend ETF (HDV). I’ve been able to buy shares of QQQ (Nasdaq Cubes) at an average of $300 a share. At the start of the year, a share of QQQ would have cost me $400. If I have $4000 to invest back then I would have been able to buy 10 shares. Now, I’m getting 13 shares with an extra $100 to spare.

I’m not trying to call a bottom of the market. I have no idea where that is. I will just dollar-cost average as it goes lower. I have a lot of confidence in companies like Apple, Microsoft, Amazon, and Google. I know that they’ve gotten very expensive over the last decade. That’s one of the reasons why I removed some tech risk from my portfolio a couple of years ago. Now is a chance to buy tech at a discount.

Should you Invest in Water?

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invest in water

World Water Day was earlier this week. Did you miss it? I did too. It’s better late than never, right?

Did you know there are 2 billion people without access to safe water? (Source: WorldWaterDay.org) That’s crazy. It’s one-quarter of the people on the planet.

Fortunately, the water in the United States is generally very good. In most places, you can get water very easily. Much of the time it is free. (The US isn’t perfect. There are the Flint, Michigan problems and our infrastructure is aging. We also have some extreme droughts in the southwest states.)

When we think of clean water, we think about environmental issues such as global warming and pollution. Those are certainly huge problems, and a great topic for Earth Day in April. Instead, today, I’d like to cover a water topic that few people seem to write about – investing in water.

Investing in water may sound silly. It’s not gold or oil or whatever you would think is a precious commodity to invest in. However, I think those climate change and pollution issues are going to make water an ever-increasing precious resource. Let’s face it, water is the most important resource. Humans can live without gold or oil – water is a completely different story.

Do you remember Cape Town’s water crisis of 2018? They almost ran out of water completely. There was a lot of talk about hitting “Day Zero” when there would be no water. Fortunately, they were able to take a number of steps to buy time and allow the rainfall to catch up. Today, Cape Town is in a good place.

It may seem like there’s plenty of water on the Earth. There is. However, only 1% of the Earth’s water is available and drinkable. The vast majority is saltwater. We can make that saltwater into drinking water, but the process of desalination isn’t cheap or easy.

Investing in Water

It turns out that there are several different water indexes out there. Some examples are:

  • Dow Jones U.S. Water Index (DJUSWU)
  • S&P Global Water Index
  • ISE Clean Edge Water Index

Unfortunately, those indexes created by companies aren’t very useful unless you can actually invest in them. You need an ETF or a mutual fund that you can buy. Fortunately, it looks like there are a few to choose from:

PowerShares Global Water ETF (NYSE: PIO) – This ETF focuses on companies that conserve and purify water globally.
PowerShares Water Resource ETF (NYSE: PHO) – This ETF focuses on companies that conserve and purify water in the United States.
Guggenheim S&P Global Water ETF (NYSE: CGW) – Like PIO, this ETF focuses on companies that conserve and purify water globally. It tracks a slightly different index, but it doesn’t differ too much from PIO. It has the lowest expense ratio of any of the water ETFs I looked at with a 0.57% expense ratio.

If I were to pick one ETF, I’d go with CGW. It has the lowest expense ratio and it is the most diversified. I would eliminate PHO because it lacks the global exposure of the other two ETFs. The performance of CGW and PIO is very, very similar over the last 5 years, so CGW wins with the lower expenses.

How Much Should You Invest in Water

If you’ve been convinced to invest in water, the next question is, “How much should you invest?”

That’s a difficult question. On one hand, water is a very narrow sector. It’s not very diversified at all. On the other hand, the water companies aren’t going away any time soon and I can see the sector growing a lot. It reminds me of investing in solar which has done very well for me since 2015.

Finally, there’s the idea that investing in clean water is… well… just a good thing. It’s investing in something that can only help humankind.

In the end, I’d say it’s probably appropriate for anywhere between 1-3% of your total portfolio. You’ll likely already have some of the companies in index funds. I try not to put too much emphasis on individual sectors. The issue with investing 1-3% of your money is that even if the water investments explode, your portfolio probably won’t see huge gains.

What do you think? Are you going to invest in water? Leave me a comment below and let me know.

Three Top REITs For Passive Income

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I’m on vacation this week. Today, Josh Arnold of Sure Dividend is filling in for me with some insight on REITs and passive income. I’ll be back later this week with an article of my own.

For many, achieving sustainable passive income is the goal after a lifetime of saving and investing. After all, the measure of when one can stop working is often when their passive income can substitute for earned income. That makes it critical that investors are able to save and invest, but when the time comes to generate passive income, it is also critical to choose the right stocks for the highest chance of success.

Real Estate Investment Trusts, or REITs, are a group of stocks that either own physical property that is leased out, or financial instruments related to physical property, such as mortgage-backed securities. REITs exist mostly as pass-through vehicles where most of the earnings of the trust are distributed to shareholders, so dividend yields tend to be quite high for the sector. That is why they are so attractive as income, and why we like them for producing passive income.

In this article, we will examine 3 top REITs that offer investors safe, passive income.

Realty Income Corporation (O)

Our first stock is Realty Income, which bills itself as the Monthly Dividend Company. Realty is so named because it’s famous for having paid common stock monthly dividends throughout the past fifty years, an astounding feat. Realty Income sets itself apart from traditional stocks that pay quarterly dividends, because monthly dividends not only allow for faster compounding, but for those using dividends for income, monthly provides regular inflows rather than large lumps of dividends every three months. For passive income generation, monthly is far superior.

Realty Income owns more than 6,500 properties that it leases under long-term agreements to commercial clients. The trust focuses on standalone retail properties, not malls or shopping centers, as it has proven during its 50+ years of operating that it can generate superior returns via this strategy.

Realty Income has boosted its dividend more than 100 times since going public in 1994, as the trust tends to opt for a few, incremental boosts of the payout during the year, rather than one large increase annually. Realty Income has scale as well, generating more than $3 billion in annual revenue, and trading for a market capitalization of $40 billion.

Apart from paying the dividend monthly instead of quarterly, we like Realty Income for its current yield, its safe payout, and its dividend growth potential. The current yield is 4.4%, which is more than triple that of the S&P 500, so on a pure income basis, Realty Income checks the box. That’s even more so the case when you consider it’s paid monthly rather than quarterly. In addition, Realty Income has raised its dividend for 26 consecutive years.

Realty Income’s payout ratio is also quite reasonable, coming in at just 75% for this year. As REITs are required to pay out substantially all of their earnings as dividends, payout ratios in the sector tend to be quite high. Given that, we see Realty Income’s payout ratio as quite sustainable, and with good room for future growth. We forecast 4% annual growth in FFO-per-share and similar gains in the dividend as a result.

STAG Industrial, Inc. (STAG)

Our next stock is STAG Industrial, a REIT that is focused on the acquisition and operation of single-tenant industrial properties in the US. The trust targets properties that have wide moats by focusing on industrial properties that support e-commerce businesses, for instance. This strategy has generated a strong mix of income and growth for STAG’s history as a public company, and we believe it to be well-positioned for years to come through this strategy.

STAG produces about $650 million in annual revenue and trades with a market capitalization of $7.2 billion. The trust sports an 11-year dividend increase streak, as it has raised its dividend every year since going public.

STAG’s payout ratio is outstanding for a REIT, coming in at just 66% for this year. That leaves ample room for both safety and dividend increases, consistent with the trust’s past. The yield is also robust at 3.7%, about triple that of the broader market, and like Realty Income, it is paid monthly rather than quarterly.

We project 5% annual FFO-per-share growth for STAG, providing long-term dividend increase potential that is stronger than most REITs, which tend to be low-growth stocks.

Essex Property Trust, Inc. (ESS)

Our final stock is Essex Property Trust, a REIT that focuses on acquiring, developing, and managing multifamily residential properties in the West Coast markets of the US. The trust focuses on high-quality apartment communities it believes are in areas with strong growth, and currently owns about 250 different communities consisting of about 60,000 units.

Essex generates $1.5 billion in annual revenue and trades with a $23 billion market capitalization, so it is also quite sizable.

Essex has boosted its dividend for 27 years consecutively, making it a very strong income stock. It pays its dividends quarterly, and the current yield is 2.6%, about double that of the S&P 500. However, we like Essex because it owns properties in desirable markets with favorable long-term demographic trends and a very safe dividend.

The payout ratio for this year is expected to be just 60%, making Essex’s dividend safety top-tier among REITs. The trust has produced strong growth for most of its operating history, and we think that will continue in the years to come, particularly as the current housing market makes it less affordable to buy a home. That leads to rent price growth for Essex and other apartment owners.

We see 1.5% FFO-per-share growth as our base case, with upside potential depending upon housing market price growth.

Final Thoughts

While there are many ways to generate passive income in retirement, we find REITs to be a very attractive choice. Two of the stocks we’ve looked at here offer monthly dividends, rather than quarterly, providing shareholders more frequent income. In addition, they all offer market-beating yields and very strong dividend safety prospects. Finally, all three have good track records of raising their dividends, even during recessions, so overall, Realty, STAG, and Essex offer investors a great mix of yield, safety, and growth potential for passive income.

Myth: No One Ever Got Rich by [X]

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I’ve read many personal finance bloggers repeat some from of “No One Ever Got Rich by [X].” It may not be a complete lie, but it’s dishonest nonetheless.

Usually [X] is “saving money on coffee.” Sometimes it’s saving money on other things. Recently, I read a new twist, “You’re not going to get rich on credit card points.”

If you take each claim by itself, it is probably true. However, coffee could cost you a 1/3 of a million dollars. (That example includes a lot about compound interest. However, that’s simply what is possible when you save money and invest it over a lifetime.)

The problem is that these are singular claims. It ignores that your total money mindset is made up of many beliefs and actions. It’s unlikely that you are going to be frugal in just one area. Usually, if you are saving money on coffee by making it at home, you are also the kind of person who brings their lunch to work. It doesn’t have to be every day, but it’s probably going to happen more often than not.

Credit card points add up over time. I probably get $750 back a year or more. My grocery card gives me 6% (American Express Blue Cash Preferred) on at least $6,000 in groceries a year. That’s more than $350. I’ve been getting cashback for probably at least 20 years now, so that’s about $15,000. My car, Subaru Forester, was around $20,000, so it’s kind of close to getting a free car. I probably made up the other $5,000 with the bonuses when signing up for credit cards. It’s fairly easy to get $500 if you are spending a certain minimum anyway.

Let’s sum up this whole idea in one sentence:

“Success is the sum of small efforts – repeated day in and day out.” – Robert Collier

The quote wasn’t necessary about personal finance. It works in many areas and personal finance is just one of them.

It’s very important to get the big things right too. You definitely don’t want to make a huge mistake buying a house or skipping health insurance. It’s not great if your car payment eats up half your paycheck. Keeping all your money under your mattress instead of investing isn’t smart either.

The big things are important. The small things that happen a lot are important.

Everyone’s heard the stories of a janitor who died with millions and millions dollars. He is the guy who “Got Rich by [X].”