In Las Vegas, there is no greater feeling than playing with house money. That means no matter what happens on the next hand or roll of the dice that you can’t lose your original capital. It gives you courage knowing you will not lose money. The second best thing in Las Vegas is breaking even.
Which get’s us to stock dividend investing. Interest rates are so low that retirees are finding it difficult to create passive income. Saving for 5-10 years has become horrible with .10% in the Vanguard money market account. And forget bank savings accounts.
Sure, some online savings accounts are paying 0.75% to 1.0% but that is still very weak. The Federal Reserve has committed itself to low rates and many don’t see the Feds raising short rates until 2024 (or later). So buckle-up on rates being low for a few years.
This topic brought me to a discussion with my youngest daughter. She’s living at home and saving nearly $2,000 every paycheck – $500 into her 401(k) and $1,500 into her Vanguard money market account.
She needs the money market funds in about 5 years when she plans to get her masters degree. But she finds it ridiculous that she’s making nothing on her savings. So we explored higher yielding dividend stocks and we talked about breakevens and house money.
Break Even
An important part of investing (rentals, businesses, stocks, etc..) is determining how long the payout will take to breakeven on your investment. For dividend investing, this means knowing how long it takes to return 100% of an original investment through dividends alone.
With dividend stocks, every time you receive a dividend the breakeven price lowers. Using the example below, at $30 per share and a dividend of $2.08 annually your breakeven price is now $27.92 after one year.
Your breakeven price gets even lower every time you receive dividends. Of course, when you’ve received all of your original investment back in dividends you’ve reached what I like to call “playing with house money.”
There is no greater feeling than playing with house money. And the faster the company grows it’s dividend the faster you get to breakeven. In the example above:
- 0% dividend growth = 14.5 years until you play with house money
- 2% dividend growth = 13 years until you play with house money
- 5% dividend growth = 11.25 years until you play with house money
Remember, if more income is required then more risk must be taken. It’s really a simple concept. How much risk you take is an individual choice but let’s talk about how we can invest some money without risking everything.
Example
We have to put our money to work. And having near-zero rates means our money is earning next to nothing. Dividends take on an increased importance now. Risk is introduced when you buy stocks, especially if funds are targeted for a specific purpose and specific timeframe.
What’s cool is we don’t have to use all of our funds to generate more income. A combination of dividends and low interest savings vehicle (i.e. money market account or savings account) can provide good balance of risk/reward.
Let’s use my daughter as an example. She has $40,000 to use in 5 years for her masters degree. Those funds need to be available but she doesn’t like the low interest rates she’s earning. She’s willing to accept some risk but not too much.
If she put’s that $40,000 into a Vanguard money market account, she’ll only earn $200.40 in 5 years. But she could take some risk with $7,900 and buy two stocks (example only) and earn $3,197.36 in dividends. If she wants, she can put the remaining $32,100 in a savings account risk free.
Earning $3,197 in dividends would give her a 1.6% annual return on her $40,000. This is much better than 0.1% in a savings account and she only had to risk 20% of her capital.
As long as AT&T doesn’t fall below $19.18 per share and Altria doesn’t go below $22.10 in 5 years then she won’t loose money. She has good upside with minimal downside and only risks 20% of her funds. This is just an example of knowing what the breakeven point is for your stocks and how taking a little risk can help your portfolio.
House Money
Once you’ve received enough in dividends to payback your original investment, everything received after that is house money. The same can be said for a combination of dividends and stock gain.
If you have received enough dividend and stock gain to equal your investment, everything after that is risk free. My daughter did this with Exxon Mobil stock in March too. She bought some stock at $31 and sold at about $50 to receive enough to payback her original investment.
She still holds some Exxon stock but she’s already taken out of 100% of her original capital. House money is what we call her remaining Exxon stock. She’s reinvesting those dividends and will let the stock grow for the next 30+ years. That, my friends, is how the game is played.
Talk about sleeping well at night … that’s how you do it. Gain enough dividend income (or stock price) where you can no longer lose any of your original investment. That is when you can say life is good.
Summary
Decent fixed income opportunities will not be available for the next few years. So, if extra income is needed then other options have to be explored. Applying a combination of cash and higher yielding dividend stocks could provide a decent risk/reward return. Just make sure it’s the right dividend stock at the right price.
It’s always good to know your breakeven price and to know when you are playing with house money. I can’t begin to explain the joy when you’ve received 100% of your original investment back. It’s the ultimate sleep well at night drug.
If you buy a dividend stock at $30 and hold it for 5 years then your breakeven price isn’t $30. Understanding that concept is critical because it might help keep you calm if the stock suddenly drops in price.
Thanks for reading!
Mr. TLR