Monday, April 17, 2006

My Investment Goals

One of the most imporant things I have learned about investing is the importance of having the right objective. When I started investing, I was looking for a Net Worth figure that I believed would allow me to safely produce the income level I desired. What I have learned is that it is far more important to focus on the income, or cash flow itself., and focus less on the actual net worth figure.

To their credit, my parents gave me a good understanding of both the need to save, and the importance of using special savings vehicles, like 401(k)s and IRAs to do so. So when I first started working. I immediately enrolled in the company's plan, which is pretty generous, offering 75 cents on the dollar for the first 8% of salary (all the more so, because the company still has a traditional annuity pension).

At the time, I figured that I was likely to retire between 60 and 63, and set a target of having $10 million by that time. My rationale in establishing this number was an assumption that I would want to have an annual income in retirement of $250,000 in today's dollars. Unlike most investment guides, which often suggest that one needs something between 60-80% of pre-retirement income after retiring, I believe that in fact, you need something more. After all, work takes lots of your time. Once I don't have work occupying my day, I want to have enough money to be able to afford to travel, or fund my hobbies. I don't want to be sitting in front of the TV watching bowling.

So, how do we get from $250k to $10 million? Inflation. I assumed that, conservatively invested, $10 million should earn 5-6% per year, or $500-$600k per year. This is significantly more than the $250k I need, but the $250k is in present dollars! The $10 million would be in 2034 dollars (when I turn 60). Since inflation runs around 2-3% per year, over the 40 year horizon that I was envisioning, the purchasing power of the dollar would fall by more than half. (It would lose half its value after 24 years at 3% and over 36 years at 2%). This means that we have to cut the $500-600k in half, which gets us to $250-$300, which leaves some cushion. If inflation runs higher, we can make up some of this by investing more aggresively.

So, having established these targets, I then began concocting a contribution and earnings plan for the next 40 years, playing with variables such as the rate of growth of my income, and the rate of return on my assets, and worked numbers that actually got me to my goal.

The bad news is that the numbers that I worked up are certainly flawed, and probably fatally so. I compounded my returns at 11% per year (which was what everyone said was the "historical" return on stocks). I have already commented on why compouding "average" returns is NOT a good idea in my first post. So, $10 million may not be in my future, at least, not by saving from earned income.

The good news is that $10 million was the wrong objective. Since money really represents freedom, my goal has changed - my focus is on developing monthly cash flow. Enough cash flow, in fact that I can a) only work when I want, and at things I want to do, b) afford myself all the travel and hobby activity that I want to participate in and c) provide for my family and loved ones.

I have changed my goal - my first goal is to develop cash flows in excess of my expenses. To that end, I have actually taken some steps to reduce my expenses (which means that more of my cashflow goes into the asset column, to create more cash flow), and I am working at purchasing some cash flow investments.

My second goal is $10,000 a month in passive income - at which point, I could stop working, and have excess cash flow that could be used to increase my passive income. At this point, I could really focus on creating and building businesses, writing, and selecting investments (which, together with sailing, travelling, and studying language and history is what I like to do).

The important thing is that chaning my goals has also meant changing my strategy. Rather than focus on capital gains investments that I hope to convert to income in the future (though I certainly look for capital gains investments), I start by looking for income producing investments that can also increase in value. Thus, I like dividend-paying stocks. I also like cash-flow real estate - though I think the best approach now is to build a cash position and prepare myself to take advantage of the downturn coming in the real estate market, so that I can actually make it flow cash, right?

I will share my portfolio in a future post, and discuss my thinking in investment decisions.


  1. Have you looked at the S&P 500 Dividend Aristocrats list? Vanguard is supposed to start an index fund based on it in the near future. There is also an S&P European 350 version. I believe the qualification is that the stocks have paid consistent dividends for the past 25 years and have increased dividends each year for the past 10 years.

    There is also the Mergent Dividend Achiever's Indexes which include High Growth, Nasdaq, Canadian, and International Indexes. I'm not sure what qualifications the stocks have to meet to be included though.

  2. never heard of it. will definately have to check it out!

  3. Michael - I checked out the URL. Great site! I own two of the stocks myself, Colgate-Palmolive and Bank of America.