In a previous article I discussed that I am on track to have my dividend income cover my expenses sometime around 2018. I received a few questions on how I am able to achieve that. I have mentioned before, that I do not like to talk about myself, because I personally find it a little tacky.
I think I have taken for granted certain topics such as saving, and the power of compounding. I always assumed that it was common sense that people who came to this site would not be interested in learning how I drive a 15 year old car, how I graduated college without any debt but $2,000 in the bank and no debt, and that my frugality has helped me save enough to build my portfolio since 2007.
I also naively assumed that everyone who already saves money sees dividend growth investing as a tool to achieve their financial goals and objectives, be that traditional retirement, early retirement, financial independence or something else. Based on many interactions I have had over the years, I think that I was wrong in my assumptions on what constitutes common sense and what doesn’t. Given the rapid growth of the site readership since its inception in 2008, it is reasonable to expect that not everyone will be on the same page when it comes to various topics.
The first thing about investing is that in order to invest, you need to have money. In order to obtain that money, you need to utilize your most important asset to either find a job, or start a business. You then have to make sure that your expenses are less than what you earn. This surplus cash is then invested every month in dividend growth stocks. The formula to achieve wealth is really simple:
This is very simple, yet the low savings rate for the average household in the United States refutes my claim about what common sense on savings really is.
We can spin the above formula any way we want, but the basic truth still stands. In my situation, it has helped me that I invested my surplus in income generating assets. Therefore, the extra dividend income I received further increased my earnings power. In addition, going back to school increased my earnings power even further. The nice thing about earnings power is that having the flexibility to go to different states for jobs has definitely helped so far.
However, for someone who already saves money, their job is not done. This is because the more you save, the less time you need to spend accumulating your nest egg. In order to achieve that goal you either have to earn more, or spend less. In my case, I have managed to earn more through more salary income, dividend income and miscellaneous projects ( such as this site). I also managed to keep expenses low on things like transportation, taxes, housing. However, I do spend on things I value like education and learning, travel, quality entertainment ( I am a major supporter of Diageo (DEO) etc).
I do continuously try to streamline operations however, and cut expenses where I need to. My way of thinking is criticized sometimes, but it is my way of frugal thinking that has helped me get to where I am. For example, I have been criticized for using Interactive Brokers and bragging that I only pay 35 cents/trade, when I could have paid $5-$10/trade. Over a month, this sounds like a measly $10. I have learned one should never despise the days of small beginnings, and should allocate every single dollar as rationally as possible.
I do not believe I should be paying $10 more per month than I have to for a commodity service that stock trading is these days. To me the above objection sounds like slippery slope – if I view $10 in monthly savings as measly, then the next stop is upgrading my deal from getting only internet to getting cable and internet from my local cable company. After all, what is the difference between $50/month and $100/month, right? Since I hate spending more than I have to, I analyze my major ticket items. I believe that frugality is a frame of mind, and extends to every activity you spend money on. This is why you see business owners who are worth millions, who will drive around looking for a parking meter with money for it. This is why you would also see successful executives who are detail oriented about every single aspect of their business – and may even collect some trash from their business parking lot. When you have frugality as a frame of mind, this influences everything you do. The frugality helps you get the capital, that will compound and pay dividends to you for decades to come. But it never leaves you.
I realize not everyone is frugal. For people who are not naturally frugal, it is helpful to focus on the biggest expenses. For example, the largest expenses for households include housing, transportation, food and taxes. I will discuss below how I tackled most of those.
My largest expense over the past decade has been taxes. Using tax-deferred accounts however, I have managed to cut this expenditure to the bone. Unfortunately, wage income is heavily taxed. This is where it has helped me to max out every single tax-deferred account I am eligible for. This reduced my tax liabilities today, and ensures tax-deferred growth of investments. With some planning, it is possible to get a tax break upfront, and not pay any taxes when I would spend the money.
The other major item is transportation. Lifestyle design can help in tackling this expense. I have tried to design my lifestyle around reducing this expense. It has helped me that I have always lived close to work, which makes driving an old car easier. It has also helped to live in an area, which is close to grocery, entertainment, etc.
The third major expense is food. Naturally, cooking for your family and brown bagging lunch to work saves a lot of funds. In my opinion, eating out is expensive, and generally unhealthy. I can easily make a sandwich for a lower price than what I can buy at a restaurant. It is cheaper and more entertaining to host a party for your friends at your home, rather than go out to an overcrowded and noisy place.
The one area where I have failed so far is capitalizing rent expenses, aka buying an affordable house. Unfortunately, I have two left hands, so home ownership looks like money and time pit to me. Not having a house has worked well actually, since I have frequently moved around every few years or so, in order to get better paying jobs. Given the fact that house prices where I live are so low relative to rent, I have most probably thrown out tens of thousands of dollars in rent that