Building passive income with stocks

Previously, I talked about building a passive stream of income with real estate. In this article, we’ll delve a little more into passive income, but instead focus on stocks.

First of all, I never recommend people buy mutual funds. Somehow, when people mention “equities”, which is a term to refer to stocks, they sweep mutual funds in there as well. Mutual funds have annual expenses you simply don’t have to pay if you own the stock directly.

Speaking of mutual funds, go check out some of the biggest ones out there. Look at what their biggest holdings are. Also check out Berkshire Hathaway. You’ll find names like Coca-Cola, IBM, Wells Fargo, and other well known businesses. Essentially, if you buy holdings in each of those companies, you will be investing just like Warren Buffett.

Of course, it’s not EXACTLY like Warren Buffett. The price you purchase a stock position can have a long term impact. Even Coca-Cola has its ups and downs. If you watch it for awhile and catch a situation where its price drops, it might be your opportunity to get in.

People like to point out that the stock market is overvalued. According to several indicators including the famous S&P 500, that is in fact true. Which is why if you invest in an index fund, you will be buying at that average, overvalued price. But if you have a short list of rock solid, dividend paying stocks, then at any given time, one of them may dip. It won’t move the big meter of the index much, but it affords you a chance to start or increase your position in that stock at a good price.

And over time, those small opportunities will start to add up as you begin to receive more dividends and dividend increases. You will begin to make more and more money from simply waking up and being alive. You don’t have to go into work and punch the clock to get paid this way. And that’s the idea.

Don’t tap the money, but instead either store it up to buy more stocks when they hit a discount, or check the DRIP option, and get paid in more stock, which leads to more dividends.

But don’t forget to do your homework. One of Warren Buffett’s strongest points was that he wouldn’t buy something he didn’t understand. He avoided technology stocks back in the 90s, and people thought he was crazy. He dodged the Dot Com Bubble, not through luck, but by sticking to his principles. When you have your eye on a certain stock, dig out financial reports. Try to understand how they make money. Figure out if they have a wide moat, a strong brand, and decades of paying dividends without any cuts.

This will eventually help you build another stream of income.

Stock options and an 83(b) election – the road not travelled

Do you have stock options? Are you about to receive a grant? Are you negotiating for a new job position and they are offering stock options? Then this article is for you.

I have written about stock options before and the pros and cons about retaining them or cashing them in. Boil it all down, and it’s basically up to you and whether you want to go ahead and grab the cash when it’s available or hold on and speculate on getting better value at the risk of losing existing value. There is no “right” or “wrong” in that. It’s really whatever you’re comfortable with.

But when it comes to taxes, there are different options to your options, that you probably have never heard of. And TurboTax probably wouldn’t help you here. This is one of those, if you don’t know about, you don’t know about it.

If you receive any form of stock or a stock option, there is the “default” way that the IRS views your situation and will tax you. Basically, as your stock vests, i.e. becomes available to you over some periodic schedule like four years, you can buy-and-sell immediately, and collect your profit. The IRS will view every nickel of profit as ordinary income and apply regular taxes. If your stock options vest over a four year period, and your company grows at a tremendous amount each year, your tax bill each year will go up, Up, UP. Yuck!

If you file an 83(b) exception at the time you initially receive the grant (but way before anything vests) you instead get to pay ordinary income taxes on the value at the time of issuance, and then later on, you only pay long term capital gains on the growth of the company’s value. The difference between a 28% and a 15% tax on your profits can become significant.

Let’s look at an example. Your company issues you 10,000 shares with a strike price of $1.00/share. Assuming it becomes available to you four years later, you have the option to buy the lot of stock for $10,000. The idea is that maybe your company goes public and the stock price if $20/share. You plunk down $10,000 and then sell the lot for $200,000, leaving you with a tasty profit of $190,000. And Uncle Sam will have his hand out, asking for $53,200(28%rate)

What does it look like if we file an 83(b)? First of all, you pay up front, within thirty days of issuance, $2800 in taxes. This is based on a 28% tax rate. From here on, any profit you glean will be based on long term capital gains. The same four years pass by, and ta-dah! The company is trading at the same $20/share. You buy-and-sell, and pocket $190,000. Only this time, you only have to pay Uncle Sam $28,500, being a long term capital gain. That totals $31,300, which is a $21,900 savings.

Maybe you’re a founder, and are actually getting issued 100,000 shares for a strike price of $0.01. Again, if you IPO four years later at $20/share, and never filed that 83(b), you would owe $559,720 in taxes. If you had filed that special 83(b) in the beginning, you would instead pay $280 up front in taxes, and four years later, a hair underneath $300,000. That is $260,000 in reduced taxes!

What risks are there in filing an 83(b). The risk is tied with the chance that your company doesn’t take off or ever acquired or IPO. In the first scenario, the amount of money on the line is $2800. In the second scenario, $280 is on the line. If you never cash in, you never get to harvest the incredible tax savings. So the question is, would you spend $2800 up front to save $21,900 later on in taxes? Or would you pony up $280 to save $260,000? Usually (99% chance anyone?) the answer is a resounding “yes!!!!!”

So why do you think the IRS has such a narrow window to get this? Because it’s almost always better to file the form and get your big tax deduction at the end.

I mentioned “the road not travelled” in the title. That’s because when I received the three different stock option letters over the past three years, I didn’t know anything about this. I could have saved a lot of tax money. But if there’s another one, I’ll be ringing up my CPA as fast as possible.

P.S. There is an entirely different range of issues when you start discussing Alternative Minimum Tax and how it can be impacted by stock options. I chatted with my CPA for thirty minutes on the phone about 83(b) elections and AMT so I could understand all the ramifications. It pays to have a CPA that understands this stuff inside and out, and yet won’t push you into particular situations. Suffice it so say, he or she is probably NOT working at an H&R Block stand at Walmart. Mine is on the other side of this country. That’s how far I went to find the right person.

Equity harvesting

There’s a phenomenon that I have seen mentioned in more than one place: equity harvesting.

The fundamental concept is the get your hands on the equity in your home and put it to good use. Certain articles seem to restrict the application to buying cash value life insurance. But for me, I prefer to look at everything in terms of capital and cash flows. When you get a one-time burst of money, that is extra capital. When you purchase a dividend paying stock, a renal property, or another device that pays monthly, quarterly, or annual money, that’s a cash flow.

Basically, fetching the equity from your home (which is paying you nothing in monthly cash flows) and using it buy a cash flowing stock can definitely grow your net worth. There is risk involved. This usually involves some type of mortgage such as a HELOC or a home equity loan (haven’t seen any other way to access home equity). Then the money is invested elsewhere and you must now pay off the debt you incurred.

The risk is whether or not you can pay off the debt. The risk is whether your investment will make money. If you bought stocks for dividends, there is risk in whether or not your stocks will stop paying dividends. I put the balance of my HELOC into Vanguard Natural Resources. Essentially, my stock pays me 9% in dividends and I turn around and use it to pay off my 4% HELOC. I pocket the 5% difference, and over the long term, when the debt is paid off, I will then pocket the entire 9%.

What are some other risks? If prime interest rises, then my carrying costs for the debt will go up. Right now it’s pegged at PRIME-0.25% with a minimum of 4%. Prime would have to go up to 4.5% before I would see a change. NOTE: This has nothing to do with the secondary mortgage market. Lending rates have gone up, but PRIME has not.

What have I done to mitigate the risk? Surprisingly, I bought even more Vanguard stock. I am actually earning dividends above and beyond what the balance of the HELOC would earn, which means I am paying off the debt faster. If PRIME rises enough that I can no longer pay off the debt (which would have to be pretty big), I can always sell part of the position and simply pay off the remaining debt.

The other risk is the chance that Vanguard Natural Resources stops paying a dividend or cuts it. To impact my strategy, they would have to make a significant cut. If that happens, I can still sell the stock and pay off the debt. Of course, such a move would probably have catastrophic impact to the stock price, but since I own a considerably bigger position than the debt, I could still make it out alright. But I don’t really expect this. Vanguard has done a great job at actually growing their holdings, acquiring new oil and natural gas reserves, and increasing their dividend payouts since its inception. You can say “past performance is no guarantee of future returns”, but past performance of this company shows that management is doing a good job.

When I read articles about equity harvesting, they aren’t lukewarm. Many tend to drip with derision, accusing insurance agents of ripping people off. I’m not doing anything like that. I wasn’t sold this idea by some shady agent. Instead, I learned about the value of arbitrage, dividend investing, and viewing everything through a lens of capital and cash flows. It allowed me to break out of the conventional investing molds many people find themselves in, and to apply this tactic to grow a new cash flow that will certainly be useful in the years to come.

And guess what I plan to do when my HELOC expires in ten years? I will most certainly investigate the rates and options, and look into doing it again!

Active management vs. passive income

I recently wrote an introductory article where I listed a slew of tactics for building wealth. In this article, I want to dive into what is a crucial aspect of making those strategies work: active management.

For some example of active management consider this: to engage in leveraged real estate you can’t simply “set it and forget it”. The same goes for buying stocks or over funding an EIUL. If you take a passive approach to managing your wealth, you will miss important things and possibly wreck any chances.

Real estate

Let’s look a little deeper at each of these. When it comes to real estate, the most important thing is having tenants in your rental properties. Empty units = no cash. If you have setup your mortgages to get automatically paid, this will drain your coffers quickly. In the area where my rentals are located, I have someone that I can pick up the phone and quickly get cracking on finding new tenants. She also can tell me what the going rate of rent is in the area. She gets a cut of the first month’s rent, but it’s worth it to ensure I’m getting the best rental income while also staying occupied.

I could try to let my property management company cover this task, but they are driven by one thing: occupancy. If they can spend less effort and get it occupied for a little less rent, they’ll do it. My tenant-finding agent doesn’t have the same motivations and so I can count on her to do her job of researching market rates and betting me the best deal. But to engage her services, I need to stay on top of things.

I have a good property manager that sends me emails when tenants are approaching the end of their lease. I also get notices when monthly payments come in. I don’t have to worry about this on a daily basis. But once a month, I need to ensure that everything is working properly and all my people are doing their jobs. This is different than the attitude of throwing money into your 401K plan and maybe looking at once-a-year. It is very different than assuming it’s going to turn in to a fistful of cash in ten years.


When I invest some of my capital in dividend paying stocks like Chevron (CVX) and Vanguard Natural Resources (VNR), I need to monitor their dividend reports. Are these stocks continuing to pay the same or more in dividends? Dividend Growth Investor has a hard rule: when a company cuts dividends or stops paying altogether, abandon ship. Move your money somewhere else. His opinion is that this is one of the first actions taken by companies steering into risky waters. I haven’t adopted that rule wholeheartedly, but it probably makes sense to make such a decision now, because I get put into such a stressful circumstance. It means I need to ensure the dividend payments happen on schedule. There are usually press releases indicating scheduled payments or the lack thereof, so it’s not hard to keep up with. This is especially important considering I’m using the cash distributions from VNR to pay off my HELOC.

I need to NOT get sucked into the daily news about the fluctuations in stock price. In fact, Warren Buffett warns against being too plugged in as well. Instead, seeing quarterly dividend reports is the best indicator of success. The Conservative Investor actually goes so far as getting some classic stock issued shares to hang on your wall, a six pack of Coke (if you own KO), and even framing a dividend check to see everyday as a reminder that holding the stock is paying you money on a regular basis. Anything to remove you from the abstract concept of minute-by-minute price fluctuations, and instead focusing on quality of business and it’s flow of dividends into your pockets. Unless you’re prepared to think in this mindset, stocks can ruin you. If you see a 50% drop in price and it drives you panic, you will not succeed. But if you have thoroughly researched a list of companies and instead see these drops as mere opportunities caused by other irrational investor, then you can do very well.


Finally, I have my EIUL funding setup on automatic. It makes things easier. This one truly is long term. If you cut out before twenty years, it would be for naught. One of the pieces of this plan is to increase monthly contributions by 4% every May. I’ve already done that once. It’s a task I do in order to emulate cost of living increases. I have more money, so why not put more money into my regular contributions. It creates a very strong improvement in the total build up of cash value.


Something that might have confused you is where I wrote “active management” in the title, and yet we are talking about things that are considered “passive income” according to the IRS. Active management is required to make sure everything is performing as expected. The style of investing where you throw money into some index funds and don’t track their historical performance, and even avoid the statements when you know the market is down can be referred to as “passive management.”

If something shifts out of alignment, it is up to me to respond properly. But most of my focus is on building passive streams of income so that when I get to retirement I no longer have to “actively” work to earn money for my day-to-day expenses. If you adopt a passive strategy, you might not realize your rental properties are either vacant, or one of your tenants is five months behind. You might not realize that one of your stocks is no longer paying you the dividends you planned on. And you might not be upping your contributions to your cash value life insurance policy.

Borrowing to spend… or invest?

I recently saw a TV commercial for my local bank where they advertised the incredibly low rates for HELOCs. And then they shot down that by showing how you could use that equity to fund a renovation.

This is classic sales stuff banks use. They know people are much more willing to spend money on themselves if they can get a hold of it. And it’s one of the reasons anti-debt people eschew HELOCs. The concept of a HELOC is to borrow money against your house, and use it to knock out high interest debt with something much lower. But many people can’t help themselves. If they get a hold of $20,000, $30,000 or $50,000, they want to spend it. And then they are even deeper than before.

This problem really escalates when something happens that requires them to sell their house. They could put themselves underwater by taking out more debt than they can sell the house for. And that ultimately leads to panic.

So backing up to the beginning, can you see why there is so much criticism out there for opening a HELOC? But if you start from the beginning with intentions of using that money to build wealth, such as investing in income property that you are going to renovate and resell at a profit, then you now have a powerful tool. I am using my HELOC to fund my position with Vanguard Natural Resources. It is yielding approximately 9% while the HELOC is costing 4%. I get to pocket the difference until I pay it off. Then I can coast into retirement with an extra stream of passive income.

That is why debt is credited as one of the most powerful tools used to build wealth. You just have to properly handle the risks and plot your escape plan.

How to build retirement wealth

If you are a new reader here, perhaps it’s time for an introduction. I like sharing my opinions on how I am building retirement wealth. I also like to document how my own investments are doing. Some of these ideas might sound outrageous or in contradiction to what you’ve heard from your financial planner, financial adviser, or some popular radio hosts.

But the concepts I lay out in my articles are backed up by historical evidence. In fact, I look at history to try and determine the best ways to build wealth. Do you know how you always hear “past returns are no guarantee of future returns”? While true that there is no guarantee, trying to shirk the past and it’s strong evidence is reckless and frankly won’t lead to a good retirement.

So what are the investment vehicles I employ?

  • No mutual funds.
  • No 401K or IRA wrappers.
  • Direct ownership of stocks (not mutual funds).
  • Leveraged real estate
  • Over funded cash value life insurance (also known as permanent life insurance)
  • Build wealth using various forms of arbitrage

These may the types of vehicles I use, but it also includes the concept of actively managed wealth building. Some of these vehicles may be considered passive forms of income, but it takes an active approach to do it right. The concept of simply dumping money into a mutual fund inside your 401K and assuming it will grow to serve you in retirement just doesn’t work.

No mutual funds

The Dalbar report has been monitoring mutual funds and tax deferred savings plans for 20 years. According to the 2013 report, mutual fund investors have significantly underperformed the S&P 500 over the past 3, 5, 10 and 20 years. In 2012, they reported the average performance of investors in equity funds was 4.25%. They further indicate that this is mostly tied to investor behavior rather than fund performance.

The performance numbers are clear: people investing in mutual funds average poorly. Dalbar goes on to make a judgment that it’s the consumer’s fault. This might or might not be a valid judgment. But is that relevant? If people don’t do well, and haven’t been for 20 years, do I really want to plan my retirement under the assumption that I can beat the average? I’m sure it’s what most others think. Dave Ramsey is happy to quote the FDIC in saying that 97.3% of people don’t follow through on their promise to pay off a 30-year mortgage in just 15 years with extra payments.

So why would we expect people to follow through on their attempt to not buy when things rise and sell when a market correction hits? I prefer to build my wealth building plans using the averages.

No 401K or IRA wrappers

401K and other government wrappers come with an incredible entanglement of regulations, restrictions, and other tricks to basically keep your hands off the money. The concept is to get you to put away money and keep your hands off of it until you reach retirement age. But many investment houses take advantage of this situation in the sense that mutual funds and other vehicles available tend to have the highest expense ratios.

People will eagerly point out things like IRAs as giving you more control, but the government has strong limits on how much you can put into an IRA. Suffice it to say, the limits on IRAs aren’t enough to build a retirement plan.

And do you really think the government designed the 401K to help you set aside money and save on taxes? The government wants you to put away money today without paying any taxes, so that you will grow the money into something bigger, and then start paying full blown income taxes when you reach retirement. Yikes!

It’s true that I have a Roth IRA and a 401K, but that is money I put in before I realized it wasn’t working. As you’ll see below, most of that money has been re-applied and is already making way more than what it used to. The only money I have left is trapped in my current company’s 401K and I can’t get to it. The Roth IRA I have is small as well and would serve little benefit if I extracted it.

Direct ownership of stocks

This one really stuns some people that I meet. I don’t like the dismal performance of mutual funds combined with their fees. Instead, I prefer owning stocks directly. If you look at all the studies done over the years, there is one stock market strategy that has proved fruitful: buying and holding dividend-paying stocks.

If you look at people like Warren Buffett, they have created billions by acquiring strong companies when they were on sale. Warren Buffett has also bought cash flowing stocks and companies, and reinvested their proceeds in other strong companies. This has created a compounding affect that has let him beat the S&P500 for years by great margins. The book value of Berkshire Hathaway has averaged it’s growth by 28% during the boom years, and by as much as 18% during bad recessionary times.

It’s not hard to find solid companies. In fact, there are many blog sites dedicated to this, such as Dividend Mantra and Dividend Growth Investor. The companies they invest in are not fly-by-night shady outfits. Instead, they mention thinks like Coca-Cola (KO), Walmart (WMT), and other names you’ll recognize. Companies like Coca-Cola have created millionaires for decades. You can find a list of companies that have paid consistent dividends, increasing them year after year, for over 25 years. It’s not that hard. It turns out, these are some of the best investments regarding inflation. A company that has managed to increase payouts to its shareholders through thick and thin is pretty solid.

Leveraged real estate

After the 2008 housing melt down, many people won’t entertain investing in real estate. The problem is that newspapers were reporting the worst scenarios regarding foreclosures. The truth is, 99% of mortgages are current and paid for. The number of people that suffered rate hikes on risky loans while having insufficient money to keep up were a fraction of a percent.

Real estate has shown a more consistent growth rate than mutual funds. And real estate is one of the easiest investments for middle class people to get into. Using prudent leverage, an average 4-5% growth can turn into 20-25% growth in your investment capital. That certainly beats the 4.25% average growth of mutual funds. Again, this is what happens if you use the averages. You can make more and take on riskier, higher paying options, but why take a risk? You’re already ahead of what mutual funds in 401K wrappers have to offer.

Since real estate was a no brainer, I cashed out my 13-year-old 401K from my old company, paid 37% in taxes and penalties that year, and used it to buy two duplexes with 20% and 25% down. I couldn’t be happier.

The rentals I own are paying me a nice monthly profit as the tenants pay off the mortgages for me. I keep a fair amount of cash in reserve to handle vacancies. And seeing my property yield monthly cash helps me to focus on that instead of pure growth in value.

Over funded cash value life insurance

This is one that stirs a lot of discussion. People have been preached to that cash value life insurance is a rip off and to never, ever, ever buy it! Phrases like “buy term and invest the difference” as well as “don’t mix insurance with investments” flies all over the place.

The thing is, many of the people that preach this opinion have an incomplete knowledge of how it works and how it was designed to function.

To be clear, I’m talking about EIULs, or equity indexed universal life insurance. And the critical component is over funding the policy to the limit set by the IRS. Essentially, buy a policy where you get the minimum amount of death benefit for a given amount of money. That causes your cash value to build faster. If you get the maximum amount of death benefit, then your cash value grows very slowly and it becomes an ineffective tool in storing wealth.

EIULs that are over funded give you the option down the road to borrow from the cash value. Essentially, you borrow money (without paying it back) and when you die, the loan is paid off with the death benefit. Whatever is left over is passed on to your beneficiaries.

EIULs have the benefit on not investing in the stock market, but instead in European options on the market. This is how they institute caps such that your principle is guaranteed to growth somewhere between 0% and 15% of the index it is linked to. If the index goes negative, your cash value stays the same. But if the market goes positive, so does your cash value.

You may not be aware, but that facet is incredibly powerful when it comes to wealth preservation. So many people have seen huge booms in their mutual fund holdings, but the overall performance is knocked back to that Dalbar average of 4.25% due to losses. If your account shrinks by 30% in one year, and then grows by 30% the following year, are back to where you started? Nope. $10,000 would drop to $7,000 and then grow back to $9,100. But if you had an EIUL, that $10,000 would stay put, and then grow to $11,500 (0% loss followed by a 15% gain based on the caps).

EIULs are very expensive for the first ten years; a fact many people like to point out such as Suze Orman and Dave Ramsey. But after ten years, the fees drop to almost nothing. After twenty years, the fees will probably average between 0.5-1.5%/year. Sure beats the 2-4% average cost of mutual funds. And then you get to start taking out tax free loans (compared to mutual fund payments at income tax rates), there is even less to fret about in retirement.

Once I understood the entire picture of what EIULs could and couldn’t do, it was a simple decision to stop investing money in my company 401K and reroute that money into an EIUL.

Build wealth using various forms of arbitrage

Something people are unaware of is how banks make money. Banks borrow money from the Federal Reserve at rates like 3.25% and then turn around and lend it out at 4.25%, pocketing the 1% difference. You can use the same concept.

I took out a HELOC against my home for (PRIME-0.25%) with a floor of 4%, so right now, it costs me 4% to get this money. Then I bought a position in Vanguard Natural Resources, an MLP that has been paying 9% distributions on a monthly basis. As I pay off the HELOC, I am essentially pocketing the 5% difference.

This is also referred to as equity harvesting. All that equity in my house was earning 0%. I am getting the cheapest form of money available, a mortgage, and using it to collect cash flowing assets. After I pay off the HELOC, I can redirect the money towards paying off investment mortgages, buying other dividend aristocrat stocks for even more passive income cash flows, or increase my position in Vanguard Natural Resources. And at that point, I can also renew the HELOC to get more investment capital.

When people ask “would you take out a $50,000 loan on your house and invest it?” my answer is a resounding “yes!”

Stay tuned

I hope you enjoyed this introduction to the concepts of build wealth at the Wealth Building Society. Wealth building isn’t hard, but when you boil things down to sound bites used by radio entertainers, some of the worst advice gets out there. Are the people that are telling you to only take out 15 year mortgages and pay them off as fast possible retiring on mutual funds? Are these people maxing out 401K and IRAs, or are they building wealth through writing books, running TV and radio shows, and piping their business equity pay offs into rental property?

VNR raises dividend 1.2%

Vanguard Natural Resources (VNR) has posted notice that it is raising their monthly dividend from $0.205 to $0.2075 per share per month. This is a 1.2% increase in dividend payouts and comes to $2.49/share every year. It results in a 9.2% dividend yield.

I’m really excited about this. By itself, it isn’t a huge increase. With my position in VNR, it results in an increase of about $7.49/month. Doesn’t sound like much to write home about. But it demonstrates VNR maintaining their historical pace of increasing dividend payments. I am eager for them to continue this over the long term, which will let me pay off my HELOC faster.

After that is taken care of (in an estimate 8 1/2 years), the money will be invaluable to contribute towards paying off real estate loans. Or perhaps I can invest it in other stocks. Or maybe I’ll run into unforeseen circumstances where an extra boost of cash will help deal with something. Every dollar I get through VNR will be thanks to my willingness to take on some low cost debt today in order to build wealth for tomorrow.

Get rich slowly

My whole portfolio is engaged. My rentals are fully leased. My stocks are purchased and yielding cash. And my EIUL is getting loaded up on a monthly basis while starting to gather credits.

In short, everything’s doing great. But I’m starting to feel the desire to invest in more stocks. I can see the success of my purchases in small bits and pieces, and it creates this desire to get some more stock, to see it grow faster.

This is what I keenly read about in Where are the customer’s yachts?  In the book, the author wryly notes how stock brokers make good money selling to clients during booms and panics. But when things are humming along with no excitement, these same brokers do themselves in by not being able to resist “tinkering” in the market. They feel an emotional urge to get in. The problem is, emotion-driven investing is often ruinous.

It’s important to put together a plan. Have contingencies in the event you get another splurge in capital or if part of the plan goes sour. And when you feel emotional drives, cross check them against your plan. But don’t let emotions take over and upset your plan. Warren Buffett along with other successful dividend investors recommend unplugging from daily financial news. Part of this news drives a desire to “feel the pulse” and get active. Are you reading too much? Worried too much about dips in the market? The idea is to invest in solid companies when they are priced right, and then ride them out.
In short, I don’t need anymore stock right now. It’s not the right time. Instead, this is the time to let my plan cruise along as it is. It doesn’t hurt to research options, but don’t do something just because you have a hankering for it. What do I mean by “cruise along”? Perhaps a year from now would be a good time to revisit this idea. And there it is.

Don’t get swept up in trying to get rich quickly. Instead, do boring stuff, like collect rent once a month on your rentals. Collect stock dividends once a month (if you’re lucky), or every three months. But resist the need to speed up the action. If you can’t resist, this isn’t for you.

If you are going to invest in stocks, you have to be able to decide when to get in and when to wait. There is no glamor in getting rich slowly. But that’s the path that is the most likely to succeed. Those who seek to move quickly run a greater risk. Don’t confuse decisiveness with getting rich quickly. After realizing my 401K wasn’t working, I decided quickly and moved towards real estate. It has taken me a year to get that plan in action. But now that that move has been made, it’s time to watch things unfold.

Valuable quotes for investors

I recently read an article that pointed out supposed advantages of mutual funds and then tore those assumptions to shreds by pointing out that something like 85% of actively managed funds under perform their relevant indices. The article proceeds to point out the incredible evidence of how index funds outperform actively managed funds.

The author finally wraps things up with some notable quotes including a partial one from Warren Buffet’s 1996 shareholder letter:

…the best way to own common stocks is through an index fund…  –Warren Buffet, 1996 shareholder letter

If there’s one thing I don’t trust, it’s partial quotes. I decided to find that quote and read it’s entire context. As you see up above, I have linked in the letter so you can find it as well.

Do yourself a favor and read this entire section Waren Buffett wrote:

Let me add a few thoughts about your own investments. Most investors, both institutional and individual, will find that the best way to own common stocks is through an index fund that charges minimal fees. Those following this path are sure to beat the net results (after fees and expenses) delivered by the great majority of investment professionals.

Should you choose, however, to construct your own portfolio, there are a few thoughts worth remembering. Intelligent investing is not complex, though that is far from saying that it is easy. What an investor needs is the ability to correctly evaluate selected businesses. Note that word “selected”: You don’t have to be an expert on every company, or even many. You only have to be able to evaluate companies within your circle of competence. The size of that circle is not very important; knowing its boundaries, however, is vital.

To invest successfully, you need not understand beta, efficient markets, modern portfolio theory, option pricing or emerging markets. You may, in fact, be better off knowing nothing of these. That, of course, is not the prevailing view at most business schools, whose finance curriculum tends to be dominated by such subjects. In our view, though, investment students need only two well-taught courses – How to Value a Business, and How to Think About Market Prices.

Your goal as an investor should simply be to purchase, at a rational price, a part interest in an easily-understandable business whose earnings are virtually certain to be materially higher five, ten and twenty years from now. Over time, you will find only a few companies that meet these standards – so when you see one that qualifies, you should buy a meaningful amount of stock. You must also resist the temptation to stray from your guidelines: If you aren’t willing to own a stock for ten years, don’t even think about owning it for ten minutes. Put together a portfolio of companies whose aggregate earnings march upward over the years, and so also will the portfolio’s market value.

Though it’s seldom recognized, this is the exact approach that has produced gains for Berkshire shareholders: Our look-through earnings have grown at a good clip over the years, and our stock price has risen correspondingly. Had those gains in earnings not materialized, there would have been little increase in Berkshire’s value.

I highlighted one section in particular, because I’ve read other versions of that in other places. Given all this, does this sound like someone that thinks the true path to wealth involves index funds? Or is he possibly saying IF you are going to buy funds, your best bet will be index funds?

Warren Buffett clearly points out that investment professionals aren’t the ticket to building wealth. He also eschews the complex statistics and fancy theories taught at business school. Instead, he leans on a business’s ability to produce and grow earnings. Balanced against price, he is obviously suggesting buying quality companies when they are on sale. When people panic and sell quality businesses, driving the price down, that is your real opportunity to buy. The price may flutter, but if the company is solid, it will recover and you will succeed.

One last thing. I noticed that further down in the comments a rather strange assumption from one person.  They suggest that if you know only 15% of the mutual funds will succeed, why not spend the extra to find them out and invest in THOSE funds. The problem with that advice is the assumption that it’s the SAME funds on top each year, an assumption that can have a dreadful effect on your overall performance as you chase yield.

In summary, I prefer finding quality stocks and real estate that have shown a strong history of earnings and holding onto them long term.

Reading the darndest things

While waiting in a doctor’s office, I couldn’t resist flipping through a copy of Money magazine and reading their title article “101 Ways to Build Wealth”.

I predicted it would be filled with classic advice, like investing mutual funds, maxing out your 401K & IRA, open a 529, and several other things that don’t have enough evidence to back them up. Essentially, things I would never use.

I was mostly right. But what startled me was item #75 buried towards the end. It indicated that now might be the time to get into real estate. I was pleasantly surprised to see Austin listed at the top in job creation, as you can see in the attached picture to the right. The tip nicely pointed out how job growth is a strong indicator of rental markets, a fact keenly mentioned in the middle of a podcast interview with Jeff Brown.

It was delightful to see references to stocks I had already learned about from the Dividend Growth Investor. I have used his website to help develop criteria for adding dividend aristocrats to my wealth building plan. The fact that I had already heard of them made me feel like I was ahead of the curve slightly in wealth building.

The tips about mutual funds were spread throughout the article. I saw a recurring pattern where they would synonymously refer to mutual funds and stocks both as equity holdings. In essence, when people talk about holding stocks, they really mean stock-based mutual funds. The commonly preached mantra is that stocks are way too risky, and mutual funds are simpler a safer way to hold the same thing. No attention is paid to overall buy-and-hold stock performances compared to buying mutual funds from the perspective of wealth building. They really aren’t the same thing, and mutual funds aren’t inherently safer. Instead, mutual funds mitigate away too much upside for the sake of not enough downside protection. Combined with terrible fees, they are a horrendous way to build wealth, and the historical evidence proves it.

Basically put, real estate is the biggest component in my wealth building plans, and this article nicely made reference to it. Stocks also play a key role in developing another basket of income. But not mutual funds. I was glad that they didn’t totally avoid the subject of these two.