Returns, Dividend Or Interest?

I found that many people appear to gravitate towards ‘safe income’ producing assets, like dividend-paying stocks. A dividend strategy can generate a “permanent” (more or less) form of income which can either be reinvested to boost wealth or be consumed without really impacting already accumulated wealth.

Opting for a dividend strategy as opposed to relying on capital gains alone seems to make people less anxious in times of turmoil. This was quite evident during the recent market see-sawing (and decline). Fellow personal finance bloggers who have a dividend stock portfolio all slept really well (or so it seemed). The same can be said for those heavily involved in investing in alternative assets that produce interest.

My strategy is very different. I have only one stock (my company’s) and buy as many shares as I possibly can. It is not as crazy as it seems as I can purchase those shares for a discounted price (I participate in an employee stock purchase plan or ESPP). But am I doing the right thing? Am I brave? Or just plain stupid and exposing myself to extreme volatility? And what is it that makes a dividend strategy so interesting? Should I consider jumping onto the dividend train?

Good questions. I know (by using plain common sense) that it is risky to rely on a single stock and that I should diversify. But when and how much? And what asset classes?

In this post I will try to compare my company stock strategy with ‘safe income’ strategies like dividend-paying stock and alternative (interest paying) assets (like crowdlending).

Before continuing, note that I am comparing and evaluating my one-stock strategy and not one-stock strategies in general. I am trying to find out what is best for me considering my circumstances and not give advice on what others should do.

Anyway, let’s get started.

In the chart below you can see the hypothetical performance of my company shares (orange), dividend stocks (grey) and alternative assets (yellow). The latter could for example be crowdlending or crowdfunding.

All rates are assumed to be 4%. In other words, the return for my company shares is 4%, the return for dividend paying stocks is 4%, the dividend yield is 4% and the interest on investments in alternative assets is 4%.

Reality will be very different, but it helps shed some light on the characteristics of the different strategies.

• The chart is split in two; the accumulation phase (2018 until 2027) and the withdrawal phase (from 2028 onwards).
• The lines represent the total value of the investments.
• The little bars represent deposits (positive) or withdrawals (negative). Note that for the company stock asset and dividend stocks asset withdrawing means selling shares. It does not include the dividend payout (for dividend stocks). Dividend payout is not visible in the chart.

During the accumulation phase the differences are not that huge (but do note that the dividend strategy outperforms the company stock strategy). The company stock and dividend stocks outperform the alternative asset due to the following reasons:

• Dividend stocks pay out a dividend, which is used to buy more stocks. This boosts the growth.
• I buy company shares for a discounted priced. This boosts the capital gain on my investment.

During the withdrawal phase some big differences occur:

• The total values of the company stock asset and alternative assets decrease much faster than the dividend stocks.

The sole reason for this is that the dividend stocks would generate some income (in the form of dividend payouts), which would cover my expenses to some extent. In other words, I wouldn’t have to withdraw as much from my principal amount (=sell less shares).

This doesn’t apply to my company stock asset. There is no dividend payout so to cover my expenses (I’ve assumed an annual amount of $40K), I have no other option than to sell shares worth $40K.

As for the alternative assets, the interest does cover my expenses to some extent, but unlike dividend stocks that benefit from both the gain and dividend payouts, alternative assets only grow via interest. The total value shows the same decline as the value of my company stock.

That’s an eye-opener in a way. Even though I can buy company shares for a discounted price, dividend stocks appear to outperform them, especially during the withdrawal phase.

I think I begin to understand why people opting for dividend stocks are sleeping so well. Even though the gain may be low, re-invested dividend payouts can boost growth significantly. And the strategy generates a predictable (safe) income stream you can rely on during the withdrawal phase.

But I’m not done yet. I assumed all returns and yields are 4%. What would happen if I use the following rates?

• Return company stock: 7%
• Return dividend stock: 4%
• Yield dividend stock: 4%
• Interest alternative assets: 7%

The chart now looks like this.

During the accumulation phase my company stock generates more value. Due to the higher return, it also performs better than before during the withdrawal phase (although still not as good as the dividend stock asset).

The alternative asset investment is still pretty inferior to both strategies.

What it means is that my company stock could perform better, but it requires a higher return than for dividend stocks, now and in the future (when I start withdrawing).

Let’s throw in some other rates.

• Return company stock:
  • 10% during accumulation phase
  • 4% during withdrawal phase
• Return dividend stock: 4%
• Yield dividend stock: 4%
• Interest alternative assets: 9%

That paints a completely different picture doesn’t it?

While the company stock has great returns and outperforms the other strategies during the accumulation phase, it’s the alternative assets strategy that wins in the long run (even the dividend stocks will outperform the company stock).

Of course, this is due to the fact that I lowered the return for the company stock to 4% during the withdrawal phase. If I had set it to 7%, the company stock would see the other strategies in the rear-view mirror.

But let’s do something different and use a bad sequence of returns.

• Return company stock:
  • 4% during accumulation phase
  • -20%, -15%, -10%, -5%, 0% and 4% onwards during withdrawal phase
• Return dividend stock:
  • 4% during accumulation phase
  • -20%, -15%, -10%, -5%, 0% and 4% onwards during withdrawal phase
• Yield dividend stock: 4%
• Interest alternative assets: 9%

The chart now looks like this.

What this chart shows is that in the event of a bad sequence of returns, the company stock asset would lose value quicker than the dividend stock asset. Again, this is due to the fact that dividend stocks generate a dividend.

In this particular scenario, the interest generating alternative assets would clearly be the best option. It’s a non-correlated asset and is not affected (or not as much) by declines in the stock market (although even alternative assets in case of a global meltdown would be affected I guess).

Now, I can continue forever and keep adjusting the return, interest and yield rates. Any strategy can come out on top in my little game. But that’s a pretty useless exercise. The rates are pure speculation.

What isn’t speculation is the behavior. Different assets behave differently to changing market conditions.

If my company stock has a significantly higher return than the dividend stocks (now and in the future) it may outperform dividend stocks and alternative assets. But…

• The company stock asset is more exposed to volatility and during the withdrawal phase there is a risk it depletes (much) faster than the dividend stocks asset (in the event returns aren’t significantly higher). Dividend-paying stocks tend to be less vulnerable to market turmoil, which could magnify the problem during a market down cycle.
• As mentioned, the dividend stock strategy is less vulnerable to market fluctuations compared to my company stock. Due to the dividend payout it has the potential to cover my expenses for a longer time. It generates a ‘safe income’ stream.
• If alternative asset investments can generate a consistent interest of around 9% it would be an extremely interesting strategy. It isn’t vulnerable to the same market fluctuations and has the potential to generate a stable and predictable income stream.

So what should I do? Should I stick to my current company stock strategy? Switch to dividend stocks? Or move all my money to alternative assets?

The key to answering these questions is hidden in the answers to some other questions.

• What is the outlook for my company stock? For the short term and long term?
• What is a realistic (and low risk) yield for dividend stocks?
• What interest rate would be realistic with alternative asset investments?
• What is my risk tolerance now and in the future?

As far as the last question is concerned, my risk tolerance during the accumulation phase is higher than during the withdrawal phase. During accumulation I want to expand quickly, but during withdrawal I want to be sure I have sufficient income to cover my expenses (for a certain minimum period).

It is not about having as much as possible, but about having enough for financial independence and early retirement.

I started with investing as late as 2015 and adopted a fairly aggressive (company stock) strategy in an attempt to accumulate enough wealth to make early retirement possible.

So far (and I am writing this in January 2019) this strategy has worked beautifully. The capital gain is in excess of 50%. But it is important to know the reasons:

• Bull market conditions the last 3-4 years (and extra-ordinary growth for my company stock).
• The possibility to obtain company shares for a discount.

But let’s compare the performance during the years 2016-2019 with the Vanguard International High Dividend Yield ETF (VYMI) and a hypothetical (9% interest) alternative asset.

VYMI is and index fund that seeks to track the performance of the FTSE All-World ex US High Dividend Yield Index. This fund has produced and average yield of around 3.5% for the last couple of years.

But let’s set it high and assume the average yield was 4.5%. Some other facts include:

• I started with an investment of approximately $5K in January 2016.
• I did the following additional (larger) investments: $1.8K, $13K,  $11K and $10K (July 2017, January 2018, July 2018, January 2019).

Note that in the scenario’s below I’ve assumed dividend payouts of 4.5% in December 2016, December 2017 and December 2018. For these amounts new shares are bought.

The chart is an approximation (except for my company stock asset, which is a fact), but shouldn’t be too far off the truth.

• In January 2019, the value of my company stock asset is $66K.
• If I would have invested in the VYMI ETF instead, the value of that asset would have been approximately $40K and produce an annual dividend payout of $1.8K.
• If I would have invested in alternative assets with a 9% interest, the value would have been approximately $45K and produce an annual interest payout of $4K.

The company stock strategy is clearly the best, isn’t it? Well, not necessarily.

It all depends on what you want to achieve. If the challenge had been ‘create as much wealth as you can before February 2019’, then my company stock strategy would indeed have been the best.

But a much more realistic challenge would be ‘create sufficient wealth so you can withdraw an annual income of $4K for the rest of your life’. What strategy would be best in this case? The alternative asset strategy. Clearly. It had a much lower risk all the way through and it managed to produce $4K of annual interest, so you can sit back and relax. Even the dividend strategy would perhaps be better as it produces a safe annual income of $1.8K, which at least can cover part of the required $4K.

Yes, my company stock may continue to do (much) better. But that is not the goal. And fanatically holding on to my company stock asset would mean I’d never be able to fully relax. The stock may crash for example. I’d need a daily dose of whiskey to keep me somewhat calm.

Again, it is not about creating as much wealth as possible, but to create sufficient wealth. I think that applies to all of us aspiring FIRE.

So does this mean I made the wrong decision after all? Should I sell everything today and invest in alternative assets? Or dividend-paying stocks?

If $4K annually was the goal I would probably sell today. But it isn’t. I need much more.

I am actually still quite far from reaching my goal and there is no doubt that the company stock strategy has generated more wealth than the other strategies. Even though we are in a rough patch and 2019 in no way will be as profitable as 2016-2018 (unless Trump calms down and the UK suddenly realizes the EU isn’t that bad after all and we all become friends and end all trade wars), I do expect my company stock strategy to keep outperforming the other strategies.

But (there is always a but).

My risk tolerance will shrink. No doubt about that. My liver too by the way if I drink too much (which I really don’t).

While writing this article and producing all the charts I’ve become more and more convinced that relying on my company stock strategy isn’t a good strategy in the long run for what I want to achieve.

And I begin to see visions of various early retirement portfolios.

• Guaranteeing the outcome using bonds (e.g. a so called ‘bond ladder’)
• Combination of stocks and bonds (like 50/50) – e.g. relying on (safe) bonds for the first x number of years and invest the rest in higher risk stocks
• Dividend only (dividend stock strategy)
• Alternative assets only
• Combination of the above

Intuitively I gravitate towards the combo portfolio (combination of all above mentioned asset classes). This would give a lot of flexibility and provide security that my income requirements can be met regardless of the market situation.

So something like this.

• 10% non dividend-paying stocks – for keeping a bit of excitement (maybe I keep some company shares for nostalgic reasons)
• 20% Bonds
• 40% alternative assets (including crowdfunding of real estate)
• 30% dividend stocks

Why not an alternative asset only portfolio? That’s a good question and I will definitely dedicate more posts to that.

The thing is that such alternative assets have their own set of risks that are not fully understood yet. However, I have started to invest on Mintos.com (crowdlending platform), which produces an interest that exceeds 10%. Not bad. And I will continue to increase my investments in this asset. Probably even speed it up.

Sorry for the long article, but see it as an inner monologue turned post. I learned something at least. Maybe you didn’t. Maybe you think ‘what took you so long Marc?’

But I’m happy. I feel I’ve gotten some clarity on what turns to take on my journey to FIRE.

How about you?

Any thoughts? What does your preferred target portfolio look like?