Part 2: The Secret Recipe for Retiring Early (Using the Stock Market)

by FI Fighter on December 13, 2012

in Stock Investing Thoughts

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In Part 1: The Secret Ingredients for Retiring, I spilled the beans and let out a “secret” that a billion people probably already knew. Just like when somebody else comes along and introduces yet another recipe for homemade apple pie, I wasn’t sharing anything new, or exciting.

Maybe Not So Easy?

But here’s something to ponder. If the secret’s out, and it really is possible to retire early using the stock market, then why do so few people actually succeed in doing so? Why do most Americans now feel like they have to work until the ripe young age of 80? Why do so many people who try investing, give up and quit?

The hard part isn’t knowing what to do. If that was the case, I wouldn’t even dare dream about investing in the stock market, let alone think about early retirement.

No, the secret ingredients to making that award winning apple pie (retiring early) are already at your disposal. Finding a way to cohesively blend and harmonize everything together to create a masterpiece, well, that’s part of the recipe. More specifically, you will need to master each of the following crucial steps:

Step 1

“Unless commitment is made, there are only promises and hopes… but no plans.”

OK, so you’ve given the idea of reaching early financial independence some serious thought. You went from thinking about doing it on occasion, to something you think about doing almost everyday. It has become that itch that you just can’t scratch. Maybe it’s because you daydream about the freedom that it can buy you. Perhaps you’re just sick and tired of racing rats all day, everyday. Or maybe you’re fed up with all the corporate politics and would rather just go at it on your own. Whatever the reason, you’ve now reached a crossroad, and must make an important decision that will greatly impact your future.

If you are serious about achieving early financial independence, then you must make a full commitment to doing this. Put it down in writing. Create a mission statement. Do whatever you need to do to make sure the message gets imprinted into your skull, loud and clear. Total dedication is needed, because quite frankly, you will not succeed if you attempt this half-assed. If you aren’t ready to make the full pledge commitment, then turn around now.

Here is the mission statement I came up with in November 2011. During Thanksgiving weekend, I made a commitment to myself to reach early financial independence by 37.5.

Mission Statement

Step 2

“Slow and steady wins the race. So, paralyze resistance with persistence.”

We all want instant gratification. In this day and age, even waiting 2 minutes to microwave a TV dinner is considered too long. But the best things in life take time to mature. You won’t get good at guitar in a month. You won’t learn to speak fluent Spanish in a year. And you probably won’t build a large enough dividend portfolio even after a few years to allow yourself to retire early.

Incremental progress is slow. So, don’t get discouraged if you feel like you aren’t advancing fast enough. It takes time. Lots and lots of time. But, if you improve just a little bit each and every day, it will only be a matter of time before you reach the final destination, freedom. The most important thing is to be persistent, and stay the course.

My portfolio still isn’t worth much today. But I’m working on it. I try to make contributions each and every month (though I will temporarily hold off from buying if I feel the market is overpriced). Here’s the slow and steady progress for 2012:

April 30, 2012:

4_30_12

August 01, 2012:

8_01_12

November 30, 2012:

11_30_12

What does the total portfolio value tell me about my passive income stream? Not much, really. So, why do I keep track of it? The growth of the portfolio lets me know that I am sticking to the plan and making regular contributions. It also gives me a quick glance on total shares, which I always expect to be increasing (due to DRIP). Also, even when the market sours, I still expect the long-term trajectory of the portfolio value to keep on rising. Quality companies will find a way to keep growing revenue and earnings (in addition to the dividend growth). So, even though capital gains are not the main objective when building a passive income stream, in the long run, the share price should still be going up.

Step 3

“Even when opportunity knocks, a person still has to get up off their seat and open the door.”

As mentioned above, building a dividend portfolio takes a lot of time. During the journey, the market will inherently swing up and down. Often. When the market is surging, most everyone gets greedy. This is right around the time you should start thinking about easing your foot off the gas pedal. Build up a cash reserve instead. Just remember, what goes around will eventually come back around again. The key is to seize the good opportunities when they present themselves. When the market heads in a downward spiral, you’ll know it. The news media will be all over it, trying to convince you that Armageddon is approaching. Many investors will panic and sell. This is our signal to swoop in and pick up all the discounts. Remember, passive income is the name of the game. If shares are cheaper, you’ll be able to buy more. More shares = more passive income. It’s that simple.

Here’s a lazy man’s approach to buying on the cheap.

Step 4

“Patience is a virtue.”

The market is not only irrational at times, but also stubborn. I love pullbacks, but sometimes even the large market corrections aren’t enough to bring down the stock price of a quality company like Coca-Cola (KO), or Johnson and Johnson (JNJ). Both KO and JNJ belong in my Core Holdings, but at this moment in time, I own exactly zero shares of JNJ.

Am I worried, or anxious to make a move? No, because I know that the right opportunity will eventually present itself. Maybe not this year. Maybe not even next year. But eventually, JNJ will be right for the picking. Until then, I’ll focus on building up my portfolio around other highly regarded companies. That’s why it’s also a good idea to make a wishlist. This way, you won’t feel the pressure to overpay for any particular stock.

Step 5

“Time is money.”

When it comes to dividend growth investing, time is money. Literally. As more time passes, more money will be returned to you. The growth is slow at first, but only until the compounding starts to pick up. If you simply stick to the plan and keep investing regularly, you can rest assured that your returns will eventually start to look exponential.

Dividend paying companies usually pay their dividends in regular intervals. Most pay quarterly, but some companies like Vodafone (VOD) pay out semi-annually. Some index funds, like Vanguard Total Retirement 2050 (VFIFX), only pay out once, annually.

Regardless of when distributions are made, the important thing is that you get paid! It’s kind of difficult to build a passive income stream without any income flowing in, right?

Just like with tracking the total portfolio value, it is also important to track the dividend progress. The fruits of your labor are in fact these dividend fruits that are returned to you. By investing in dividend growth stocks, you will also be rewarded with increasing dividend payments each year. Pretty sweet!

Here’s the progression of my dividend income stream for 2012 (organized by distribution cycle):

Dividend Progress

Step 6

“The successful man/woman will profit from his/her mistakes and try again in a different way.”

Lastly, it’s important for a dividend growth investor to learn from their mistakes. No one is perfect, and we all make bad decisions from time to time. We must remember to always focus on the big picture! Don’t let emotions cloud your judgement and force your hand into holding onto a stock, or selling a stock prematurely. Do your research. Think it through. And most importantly, learn and adapt.

There’s no hard and fast rule that says you can’t fine-tune and adjust your strategy as your journey progresses. Good judgement comes from experience, but experience often comes from bad judgement.

Summary

Now we have both the secret ingredients and recipe for “how to retire early” using the stock market. The rest is up to you. It’s as easy as pie.

{ 25 comments… read them below or add one }

1 JC @ PassiveIncomePursuitNo Gravatar December 13, 2012 at 7:21 am

Your point about JNJ is exactly what I was trying to make in my recent post about valuation. It truly is paramount to determining the long term return you can expect to receive. One thing I would recommend to anyone trying to start down this path is to keep track of everything at first, even more information than you think you could possibly need. Being able to see the progress that you’ve made and having a beginning reference point go a long way towards keeping you motivated, especially when the markets start going haywire.

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2 FI FighterNo Gravatar December 13, 2012 at 9:55 pm

JC,

Great advice on keeping tabs on all the progress, especially when first starting out. All I have to do is look at that the charts and it instantly gives me more motivation to continue the journey.

Best wishes!

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3 PaulineNo Gravatar December 13, 2012 at 7:21 am

Great post about showing it can be done but is certainly no picnic in the park.

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4 FI FighterNo Gravatar December 13, 2012 at 9:58 pm

Pauline,

No one ever said it would be easy, but few things in life worth achieving ever are. The good news is that it also isn’t as difficult as many might believe. The “what to do” part has already been unveiled to us. It’s the “doing” part that we have to commit to.

Take care!

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5 PKNo Gravatar December 13, 2012 at 8:08 am

Where are you holding your stocks, mainly? Are you able to invest in individual stocks through a 401(k)? IRA? Or taxable brokerage? I’m curious about the tax strategy you’ve got going on.

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6 FI FighterNo Gravatar December 13, 2012 at 9:59 pm

PK,

Dividend holdings are all held in a taxable portfolio. I hold index funds and bonds in the retirement accounts. No tax relief for me 😉

Take care!

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7 Kurt @ Money CounselorNo Gravatar December 13, 2012 at 8:12 am

If you’re successful at building a portfolio that consistently beats market indexes, you’ve got a great opportunity to achieve financial independence: Become a money manager! None of today’s professional money managers can beat indexes year in and year out, so you’ve really got something if you can do it. Good luck!

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8 FI FighterNo Gravatar December 13, 2012 at 10:02 pm

Kurt,

Although it would be nice to beat an index fund, that’s not the goal with the passive income portfolio. I hope I didn’t imply that it was necessary to beat an index above, since that’s not what I’m trying to do at all.

The main objective is to build a sustainable income stream that increases its payouts each year. Dividend growth investing is the strategy used to achieve that.

Best wishes!

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9 John S @ Frugal RulesNo Gravatar December 13, 2012 at 8:19 am

That’s quite nice growth in your portfolio and some good picks as well. It does take time and so often we’re not willing to take that time. Anything that’s worth while takes time in my opinion, so it’s worth the work.

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10 FI FighterNo Gravatar December 13, 2012 at 10:03 pm

John,

Thanks. I agree with you. It will take a lot of work and effort, but I doubt you’ll ever run into anyone who says, “you know, I sure regret reaching financial independence at such a young age. What a shame!”

Take care!

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11 Dividend Growth InvestorNo Gravatar December 13, 2012 at 5:05 pm

I am still surprised when all the investors I talk to discuss how they want to beat the market, and achiever 15% returns year-in and year-out. To me that sounds like lack of maturity, and also looks like someone doesn’t know what they are talking about.

Of course, when you talk about buying quality income stocks, with the goal of generating extra income in the future, that to me shows maturity, patience and ability to develop and stick to a plan through thick and thin. And show that you like to take charge of your own destiny. Good luck!

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12 FI FighterNo Gravatar December 13, 2012 at 10:13 pm

DGI,

Thanks. I’m trying to retire early, so building a passive income stream through the use of dividend growth stocks seems like the winning formula for me.

Though, I doubt any single investment strategy will work for everyone, since everyone’s goals are different. Some favor capital gains and like trying to beat the index every year. I guess that strategy works for them, but it’s of little concern to me. I’m focused on income, so dividends and dividends growth are what matter the most to my bottom line.

Best wishes!

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13 Lisa @ Cents To SaveNo Gravatar December 13, 2012 at 7:01 pm

I know nothing about stocks so I look forward to reading your blog and learning more!

You write in a manner that is easy to understand, and I greatly appreciate that 🙂

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14 FI FighterNo Gravatar December 13, 2012 at 10:19 pm

Lisa,

Thanks for the kind words! 😉 I try to provide actual results/actions taken whenever I can, so that readers can gain better insights on what I’m talking about. Hopefully that helps provide better clarity.

Feel free to message me if you have any questions.

Take care!

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15 The First Million is the HardestNo Gravatar December 13, 2012 at 7:07 pm

I love the point about being patient. I too have a wishlist of stocks I’m looking to add, but waiting until the price is right is really important. In a way I liked investing during the recession better! As long as you stayed away from bank stocks it was really hard to go wrong!

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16 FI FighterNo Gravatar December 13, 2012 at 10:22 pm

First Million,

Yep, especially for those who have a long time horizon ahead of them, it definitely pays to be patient. Stocks go up and down all the time, so it’s important to buy at good prices.

Market crashes are the best times to load up on stocks. You’ll usually find everything on the clearance bin then. It’s always prudent to keep some dry powder handy.

Cheers!

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17 JC @ PassiveIncomePursuitNo Gravatar December 14, 2012 at 5:47 am

That’s one of the hardest things for me to do. I get cash in my brokerage account and I want to go and get it invested already.

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18 FI FighterNo Gravatar December 15, 2012 at 11:07 pm

JC,

Totally, I’m the same way. It’s like I have withdrawal cravings if I don’t invest on a monthly basis. Though I am starting to get better at that (I didn’t make a single purchase this month, so far).

Cheers!

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19 Jon @ MoneySmartGuidesNo Gravatar December 14, 2012 at 9:40 am

I think that time is the hardest part. With time this can be done and it’s what I am working on growing now as well. But our society is an instant gratification one and if we don’t see results immediately, we quit and try something else. With patience and hard work, you can build a great income providing portfolio. Sadly though, too many don’t want to wait for it!

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20 FI FighterNo Gravatar December 15, 2012 at 11:10 pm

Jon,

You’re right, if you are after quick results, forget about it, because it won’t happen. A passive income stream takes time to build, but it’ll be totally worth it in the end. It’s funny, most people are willing to invest sufficient time to build relationships, work skills, etc., but aren’t as patient in building something that may be equally as valuable.

Take care!

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21 Compounding IncomeNo Gravatar December 14, 2012 at 7:12 pm

Fantastic article!

On JNJ: At first glance you’ll notice it has a p/e of 23 and payout ratio of 80%. Gah that doesn’t sounds like a bargain at all. It appears to be very expensive.

It’s not.

In the past year JNJ had a bunch of one time extra items including litigation settlements and product liability expenses. Excluding one time non-recurring items it’s rocking a p/e of 14 and a payout ratio of 49%. Personally I have a fair value of $76 on it. I’m not saying to go out and buy it right now however!

I think the main reasons people fail at early retirement is not knowing what to do, a lack of patience, and not being committed. Also sometime unforeseen events (sickness, injuries, losing a job) get in the way. Thanks for a great read!

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22 JC @ PassiveIncomePursuitNo Gravatar December 15, 2012 at 5:15 am

I’d read that about JNJ in a SA article. I think JNJ is still set up to deliver some great long term returns for investors. Hopefully that price will come down a bit with the fiscal cliff looking like a standstill.

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23 FI FighterNo Gravatar December 15, 2012 at 11:24 pm

JC,

Yes, I would love to load up on some JNJ. Hopefully a good opportunity will soon present itself.

Take care!

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24 FI FighterNo Gravatar December 15, 2012 at 11:17 pm

CI,

Thanks for the great comment. You make a very good point about JNJ being incorrectly valued (using standard P/E ratio) at this time. This is why it’s important for investors to do their due diligence and follow up on the companies they are interested in. Sometimes the true value is obscured from plain sight.

I didn’t mean to suggest that JNJ is wildly overvalued at this time or any other time. In my Core, though, it’s the last remaining piece that’s missing. Back in June, it did test the $60 level, but at the time, I chose to invest in CVX instead. Probably more due to a psychological reasoning than valuation, I’ve always had that number firmly implanted in my head. I’ve been waiting for it to test $60-$64 before making a move, and since it hasn’t quite gotten there yet, I’ve been having to exercise patience with it. Which is why I used this example in the patience piece above. KO is probably a better example of a quality holding that’s slightly overvalued at present time. Like JNJ, I want to add more, but am patiently waiting for this one to pull back slightly.

Best wishes!

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25 Brick By Brick Investing | MarvinNo Gravatar December 16, 2012 at 7:16 am

As always a great write up! Step 2 is timeless and priceless advice, things worth having don’t come over night. You have to work hard for them and I see you doing exactly that. I can’t wait to see your portfolio 3 years from now let alone 20! The funny thing about it, once you do retire early you’ll be considered an overnight success 😉

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