Stocks — Part VI: Portfolio ideas to build and keep your wealth

Posted: May 12, 2012 in Stock Investing Series
Tags: , , ,

That’s OK.  It’s about to start.

Today we’re gonna look at the fun stuff.  What, exactly, can we use to build and keep our wealth.

I’m going to give you three portfolios each using the tools (funds) we discussed last time.  First will be exactly what I tell my 20-year-old to do.  She could care less about investing.  With this simple approach she doesn’t have too.  All she needs to do is to keep adding to the pot and let it ride.  Years from now she’ll wake up rich.  Along the way she’ll out-perform roughly 80% of the more actively engaged investors out there.  We’ll call this The Wealth Building Portfolio.

Next I’ll share with you what Mr. and Mrs. jlcollinsnh do as the semi-retired couple we are.  We’ll call that one The Wealth Preservation and Building Portfolio.

Your personal situation is likely different from ours.  But using these two as parameters, and after reviewing your personal “considerations” as we discussed last time, you should be able to fashion the four tools into something that works for you.  If you have questions just post them in the comments and we’ll work thru them together.

Finally, I’ll share with you an idea I’ve been playing with of late.  Let’s call it The Wealth Building with Cash Insurance Portfolio.  I know I’ve got some pretty sharp investors reading this blog and I hope they’ll weigh in with some opinions on it.

The Wealth Building Portfolio.

Here’s the thing.  If you want to survive and prosper as an investor you have two choices.  You can follow Dr. Lo’s advice and seek out broad diversification with asset allocation.  Your hope is that this will smooth out the ride even as it reduces your long-term returns.

Screw that!  You’re young, aggressive and here to build wealth.  You’re out build your pot of F-you Money ASAP.  You want what’s behind door #2.  You’re going to focus on the best performing asset class in history:  Stocks.  You’re going to “get your mind right,” toughen up and learn to ride out the storms.

You’ve heard the expression, “Don’t keep all your eggs in one basket.”

You’ve likely also heard the variation, “Keep all your eggs in one basket and watch that basket very closely.”

Forget it.  Here’s what your old uncle jlcollinsnh says:

Put all your eggs in one basket and forget about it.  

The great irony of investing is the more you watch and fiddle with your holdings the less well you are likely to do.  Fill your basket, add as you go along and ignore it the rest of the time.  You’ll likely wake up rich.

Here’s the basket: VTSAX.  No surprise here if you’ve been reading along in this series so far.  Stock Index Fund.  Low cost so almost all our money is working for us.

Owning 100% stocks like this is considered “very aggressive.”  It is and you should be.  You have decades ahead.  Market ups and downs don’t matter ‘cause you avoid panic and stay the course.  If anything, you recognize them as the “stocks on sale” buying opportunities they are.  Perhaps 40 years from now you might want to add a Bond Index Fund to smooth out the ups and downs.  Worry about that 40 years from now.

At this point I can see the financial gurus of the world gathering feathers and heating up the tar.  So let me explain.

Previously, we explored the idea that financial crisis are just part of the landscape and the best results come from simply riding them out.  You can’t predict them.  You can’t time them.  Over your investing career you’ll experience many of them.  But if you are mentally tough enough you can ignore them.

So now if we agree that we can “get our minds right” what shall we choose for riding out the storm?  Clearly we want the best performing asset class we can find.  Just as clearly, that’s stocks.  If you look at all asset classes from bonds to real estate to gold to farmland to art to racehorses to whatever, stocks provide the best performance over time.  Nothing else comes close.

Not even close

Let’s take a moment to review why this is true.  Stocks are not just little slips of traded paper.  When you own stock you own a piece of a business.  When you own VTSAX you own a piece of every publicly traded business in the USA.  Many have extensive international operations so you get to participate in the world markets too.

These are companies filled with people working relentlessly to expand and serve their customer base.  They are competing in an unforgiving environment that rewards those who can make it happen and discards those who can’t.  It is this intense dynamic that makes stocks and the companies they represent the most powerful and successful investment class in history.

Because VTSAX is an index fund we don’t even have to worry about which will success and which will fail.  It is ‘self cleansing.’  The failures fall away and the winners can grow endlessly.

A portfolio of 100% stocks, which is what VTSAX gives you, in study after study provides the greatest return over time.  The only downside, and I mean only, is that the ride will be very rough at times.  Admittedly, it’s a big one.  If you are not tough enough to stay the course, if you get scared and bail when the storms are raging you are going to drown.  But that’s a failure in you, not a downside of this asset class.

As an aside, there are a few studies that indicate that a 80%/20%, stock/bond mix will actually outperform, very slightly, 100% stocks.  It is also slightly less volatile.  If you want to go that route and take on the slightly more complicated process, you’ll get no argument from me.

Could it really be this easy?  Yep.  I started investing in 1974.  At the time VTSAX had yet to be created (Bless you Jack Bogle!), but just $15,000 invested in the Dow stocks, and left to ride, by the end of 2011 would be $1,000,000. This despite all the panic and collapses and recessions and disasters that we’ve endured during these last 38 years.  Imagine what you’d have if you’d kept adding to the pot along the way.

Unfortunately, I wasn’t smart enough at the time to do it.  But this is the “Simple Path to Wealth” I created for my then 19-year-old daughter:  Put all your eggs into one basket, add more whenever you can and forget about it.  The more you add the faster you’ll get there.  Job done.

The Wealth Preservation and Building Portfolio.

But wait you say, I’m at or nearing retirement.  I’ve built my wealth.  Now I want to hang on to it.  I want a smoother ride.  What then?

Yeah, me too.  A few years ago as I was nearing my own retirement I made some additions to VTSAX.  Hold on now, this is going to get really complicated.  You’re going to have to add two more index funds.  Oh my!

We now enter the world of Asset Allocation and this will require slightly more of our time.  In addition to adding the additional funds we’ll want to decide how much to allocate to each.  Then once a year or so we’ll want to rebalance to keep the allocations where we want them.  This is also what you’ll be doing if you use the 80% stock/20% bond mix option above.  It’s going to take a couple of hours once a year.  You can handle it.

100% stocks, even in the broadly diversified VTSAX is considered very aggressive.  High short-term risk (read: gut wrenching drops) rewarded with top long-term results.  Perfect for those who can handle the ride and have the time.

But it’s not for everybody.  Maybe you don’t want to deal with this level of risk.  Maybe a bit more peace of mind is required.  As you get older you might want to smooth the ride a bit, even at the cost of lower overall returns.   You have to sleep at night.

Now that I’m kinda, sorta retired and we have F-you Money, me too.  My wife and I hold some other stuff in our portfolio.  But not much.   Here it is:

50% Stocks.  VTSAX (Vanguard Total Stock Market Index Fund)  Still our core holding for all the reasons we’ve discussed.

25%  Real Estate.  VGSLX  (Vanguard REIT Index Fund) and the equity in your home if you own one.  REITs (Real Estate Investment Trusts) invest in real estate.  They provide an inflation hedge and dividend income.  But during periods of deflation real estate prices plummet.

REITS are the Ying to our Bonds’ Yang.

20%  Bonds.  VBTLX (Vanguard Total Bond Market Index Fund) Bonds provide income, tend to smooth out the rough ride of stocks and are a deflation hedge.  But during times of inflation and/or rising interest rates they get hammered.

5%  Cash.   Cash is always good to have in hand. Cash is also king during times of deflation.  The more prices drop, the more your cash can buy.  But idle cash doesn’t have much earning potential and when prices rise (inflation) its value steadily erodes.

We mostly keep ours here:  VMMXX.   Money Market Funds used to offer higher yields than banks.  When rates rise they will again.  These days, with interest rates near zero, not so much.  Now we also keep some in our local bank.  If you prefer, an on-line bank like ING works fine too.

So that’s it.  Four simple tools.  Three Index Mutual Funds and a money market and/or bank account.  A wealth builder, an inflation hedge, a deflation hedge and cash for daily needs and emergencies.  Low cost, effective, diversified and simple.

You can fine tune these investments to your own personal considerations.  Want a smoother ride?  Willing to accept a lower long-term return and slower wealth accumulation?  Just increase the percent in VBTLX. Comfortable with volatility?  Want more growth?  Add more to VTSAX.  Expecting higher inflation?  Add more VGSLX .

The Wealth Building with Cash Insurance Portfolio.

Confession time.  I hate bonds and I’m not all that keen on REITs either.

The more I own of them the less I own of stocks and, as we’ve discussed, stocks are far and away the best performing asset class.  So, each dollar not in stocks is a dollar working below par.

Dollars in cash are completely lazing away in the sun drinking Pina-coladas.

Since I consider these dollars are my slaves I want them working full time all the time.

Problem is sometimes (to beat this analogy to death) financial panics and market collapses come along and kill off a bunch of my slaves working away in the stock market fields.  It’s nice then to have others less stressed to pull from the bond and REIT fields to take their place.  But still, even these tend to get wounded in a collapse.

The cash slaves on the beach their feet up in the lounge chairs, slathered sun tan oil and sipping cool drinks get fat and steadily worth less.  But when collapses come they are away from the bullets.  They are the most rested of all when I put them back to work.  Their laziness drives me crazy but when the crunch times come I always wish I had more of them.

Let’s look again at the The Wealth Preservation and Building Portfolio above, figuring we have a million in it:

  • 50% of our dollars in the stock fields working full tilt in the hot sun.  500k
  • 25% with easy duty in the REIT fields.  250k
  • 20% with really easy duty in the bond fields. 200k
  • 5% napping in the sun on the cash beach. 50k

You could easily pull about 4%/40k from it each year for your living expenses and ride out most financial storms.  But you are giving up a big slug of wealth building potential.  Since most financial storms last less than three years, maybe there’s a better way.  What if we did this:

  • 88% of our dollars working full tilt in the hot sun.  880k
  • 12% napping in the sun on the cash beach. 120k

Since most of the time the market goes up, this portfolio will have a far stronger ability to build wealth.  We can draw our 40k from the dividends and capital gains our stocks in VTSAX throw off.

When times get tough and stocks slide, we leave VTSAX alone and let it heal.  With a 120k/three year cushion in cash we can pull those dollars off the beach to spend in the meantime.

When times improve we go back to tapping VTSAX and we rebuild our cash position for the next cycle.

Mmmm.  I haven’t convinced myself just yet.  What do you think?

Disclaimer:  Like everything on this blog, this is only sharing ideas.  You are solely responsible for your own choices.

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Comments
  1. SC says:

    Love it! Love it! I’ve been wanting less theory and more practical steps. Keep it up!

    I like the idea of VTSAX, but as I hope we’ve reached a bottom in housing prices, and we can’t get any lower interest rates, that hopefully implies that interest rates and housing prices will increase going forward. If this is true wouldn’t buying REITs be a great place to put a larger chuck of money over the new few years?

    Also, this might be newbie question, but if you have several index funds within Vanguard, say 50% and 50%, if you want to rebalance them to 60% and 40%, you’d have to sell one to add to the other obviously, but do you have to pay the tax on whatever you’ve earned that you sell to put into another fund? Or because its still within the vanguard account do you not have to pay tax until you sell and/or take it out?

    LOVE IT! Keep it up!

    • jlcollinsnh says:

      And I love your enthusiasm, SC!

      Your thinking on interest rates, housing and REITS is sound. As it happens, I agree with your assessment. But remember, we are both now on the slippery slope of predicting the future and timing the market. A losers game, that. Be careful overweighting into REITS.

      As it also happens, I am in the process of selling my house and returning to the wonderful carefree life of renting. Probably bad timing.

      As I discuss above, at this stage of my life I personally use the The Wealth Preservation and Building Portfolio. That holds 25% in VGSLX (Vanguard REIT Index Fund). Once I free up the house equity it will go into this fund to maintain the allocation, but no more.

      Newbie or not, it’s a good question. The fact that you’d be selling one Vanguard fund and buying another does NOT protect you from any capital gain due on the sale. It is a taxable event. Unless, of course, you hold the funds in a tax deferred account like an IRA or 401k. In that case you can buy and sell funds tax free even across fund companies.

      Love your comment. Keep it up!

  2. […] Stocks — Part VI: Portfolio ideas to build and keep your wealth […]

  3. Scott says:

    Look up value averaging — that’s the best way I’ve found to know when to move money between the stocks and the cash.

    And I’d suggest that you stick with the mutual fund, not the ETF, for the major holdings to avoid any bid-ask spread problems. Maybe start with the ETF for the low expense ratio, but once you’re comfortably above the admiral line, flip it into the mutual fund so you don’t have to pay ask for more, or settle for bid when you take it out.

  4. Chetbodet says:

    Why do you recommend VTSAX over the ETF version of the fund VTI? I am looking to invest in one next year in a non tax deferred account. It seems like the trading costs that go along with the mutual fund make it slightly less attractive than the ETF.

    Note: I am looking to invest approx $11K starting with bimonthly investments of $250, but will have less than $50K total invested with Vanguard.

    • jlcollinsnh says:

      I don’t actually. As you point out, VTSAX and VTI are just different versions of the same fund, along with what is called Investor Shares which has a 3k buy in and a slightly higer expense ratio. VTSAX is just the version I own.

      VTSAX and VTI even have the same ultra low expense ratio and you can get into VTI with out the 10k minimum invstment required by VTSAX.

      My only reservation with VTI would be if you are paying a brokerage commsion to buy and/or sell. That’s a no-no. But dealing directly with Vangard, no problem.

  5. […] Stocks — Part VI: Portfolio ideas to build and keep your wealth […]

  6. […] Stocks — Part VI: Portfolio ideas to build and keep your wealth […]

    • Cody says:

      I know you endorse VTSAX until you get closer to retirement. My question is how do you know when to start diversifying? I realize that everyone’s situation is different and it’s a tough question to answer. Are there any warning signs or checkpoints where one should look to start diversifying? I’m just starting to invest and I hope to have my F-you money in 10 years. I haven’t built much wealth so diversifying for me is counterproductive. I have no idea when to start. Please excuse me if there’s a post on this that I’ve missed.

      • jlcollinsnh says:

        Hi Cody….

        Great question. Remember that diversifying smooths out the ride, but at the expense of overall performance. With that in mind….

        I’d stick with VTSAX (stocks) as long as I was working and saving 50%+ of my income. I’d just keep adding and building my holdings and actually hoping the market would fall so I could buy more shares on sale.

        As I was approaching the time I wanted to live on that money and would be unable to contribute more I would diversify.

        If the market were down or flat as I approached that shift, I’d keep adding to VTSAX till the last possible moment.

        If the market was soaring and everybody was talking about how this time it was different and the market could only go higher, I’d start shifting my allocation sooner. That’s when crashes happen.

  7. […] Stocks — Part VI: Portfolio ideas to build and keep your wealth […]

  8. […] 4. You can’t go wrong with an Index fund A portfolio of 100% stocks, which is what VTSAX(Vanguard Total Stock Market Index Fund) gives you, in study after study provides the greatest return over time.  The only downside, and I mean only, is that the ride will be very rough at times.  Admittedly, it’s a big one.  If you are not tough enough to stay the course, if you get scared and bail when the storms are raging you are going to drown.  But that’s a failure in you, not a downside of this asset class.  –  jlcollinsnh […]

  9. Nephi says:

    One question that I have is at what point do you sell? You mention that “We can draw our 40k from the dividends and capital gains our stocks in VTSAX throw off.” The capital gains come from selling, right?

    • jlcollinsnh says:

      Hi Nephi….

      Great question! Depending on your needs, there are several options.

      Stock funds, like VTSAX actually provide three avenues that can increase your holdings:

      Dividends, capital gains distributions and capital gains in the price of your shares.

      Dividends are based on the dividends the stocks held in the fund pay and they are paid out on a regular basis, typically twice a year. You can choose to have them paid to you in cash or reinvested in the fund. VTSAX currently pays out around 2% in dividends.

      Capital gains distributions are any capital gains the fund earned by selling stocks within the fund. As you might guess from the name these are paid out, or distributed, on a regular basis just like the dividends. usually on an annual basis. Like dividends, you can choose to have them paid to you in cash or reinvested.

      Also like dividends you will owe tax on these assuming the fund is held in a taxable account.

      Finally, if your fund shares increase in price you will also have a capital gain. However, this is not distributed and no tax is due until you sell your shares. To access this money you must sell shares, something you can do anytime. You can also arrange to have shares sold automatically.

      Hope this helps!

      • Nephi says:

        Huh, that’s really interesting. I’ve never heard of capital gains distributions before. I know about dividends but not those. The page for VTSAX on Google Finance only shows dividends but not capital gains distributions information as far as I can see. Looking at morningstar it looks like maybe it hasn’t done any capital gains distributions at least in the past two years. Is that correct? Also, I checked the box to receive follow-up comments by email but it never notified me of your recent reply… I guess I’ll just keep checking back here on my own until I know that’s working.

        • jlcollinsnh says:

          Correct!

          As an index fund VTSAX will very rarely, maybe never, sell the stocks it holds so you are unlikely to see a capital gains distribution. This is one of the reasons index funds are considered to be “tax efficient.” for more on how they report such things:

          https://personal.vanguard.com/us/content/Funds/FundsVGFundsAboutGainsLossesJSP.jsp

          actively managed funds, on the other hand, buy and sell all the time. the “active” part of their name.

          each time they do, it is a taxable event, the sum total of which is accounted for at the end of the year. If there is a net gain on these transactions, the shareholders receive a taxable distribution. Any net loss is NOT tax-deductable to the shareholder, but it is carried forward in the fund to offset any future gains.

          This is one of the:

          — many reasons I prefer index funds.
          —reasons some investor prefer choosing their own individual stocks so they can choose if/when to take profits/loses.
          —reasons that if you own actively managed funds it makes sense to hold them in tax advantaged accounts.

          Very sorry to hear you are having trouble with the follow-up comment feature. That’s a WordPress issue and I am clueless as to how to correct it. Any ideas? Anybody?

  10. […] Stocks — Part VI: Portfolio ideas to build and keep your wealth […]

  11. Julie says:

    I’m really enjoying this series. You have a way of simplifying everything without being condescending that is very unique. If you ever get bored with retirement, you should consider becoming a teacher, or at least a financial tutor.

    My only disappointment is that I did not find your blog or this series a year ago. I recently hired a financial advisor and invested my savings after way too many years of not having my money work for me, and I’m realizing that I should have done it differently. Oh well, live and learn, right? I’ll start “fixing” things soon, so that it’s all set up in a way that I’m much more comfortable with. From the start, I kept wondering why I shouldn’t just invest most or all of my money in the S&P 500, but I made the mistake of listening to everyone else’s “advice,” including the so-called experts. It’s great to hear someone with experience confirm what I already believed. Thanks for all of the great advice!

    • jlcollinsnh says:

      Wow, Julie….

      high praise indeed. you made my day!

      it’s never too late to get things on track. good luck!

      • Julie says:

        Thanks for the encouragement! Unfortunately I have to delay getting things on track; due to illness, I can’t work, and will likely go through my cash long before I’m better, so I’ll have to liquidate some investments. It’s definitely not the time to be moving things to something new. But as soon as I get back on my feet, that’s the first thing (in addition to finding a way to save up again, of course.) This is a great lesson in why it’s good to have savings!

        And you’ll have to trust me when I say that I wouldn’t have said it if I didn’t mean it. I’ve been following a lot of personal finance blogs, and this is now my favorite. I love your direct, straightforward approach.

  12. […] a habit of making incremental change so that you are shifting your goal to create more discretionary time than making more […]

  13. Toddius says:

    I have enjoyed reading the blog.

    You said:
    “At the time VTSAX had yet to be created (Bless you Jack Bogle!), but just $15,000 invested in the Dow stocks, and left to ride, by the end of 2011 would be $1,000,000.”

    How are you figuring this? Back on 1974 the Dow was at about 850 and today it is about 12420. That is only 14 time greater.

    • jlcollinsnh says:

      Hi Toddius…

      Glad you like it.

      I used the spreadsheet calculator you can find here:

      http://observationsandnotes.blogspot.com/2011/08/stock-market-dow-growth-calculator.html

      In put start year: 1974
      Under that input investment: $15,000

      In put end year: 2011

      It will tell you the 15k grows to exactly $1,003,387, an annual return of 12%.

      Alternatively it will also tell you that it takes an initial investment of exactly $14,949.36 to end in a cool, even 1m.

      What? You thought I was making it up?? :)

      • Toddius says:

        I thought that 12% was high for the dow, but I wasn’t looking at the dividends. Without the dividend it is only about 7% annually.

        Thanks for your advice. It’s making me rethink my investments entirely.

        • jlcollinsnh says:

          My pleasure, and I appriciate your question.

          Just curious, how are you invested at the moment?

          • Toddius says:

            I am 30, no kids, not married (but we might as well be), and currently renting our apartment.

            My retirement is 60% in my company’s stocks. The company I work for is employee owned. 20% in various higher-risk, what I now know are, index funds. The last 20% are in various stocks that, looking back, I choose randomly. A total of 40k in my retirement fund.

            Most (80%) of my private savings is cash siting in the bank and the other 20% are in other various stocks. A total of 70k private savings.

            No debt.

            The stocks have done good and bad, but I don’t think they are making money as a whole, far to risky and take more time than I should be spending on them. I put away about half my income, but have not maxed out my retirement in the past. I could have, but I’ve been thinking about buying a house.

            I live in a relatively expensive housing city, and currently looking at rental properties (duplex or triplex). We’d live in one and rent the other(s). I see this as a much better investment than a house, which my friends are all buying. I know it will be more work, but the numbers work out so much better. If I were to buy I will have to use all of my savings and probably dip into some of the retirement.

            That’s me. What do you think?

            • Toddius says:

              I should probably follow this up with admitting that I haven’t had much of a strategy so far. Other than saving and the investment property.

            • jlcollinsnh says:

              I think you’ve done very well. Looks like an aggressive savings rate and no debt. Kudos.

              Right now you are almost exactly at a 50/50 allocation stocks v. cash. Way too conservative for a 30 year old, but I’m guessing you are building cash for the house purchase.

              If you haven’t already you might want to read:

              https://jlcollinsnh.wordpress.com/2012/02/23/rent-v-owning-your-home-opportunity-cost-and-running-some-numbers/

              Buying a house isn’t just about the numbers, but it is important to run them so you know what they say. Personally, in you situation, I wouldn’t do it. 30, single, no kids, working hard…who needs the house hassle. But that’s just me.

              If you do decide to buy, now is likely as good a time to do it as we’ll see for a long while. And I agree the multi-family is the better investment. but that will make you a landlord and that’s a part time job. Think long and hard before taking it on. The market is filled with people burned and desperate to get out of it. who, of course, make great sellers for you.

              as for your stocks, as you know I believe trying to pick individual stocks is a loser’s game. I still do it for fun with a tiny amount of my capital, but the heavy stock lifting in my portfolio is done by VTSAX. but any low cost total stock market or S&P 500 Index Fund offered in your 401k will do.

              Also, 60% in just one stock is very scary. I’d adjust that ASAP.

              My guess is I’m not telling you anything you don’t already know. :)

              Check back and let us know what you decide. Good luck!

              • Toddius says:

                The company stock is not in the same investment category as regular stock. The company is small (500 people) and not publicly traded. In fact, we can’t sell the stock unless we leave and if this is the case then we are forced to sell. The stock price is adjusted annually to the calculated value of the company’s worth. It has an excellent track record, 10% consistently for the past 30 years. I also see this as an investment in my career and position within the company.

                Thank you for the advice. I’ll let you know how it goes.

  14. […] Stocks — Part VI: Portfolio ideas to build and keep your wealth […]

  15. ddrem says:

    Buying the indexes may have historically been the most profitable way to invest, but we can’t be sure that trend will continue.

    The stock market is a great vehicle for exactly two groups of people: institutions and corporate executives. For individual investors, it’s very much like a ponzi scheme since many companies pay none or only a tiny dividend these days. We have to hope that there is more money pouring into the stock market in the future to keep share prices rising if we hope to achieve our investment goals.

    But stock prices are a function of supply and demand. What would happen if demand left the market for a very long time? There could be any number of financial “disaster” scenarios or even more normal events which greatly reduce demand for stocks. e.g., What would happen if Baby Boomers moved out of the market and into more “safe” investments like bonds as they retired? As it clearly states in every stock market-related commercial: past performance is no guarantee of future results. And if everyone is basing their investment strategy on the belief that because it has always gone up over time it will continue to do so, that seems like a disaster waiting to happen. That is the same logic people were using for buying into the top of the tech bubble.

    And while index funds are surely a better bet than typical mutual funds due to lower management fees, in reality you are trading one stock-picker for another. The indexes aren’t static. The stock pickers at Dow Jones and S&P jettison poor performers and bring in newer stocks all the time.

    But what about the companies comprising the indexes? Their executives and boards are diluting the hell out of your shares with the options they grant themselves. And then they take the cash that could have been returned to you as a dividend and initiate share buybacks to cover up all of that dilution. They have found a great way to enrich themselves at your expense, and no one seems to mind much so long as the stock price continues to climb.

    Our economy and our stock market are not ATMs with a never-ending supply of cash coming out of them. They are vulnerable to many things beyond the control of anyone — even our politicians, central bankers, etc., as witnessed by the near-collapse of our banking system a few years ago. In 1494, the Pope divided the new worlds up between the two greatest world powers, Spain and Portugal. Anyone know how they’re doing now? And if the Roman Empire only lasted 1,000 years, America’s days are surely numbered too. The line may have been up for 100+ years now, but it won’t remain that way indefinitely.

    The stock market could revert to its original purpose of raising capital for corporations instead of being a vehicle for enriching the brokerages and corporate executives at the expense of shareholders. Companies could start paying real dividends again (higher than their bond rates since equity is inherently more risky) and stop diluting their shareholders. The politicians could gets their acts together and reform social security, medicare, etc., balance the budget and start paying down our national debt (~$15T with another ~$60T in unfunded/off-balance-sheet liabilities). And if all that happens in a timely manner, you’ll probably be just fine investing in the indexes. But if all the problems we’re facing aren’t solved, and demand contracts for an extended period of time, the stock market is probably not going to be the best place to put your nest egg.

    • jlcollinsnh says:

      Hi ddrem…

      …and welcome.

      Reading thru your comment, pretty clearly we are going have to agree to disagree.

      My views are laid out in some detail in my Stock Series and address the issues you raise. In addition, below I’ll offer some thoughts point by point. I’ve put your words in quotes to separate them from my response for clarity.<

      "Buying the indexes may have historically been the most profitable way to invest, but we can’t be sure that trend will continue."

      True enough, but also true of anything at all. When it comes to predicting the future we have to work with what we have.

      “The stock market is a great vehicle for exactly two groups of people: institutions and corporate executives. For individual investors, it’s very much like a ponzi scheme since many companies pay none or only a tiny dividend these days. We have to hope that there is more money pouring into the stock market in the future to keep share prices rising if we hope to achieve our investment goals.”

      Not sure how the size of dividend payments makes stocks a Ponzi scheme.

      There is nothing magic about dividends. They are only one option companies can use for allocating their earnings.

      Basically there are four things (at least that I can think of off the top of my head) that companies can do with their profits.  They can pay them out as dividends.  They can use them to build the company.  They can buy back their own shares.  They can buy other companies. They can sit on them waiting for opportunities.   See I came up with a fifth!

      Further, dividends are not related to or dependent on investment money coming into the market or the stock paying the dividend. They are sourced from the earnings of the business.

      “But stock prices are a function of supply and demand. What would happen if demand left the market for a very long time? There could be any number of financial “disaster” scenarios or even more normal events which greatly reduce demand for stocks. e.g., What would happen if Baby Boomers moved out of the market and into more “safe” investments like bonds as they retired? As it clearly states in every stock market-related commercial: past performance is no guarantee of future results. And if everyone is basing their investment strategy on the belief that because it has always gone up over time it will continue to do so, that seems like a disaster waiting to happen. That is the same logic people were using for buying into the top of the tech bubble.”

      Supply and demand are only one force driving stock prices. This is the “foam” I describe in Part III: https://jlcollinsnh.wordpress.com/2012/04/25/stocks-part-iii-most-people-lose-money-in-the-market/

      The other, and far more powerful, force is the earning power of the business your stock gives you ownership in.

      “And while index funds are surely a better bet than typical mutual funds due to lower management fees, in reality you are trading one stock-picker for another. The indexes aren’t static. The stock pickers at Dow Jones and S&P jettison poor performers and bring in newer stocks all the time.”

      There is a profound difference between what an active fund manager is attempting and the flow of stocks into and from an index.

      The active manager is trying to choose which companies will out perform their peers. Will JPMorgan do better than Bank of America?

      An index adds companies as their business grows to a sufficient size and discards them only when their business collapses below a minimum level. This is a very powerful process of self cleansing. I covered this in some detail here:
      https://jlcollinsnh.wordpress.com/2012/04/19/stocks-part-ii-the-market-always-goes-up/

      “But what about the companies comprising the indexes? Their executives and boards are diluting the hell out of your shares with the options they grant themselves. And then they take the cash that could have been returned to you as a dividend and initiate share buybacks to cover up all of that dilution. They have found a great way to enrich themselves at your expense, and no one seems to mind much so long as the stock price continues to climb.”

      Certainly there are executive abuses in the board room, but they are not as common as you seem to believe. Shareholders can, and do, vote with their feet. If the execs and board of a company behave irresponsibly it takes surprisingly little time for shareholders to react and step away.

      It is hard for an individual investor to see this coming in any given stock, and that’s another reason indexes outperform.

      Finally, share buybacks are not done to cover up dilution, nor would they be effective in that roll. They are an alternative way to return value to the shareholders, exactly like dividends, but without tax consequences.

      “Our economy and our stock market are not ATMs with a never-ending supply of cash coming out of them. They are vulnerable to many things beyond the control of anyone — even our politicians, central bankers, etc., as witnessed by the near-collapse of our banking system a few years ago. In 1494, the Pope divided the new worlds up between the two greatest world powers, Spain and Portugal. Anyone know how they’re doing now? And if the Roman Empire only lasted 1,000 years, America’s days are surely numbered too. The line may have been up for 100+ years now, but it won’t remain that way indefinitely.”

      Here we agree. No great power lasts forever and if you believe “America’s days are surely numbered” certainly you might want to look elsewhere for your investments.

      But the US is still the dominate world economy and, in my view, will remain so for the next 100 years and counting. That dominance will shrink over time, as it has been doing since the end of WWII, but it is not ending anytime soon.

      “The stock market could revert to its original purpose of raising capital for corporations instead of being a vehicle for enriching the brokerages and corporate executives at the expense of shareholders. Companies could start paying real dividends again (higher than their bond rates since equity is inherently more risky) and stop diluting their shareholders. The politicians could gets their acts together and reform social security, g>medicare, etc., balance the budget and start paying down our national debt (~$15T with another ~$60T in unfunded/off-balance-sheet liabilities). And if all that happens in a timely manner, you’ll probably be just fine investing in the indexes. But if all the problems we’re facing aren’t solved, and demand contracts for an extended period of time, the stock market is probably not going to be the best place to put your nest egg.”

      Overall, a fair list of some of the challenges around today, and they are not likely to be resolved in anything like a timely manner. But it is no where near as grim as the list that might have been put together in 1860 or 1916 or 1933 or 1941.

      But that’s exactly why I favor ownership in successful corporations operating in the USA (still the world’s strongest economy) and around the world seeking new opportunities. That’s what it means to be invested in a broad-based Index Fund. That’s exactly what VTSAX is and it allows me to be poised to benefit from growing prosperity anywhere in the world.

      So, as I said, we disagree and that leaves me curious. Where do you invest your nest egg?

  16. Fritz Hahn says:

    Hi Jim-
    Here is a solution for those of us who work with brokers:
    http://now.msn.com/money/0527-german-financial-adviser.aspx
    the New Mexico Fritz

    • jlcollinsnh says:

      wow! that’s wild. but actually I’m surprised it doesn’t happen more often.

      Mmmmm….

      …..I wonder if there’s an investment opportunity in tar and feathers?

  17. Nephi says:

    I’m new to your blog, found it via the MMM blog. I really like this investing strategy but I am having a hard time understanding from looking at the chart for VTSAX on google finance how I would achive these massive gains that you are talking about. Overall, the chart does not indeed always go up. It drops to the bottom and then raises to the top, then drops to the bottom again but doesn’t seem to be going consistently up over the long term. And if you’re referring to the dividend income, for this past year it seems to be around 2% but it doesn’t look much higher or lower in any other years. Is this dividend income the only growth that is gained from the fund? Although after having another look at it I see that the dividend yield would be much greater if I were to purchase during a “sale”. I’m used to looking at dividend stocks so I’m not quite sure how to read the data from a fund. Up until yesterday I was planning on implementing the dogs of the dow strategy that Jacob from ERE recommends.

    • jlcollinsnh says:

      Hi Nephi…

      Great question!

      The problem is VTSAX has only been around since about 2000.

      If you look at the chart from its inception what you are seeing is the last 10-12 years of exceptional volatility the market has been thru. If instead you’d been looking a chart from say 1982-1999, you be forgiven if you started to believe the market only went up without pause.

      Check out the chart here:
      http://investing.money.msn.com/investments/stock-charts/?CA=0&CB=0&CC=0&CD=0&D4=1&DD=1&D5=0&DCS=2&MA0=0&MA1=0&C5=0&C5D=0&C6=0&C7=0&C7D=0&C8=0&C9=0&CF=0&D8=0&DB=0&DC=0&D9=0&DA=0&D1=0&symbol=%24inx&SZ=0&PT=11

      This is the S&P 500 Index from 1950 and you can more clearly see the relentless upward bias. Or look at the chart I provided in Part IV of the series for an evan longer view.

      Now VTSAX is even broader based (all 5000 US based stocks) than the S&P 500 (the 500 largest) but that provides more diversity and should offer a slightly better performance over time.

      Dividends for VTSAX are around 2%. Sometimes higher, sometimes lower depending on the direction of the market at any given moment. Just like an individual dividend paying stock.

      If you haven’t already, you might want to read the rest of my stock series for more.

      Regarding the “Dogs of the Dow” strategy some love it and some loath it. There are plenty of conversations elsewhere, like ERE, on it. Since it’s not my 1st choice I won’t rehash them here.

      But for readers unfamiliar with the “Dogs” it is basically a strategy of buying the four or five highest dividend paying stocks from the 30companies on the Dow Industrial average. Since dividends rise as share prices fall the idea is that these companies have likely seen problems and a drop in their share price. Since they are large established companies and it is unlikely that they’ll go out of business, the bet is that the share price will recover and you’ll profit. Meanwhile you collect dividends in the 4-6% range.

      Each year you sell the winners and add the new dogs.

      I will say this. If I were trying to retire as early as possible with as little capital as possible I might consider it. This is what Jacob @ ERE did and, while I don’t recall his thoughts on the Dogs I can see where he might like it.

      Suppose you had 150k and wanted to hang it up. The traditional idea of a 4% withdrawal rate would give you $6000 in annual income. The Dogs might throw off 5/5.5% or $7500/$8250. That’s a big step up.

      For more on my thoughts on dividend investing:

      https://jlcollinsnh.wordpress.com/2011/12/27/dividend-growth-investing/

  18. Fuji says:

    I may have asked this questions previously (can’t find the correct blog post if I did), but can I replace Total Bond Market Fund with Wellesley Fund? I know they aren’t the same, but Wellesley is mostly bonds, plus some dividend paying stocks and it seems it might work. I know this is probably obvious to everyone else, so apologies for the dumb question.

    • jlcollinsnh says:

      Hi Fuji….

      we did indeed have this conversation and you’ll find it in the comments section here:

      https://jlcollinsnh.wordpress.com/2011/06/14/what-we-own-and-why-we-own-it/

      Oh, and it’s a great question!

      • Fuji says:

        I vaguely recalled I had asked the question previously – thanks so very much for such a thorough response! It’s nice to have a smart person’s brain to borrow on occasion. :)
        I feel much better about my choice now. I used to be spread out all over with Vanguard – Energy Fund, PrimeCap, V500 and more. Now I have 50% in Wellesley and 50% in a total stock fund via a 401K and I think I’m going to leave it and forget about it. We’re at least 10 years from retirement and even then I hope not to have to touch that money.
        Thanks again for such a substantive blog, I always am happy to see a new post.

  19. AverageJoe says:

    Nice and clean! I love it. You include your home equity as real estate? That part surprises me. I don’t like including my house as an “investment”, though I always want to make a good investment decision when buying/selling property I’m gonna live in (like any other piece of the portfolio….).

    • jlcollinsnh says:

      Thanks, Joe….

      …glad you like it and glad you’ve chosen to comment.

      I agree that a personal home is not an investment, but since it does soak up a big chuck of my net worth I like to include it as I consider my asset allocations. Make sense?

  20. 101 Centavos says:

    I quite like the idea of keeping some cash around. All the better to go shopping with when the markets take a dump.

    • jlcollinsnh says:

      True enough, but in this strategy the cash would be there to prevent selling while the market is swooning.

      If you are keeping some cash aside to invest on drops, how do you decide when the market has dropped enough? Seems I always push my chips in too soon…..

      • 101 Centavos says:

        Me too. But if a stock or fund was soundly valued at say, X, and nothing fundamentally has changed, it’s more of a bargain at 20 or 30 percent off. Calling a bottom and timing the market is a fool’s errand, as you say. I guess the trick is having the conviction huevos to double down.

  21. WorkingRachel says:

    While I strongly support most of this, do you have any thoughts on foreign investing? I tend to think it’s at least possible, if not likely, that over the course of my lifetime (I’m 31) American companies’ share in and dominance of the world investment market may decline. Given that any wage income I’m earning is also tied into the US economy, I’m inclined to put at least some of my money in foreign investments (of the index fund variety, of course, not in individual shares of random foreign companies). I currently hold some VEIEX and VTMGX–if you wanted to keep it simpler I believe Vanguard has an all-world-minus-U.S. fund, too.

    • jlcollinsnh says:

      Welcome Rachel…

      ..thanks for stopping in. Great question!

      Regarding international funds you can certainly add them if you’d like. As you point out, Vanguard offers International Index Funds. They’ll serve you well.

      I don’t bother for these reasons:

      1. The US is still the dominate world economy and, in my view, will remain so for the next 100 years and counting. That dominance will shrink over time, as it has been doing since the end of WWII, but it is not ending anytime soon.

      2. VTSAX is loaded with US companies that are fully international in their operations. Indeed many generate well over half their revenue and profits overseas. So it provides exposure to expanding world markets.

      3. This trend will continue to expand as the international economies around the world continue to grow and prosper.

      4. Accounting standards and transparencies in the US remain the envy of the world. Less funny business to worry about.

      5. Direct international investing introduces currency valuations into the mix and that is a whole other level of risk that needs to be considered.

      Hope this helps!

  22. Shilpan says:

    I like the idea of wealth building with cash. It’s your fund to rely on when markets slide. What if markets slide for more than 3 years? I’m afraid that the way our government is printing money like a mad man, and borrowing from China, a payday will be ugly. And markets may fall until we can get our financial house in order. What if you add reserve up to 5 years? Or as you keep growing your nest egg, increase % of cash reserve accordingly. So, a young person may not need much but an older person may need higher percentage of cash reserve to ride out market volatility. Just a thought.

    • jlcollinsnh says:

      Since I hold your opinions in such high regard, Shilpan….

      I’m intrigued and encouraged you find value in the idea.

      When I look at the 2008-09 debacle I see a three year climb out of the hole. Since this was the biggest hit since the Depression, and since I think it’s a mistake to build a plan around the possibility of a rare event like a Depression, three years seems a good line. It keeps the majority of capital at work while providing cash to ride out even a very nasty storm. I

      Were an upcoming storm to prove even nastier, we would have to tighten our belts to make it thru. But that is likely true with almost any asset mix.

      I’d be concerned that a five year cushion begins to hurt growth in the good times by keeping too much “on the beach.”

      Interesting idea about increasing the percent of cash as one ages. Maybe a very young person might even decrease it….

  23. […] At the time VTSAX had yet to be created (Bless you Jack Bogle!) … … Excerpt from: Stocks — Part VI: Portfolio ideas to build and keep your wealth … ← Rise of a Millionaire: Underemployed and Still Building […]

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