The Financial Independence Retire Early (FIRE) movement has been all the rage over the last 10-15 years. The idea is to reach a certain financial position and leave the workforce for good. Most FIRE starters also have some form of passive income, such as a blog, podcasts, or YouTube channel.
But what is the best way to reach this magical financial independence number? Well, first, let’s break this question down into two separate paths.
Your financial independence number. There are two ways to approach your financial independence number; a static amount or the income it produces. I discuss these differences in “Net Worth vs. Passive Income.”
Investing Insider vs. Outsider
For example, one person may aim to reach $1 million in their portfolio as their financial independence number. Another couple may strive to achieve $50,000/year in dividend income before retiring.
Static number debate. Most FIRE starters use the static number approach to reach their FIRE number. Why? Because it is much faster to achieve this amount and requires less attention to your investments.
The primary way to build a sizable static number is through passive index fund investing. The main idea is to dollar-cost-average a large percentage of your income (over 50-60%) into various index funds (mainly the S&P 500 (SPY)).
Investing in these index funds can speed your number rather quickly, especially if you double down during downturns like in 2020. Then, if you catch a wave of “luck,” you will be sitting pretty rather quickly.
Dividends vs. Royalties part II
The issue with passive index investing. The long-term problem with passive index investing is basing your retirement on the 4% rule. This means that you are selling shares of your index funds to provide you income during retirement.
This can be risky because the stock market is not your friend. You do not want to sell shares during a downturn when stocks are at their low points. Most FIRE starters have a large emergency fund of 1-2 years to prevent selling in a downturn, but you will still be nervous about the stock market situation. You are not in control of the outcome.
Dividend growth investing. Dividend growth investing is the concept of investing in strong dividend-paying blue-chip companies over the long term.
Through dollar-cost-averaging, dividend growth, and dividend reinvestment, your nest egg will produce a more significant amount of income. Over the long haul, a dividend growth portfolio will deliver excellent results, but it is a slow path.
For instance, you may experience 8-10% annual growth with index funds. You may also experience 8-10% growth with dividend growth, but only 2-3% will be from dividends, and the other 5-7% will be from capital appreciation.
Boring Investing is Good Investing
The issue with dividend growth investing. The problem with dividend growth investing (for FIRE purposes) is that your only concern is the 2-3% dividend growth. Capital appreciation is very nice, but it doesn’t matter to you.
Your goal is to live off the dividend income, so those are the main numbers you will be evaluating. Sure, you could load on older, high-paying stocks like Verizon (VZ) and AT&T (T), but you have to balance those with newer players.
Companies like Microsoft (MFST), Apple (APPL), Costco (COST), Ally Bank (ALLY), and Carrier (CARR) are reasonably new to dividends and pay under 2% yields. You will have nice appreciation in the long run, but those are not livable dividend yields in the near term.
So you may have $1 million in your dividend growth portfolio, but it may only pay you $30,000/year. That means you have a long way to go to reach your $50,000.
Income Investing. I’ll try not to sound biased, but income investing is the best way to achieve FIRE. However, it takes a lot of study and a deep understanding of markets.
Retirement Planning in Your 30s
Income investing is the art of investing in high-yield products purely for income. You may achieve a little capital appreciation, but that’s not the reason for investing in high yield.
I strive to reach an 8% yield with my income portfolio. At this yield, it would take $625,000 to earn a $50,000/year of income. Even better, your income portfolio instantly begins to assist you in the process by giving you current income.
I just love, love, love income investing. I can receive my paycheck, invest $800 into the mortgage REIT AGNC and start receiving $6.70/mo forever. If I did that every month for a year, my income would be $80/mo. That doesn’t include dividend reinvestments.
Suppose I reinvest that $80/mo back into AGNC, buying me 4-5 more shares every month. What a fantastic story. So why don’t more people use the income investing method?
The issue with income investing. Income investing takes time and understanding to utilize principles such as debt, leverage, yield traps, commodity cycles, and interest rates. In short, you have to know what you are doing and what to expect.
Retirement Planning at Any Age
For example, the price of AGNC fluctuates based on the cost of the 10-Year Treasury Note. If you buy AGNC expecting it to rise in price continually, you’ll be sorely disappointed. However, if you understand the cycle, you can double down when the price is low and gain your capital appreciation as it resets back to normal.
You will gain most of your capital appreciation from understanding the market cycles of your preferred shares, closed-end funds, business development companies, energy stocks, tobacco stocks, and mortgage REITs.
The best part is that you are also getting higher dividend yields when you purchase at low points. It is a win-win. To become an income investor, you need to spend two hours a day following income products and the stock market.
Look at this example of the preferred share GLOP.C. My dividend yield on cost is 13.3%, and I have a 59% capital gain. You only need a few of these mega wins to turn the tides in your favor.
$1,000 Dividend Shopping Spree
Time requirements. How much time you invest into your portfolio can determine which of the three methods you decide to follow. Let’s look at some rough estimates.
- Index Fund Investing. 1 hour a month, just to ensure everything is working correctly.
- Dividend Growth. 2-4 hours a month, following some of your stocks to ensure nothing crazy happens. You can just catch up on the news on Saturdays.
- Income Investing. 1-2 hours a day. You need to understand interest rates, inflation, commodities, and real estate trends. If you don’t like reading every single day, probably not your method.
The perfect scenario. Yes, I love income investing because it is the most challenging method and requires the most knowledge. I love the challenge and watching my income production grow over time.
However, I still have an index fund portfolio and three dividend growth portfolios. In the perfect scenario, you would have all three for various outcomes.
Again, having all three will delay the speed you can FIRE and quit your job, but it will give you the best outcomes. My goal would be to live entirely on my income portfolio, leaving the other two for generational wealth and estate planning.
You’ll Need $20,000/mo Passive Income
Conclusion. If you are new to investing, start with passive index fund investing. This will give you an understanding of market fluctuations, dollar-cost averaging and help you navigate your particular platform.
After about a year, you can add DGI stocks like McDonald’s (MCD) and Starbucks (SBUX). Maybe you prefer a dividend ETF that will give you a basket of dividend-payers.
If you fall in love with the stock market, then income investing may be up your alley. Start by reading Seeking Alpha every day. You will start to learn terms like closed-end funds and business development companies.
There is so much information there; don’t be afraid to get started. What’s the worst that can happen? If you want to put $200 in the market over a year and watch the results, do that. No one says you need to go all-in on day one.
Remember, time in the market is better than timing the market. Any method you choose will put you at a significant advantage over your peer group. Jump in!
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Disclosure: I am not a financial advisor or money manager, and any knowledge is given as guidance and not direct actionable investment advice. I am an Amazon Affiliate. Please research any investment vehicles that are being considered. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article. All Right Reserved Military Family Investing
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