Dividend Surprise Part 2

Risky business be careful!

After taking a parting blow to the head from CHEAP.SHOT his sparring buddy THE.CONTENDER was dazed and disorientated. Is the right thing to be doing, he asked himself? This fighting THE.FUTURE stuff is quite risky. Is he risking it all on black?
CHEAP.SHOT: "CONTENDER! CONTENDER! are you alright? Sorry mate I thought we were still sparring. I did not hear PLAN.AHEAD calling us over"
PLAN.AHEAD took THE.CONTENDER to one side: "Look what happened, you dropped your guard. You thought you were safe and in control. This is a risky business and you need to have your wits about you at ALL times"
In part 1 of this post (found here) we had a look at the pros and cons of dividend investing. Here in Part 2 we are going to have a look at the risks of investing in dividend stocks, our strategy and tracking progress.
Personal Financial Goals
As we are well into our financial freedom plans we have been fortunate to accumulate enough savings and investments to be very close to our desired goal. This is to buy a "nice" property in France and enough passive income to cover living costs. Currently this nest-egg is 2/3 in cash and funds and 1/3 is in dividend stocks. Ultimately we need our investments setup in the following manner:

45% in cash to buy a property outright
45% in dividend stocks. We are aware the nominal value will rise and fall with the market and company performance but the income that we need will hopefully grow over time.
10% in our protection portfolio for emergencies cash and cash alternatives such as precious metals.

So what do I think are the risks that lie ahead for this approach if we follow this route?
Mitigating Currency Risk
US shares carry a premium (more costly / lower yield) to them but the dollar is the reserve currency of the world. Likewise UK and Continental European stocks carry Pound Sterling and Euro risk (get the money printing presses ready, Mr Carney - New Bank of England Governor)
We are going to be living in France and paying for everything in Euros so what do we think are our options to reduce currency risk?
a) Ideally we want to have much more income than outgoings if possible. This is the ideal situation as we can continue to invest and grow our income and it will provide a buffer in hard times. Likelihood low - we want to spend as much as possible on a home.
b) Investments will be made in countries with strong currency fundamentals and good trade agreements that avoid double or punitive taxation. Global low cost funds can help to mitigate currency risk instead of trying to work out the "best" country to invest in. In our case we cannot invest in funds in the short term due to higher French taxation. Our income will be paid in multiple currencies before being converted to Euros.
c) PROTECTION - our cash will be spread across different currencies and cash equivalents. Primarily this will be covered by income from multiple countries in the form of dividends, pounds, euros and some precious metals fund.
d) We will monitor all investments and country risk monthly and change the mix of the portfolio as required. Our monthly dividend tracker and risk evaluator is outlined below.
There are several countries and currencies that are of interest to our little tribe Canada, China, Chile, Singapore and to a lesser extent Brazil, countries located in Eastern Europe and Australia.
Canada and Chile are of interest for example as they both have growing populations, an abundance of natural resources, are business friendly and have a lot of undeveloped land for agriculture and natural resources.
For more on risk management and the low cost fund approach to investing have a look at the videos on the Bogleheads wiki.
Please read on to have a look at the tribes own strategy and progressTribe Income Strategy (and diversification risk) [lose the brackets]
After one year we have about $1100 per month income from the growing portfolio. We believe we can support our family on $1700 per month in France.
Currently all dividends are collated each month, new earned cash is added and then we chose the next stock to buy. This is bought via a low cost regular investment option from our broker ($2 per share).
You may ask why are we going for individual shares and not a "safer" income tracker fund or just sell part of the growing fund each year? This has been partly covered in the post Get Real - Investing in REAL Assetsand here is a seekingalpha article on being 100% invested in dividend stocks.
Here are a few other considerations:

Owning the shares individually cuts out annual fees completely.
Ensuring there are at least 15-20 companies across several sectors removes the majority of the diversification risk.
We are targeting similar / the same sums of money in each company to diversify risk.
Targeted sectors are used that our Tribe understand and follow or have an interest in. These sectors are mainly considered defensive dividend shares. A proportion of them have a history of increasing the dividend at least in line with inflation over many years.
We are young so some high risk vs reward dividend stocks have been included to increase the overall yield of the portfolio.
Being paid! Actually seeing the income being paid in our account is very motivating.

What is our end goal? This has been and still is the most difficult question we have asked ourselves. What do we want out of life, what about our kids, where to live, how much material wealth we want, how much leisure time we want and what activities can we afford?
As we were unsure of our plans we saved as much as possible, invested the money in funds and held some defensive stocks and cash equivalents. Our portfolio looked something like this:
INCOME: Defensive and growth dividend stocks and some riskier higher dividend payers (10%)
GROWTH: Tracker funds / ETF's (60%)
PROTECT: Cash and cash equivalents with some fixed income assets (30%)

"I will tell you how to become rich. Close the doors. Be fearful when others are greedy. Be greedy when others are fearful." - Warren Buffett

At the moment we are converting our Growth portfolio into INCOME now that we know what our medium plans are and the required income we require to live off is.
We could have tried other strategies to get rich quick such as rental property (preferably business units), aggressive speculation in the stock market, setup our own business, committed ourselves to work for the elusive highly paid managerial role. Perhaps thinking about THE.FUTURE and THE.PAST clarified our thinking into a bit slower and less risky.
Building a Defensive Portfolio
We need to invest in a buy and hold portfolio and each month we will review how the company holding the dividend earning shares is doing as part of the monthly review process. Below is a snapshot showing the share holdings, values, yield and monthly income. What if companies and shares are added (after being chosen by a value, yield and sector screen process.
This provides an estimate of the eventual yield of the portfolio and most importantly how much it will cost to purchase the shares at their current prices.

Estimating how much an income will cost to purchase - Click image to enlarge

This sheet allows us to

Look at the balance of the portfolio we are aiming for (value of each holding)
Consider risks of holding the stock
Check some of the key financial information
Choose our next investment
We also check press coverage of the companies we are investing in and reviews from sites such as seeking alpha.

Tracking and checking income

"Know what you own, and know why you own it." - Peter Lynch

Our plan is to have at least £1100 (~ $1700) per month income. We have been aggressively buying income stocks since March 2012. Below is a graph of the progress so far:

When we are paid, by who and how much - click to enlarge

The colored squares represent the individual companies and the dividend estimate for each payment. The graph shows the growth in the dividend income over time.
We have not aggressively sold our GROWTH funds to buy the income over this period. Gradual sales and additions of earned income have been combined with the dividends each month. Then we have made "cheap" purchases of stock each month, diversifying sectors and companies as we go. This has been beneficial to look at when yearly dividends are paid and the best opportunity to buy into that particular stock
Purchases have been checked to see what we perceive as the best value stock at the time see Financial Independence Planner & Stock Screener for more information. This has also allowed us to understand the qualities and potential pitfalls of the individual companies we are investing in.
We have been pleasantly surprised how quickly the income has increased. This extra income has compounded with every "re-investment" into the next stock. While this may not be the most "tax effective" way to grow wealth it is providing the income we need at this point in time of our financial independence plans.
Will this strategy pass the fullness of time? Who knows. Certainly THE.FUTURE will have some challenges in the years ahead - will the portfolio perform its role or will THE.CONTENDER have to get back in the ring for one more fight?
Create An Income Strategy
Do you have any unique skills to exploit that can take you on your way to financial independence?
Perhaps you could go extreme like Jacob from ERE if you don't mind living in a caravan next to work.
Perhaps you could choose a profession such as a builder instead of spending years racking up debt in law school. You would start earning earlier in life and can build your dream home.
Will you choose your own business, buy to let properties, stock market gains or return on cash and bonds? How would you start what are the steps you envision to get to your end goal? Everyone is unique, the opportunities in the world are unique there is a unique opportunity to find what makes one happy in the world we live in.
Income streams for life

Consider your risks

We are so fortunate to live in a world full of possibilities. Luckily we have been blessed with the intellect to exploit them in ways to make us happier and freer in life which could not have been dreamt of a hundred years ago.
If we can see through the fog of the modern world, peal back the complexity and see that life does not have to be as complicated as we make it, will a new golden age await us? Will advances in energy and health sustain us? Will we evolve our compassion and desires in a way to reach for global happiness over money and things?
One thing is for sure THE.CONTENDER and his tribe are here for the ride of a lifetime. We all are.
Peace, prosperity and happiness

THE.CONTENDER
Welcome New CONTENDER Readers! Take a look around. Find out who THE.CONTENDER is or Start at the first article, browse the all posts or just go for a Random Post. Please feel free to play with the FREE planning tools and checklists.
Keep in Touch: RSS Feed, follow THE.CONTENDER on Twitter or subscribe to posts by email: