Why It’s Better To Invest In Growth Stocks Over Dividend Stocks For Younger Investors

Growth stocksDividend stock investing is a great source of passive income. The problem is, with dividend yields relatively low at 2-3% you need a lot of capital to generate any sort of meaningful income. Even if you have a $500,000 dividend stock portfolio yielding 3% that’s only $15,000 a year. Remember, the safest withdrawal rate in retirement does not touch principal. Furthermore you must ask yourself whether such yields are worth the investment risk.

If you’re relatively young, say under 40 years old, investing the majority of your equity exposure in dividend yielding stocks is a suboptimal investment strategy in my humble opinion. You’ll be hoping for filet mignon for decades while you eat Hamburger Helper in the meantime. When you reach your desired age for retirement, you might just be asking yourself, “Where the hell is the feast?

Out of the few multi-bagger return stocks I’ve had over the past 16 years, none of them have been dividend stocks. I’m sure dividend stocks will provide over 100% returns if you give them a long enough amount of time. But if you are like me, you’d rather build your fortune sooner rather than later. If I’m going to bother taking risk in the stock markets, I’m not playing for crumbs. When things turn south, everything turns south so there had better be more than a 3% dividend yield and some underperforming appreciation to compensate.

The following article will attempt to argue why younger investors should focus on growth stocks over dividend stocks in a bull market with potentially rising interest rates. In a bear market, everything gets crushed but dividend stocks should theoretically outperform.

A FUNDAMENTAL POINT TO UNDERSTAND ABOUT DIVIDEND PAYING COMPANIES

Welcome To The Financial Samurai Forum (FSF)!

beach-north-shoreDear Readers,

Due to popular request I’ve launched the Financial Samurai Forum where the community can come and share their thoughts in five main categories:

* Investing

* Real Estate

* Career / Entrepreneurship

* Retirement Life / Wealth Management

* General

Financial Samurai has been up for four years now and I’m proud to say we’ve got some of the most interactive personal finance enthusiasts around. Just look at the Most Commented Posts on the right sidebar. We’ve got eager readers who are just coming out of school with so much opportunity ahead of them as well as multi-millionaire readers who are looking to change things up a bit. All of us have something to contribute so don’t be shy.

Since 2009 I know many of you have taken great strides to achieving financial independence which is absolutely fantastic. The core motto on Financial Samurai after all is to “achieve financial independence sooner rather than later.” I’ve learned a tremendous amount from all of you and I hope you have done the same from my writing. Financial freedom seekers this forum is for you!

CATEGORY DETAILS

Don’t Stop Fortune Hunting – Money Making Opportunities Are Everywhere

So close yet so far. Giraffe reaching for leaves.

When I was 23 I got lucky, very lucky. No, a Ford agency supermodel didn’t decide to stalk me around Manhattan and show me off to her beautiful friends in case we didn’t work out. Instead, a $3,000 investment turned into $155,000 in two months. The stock was VCSY a Chinese internet company with a homepage consisting of a simple dial pad. I had no idea what the company did except for the fact that Internet + China in December 1999 sounded like a fantastic idea during one of the greatest bubbles of our times.

VCSY went from around $3 to $6, did an inexplicable 20-for-1 stock split and then went up to around $9. In other words, it went from $3 to $180 pre-split and I had 1,000 shares. The stock’s move was one of the most ridiculous things I’ve ever seen as everybody I knew on the Street started piling into the name. I eventually got out of the stock at around $155 a share, netting a cool $153,000.

I proceeded to do what every foolish 23 year old would do and blow it on things! I bought a 600cc racing bike along with a second hand Volvo 850 GLT. At least I didn’t go out and buy a pound of coke. The safety of the Volvo was a way to balance out the risk of death during wheely popping attempts on FDR drive at 100mph. With both vehicles came insurance payments and a $300 a month parking bill. Yes, even back in 2000 parking was that expensive in lower Manhattan.

My biggest regret wasn’t actually spending $25,000 on goodies after the financial windfall. My biggest regret was not investing MORE into VCSY! I could have put in up to $20,000 worth in the name because I just received my first stub bonus after starting work in the summer of 1999. Meanwhile, the ritual of saving more of my after tax paycheck had begun because getting into work before 5:30am and regularly leaving after 7:30pm didn’t seem sustainable long term. Unfortunately, I was too chicken shit to dump everything into VCSY. If I did, the $20,000 could have turned into a cool million! Sob. So close, yet so far from being able to make it rain!

Ever since the spring of 2000, I’ve regretted not taking more risk. I swore to swing for the fences more often with the new found capital. Instead of fulfilling my oath, I decided to cower in the corner like a scared child in the night because the internet bubble began to burst in March 2000. After a couple $10,000+ down days thanks to reinvestments in B2B stocks like Ariba Technologies I bid the stock market casino sayonara! The one year time period of confusing brains with a bull market was over.

GOODBYE STOCKS, HELLO CAREER

How To Make A Lot Of Money In The Stock Market And Still Feel Like A Loser

Sea turtles on the beach

Slow and steady often wins the race.

On May 5, 2013 I wrote an article called, “Should I Invest In China? A Top Down And Bottoms Up Perspective.” My simple thesis was that with the Yen depreciating to 100+ due to Abenomics coupled with strong world markets, China must inevitably catch up in a risk-on environment. I then identified the Chinese internet space as the most laggard sector where investors should consider putting money to work. Chinese internet stocks have been going straight down for two years. Stock picks included BIDU, SINA, and RENN.

So what happened with the stock picks since then? And more importantly, did I put my money where my mouth is or was I just pontificating like some useless Wall St. research analyst does with Neutral/Hold/Wait And See ratings? I hope you know by now that I don’t like wasting time writing about things I don’t know or care to act upon. Of course I invested in my thesis. I just didn’t invest enough.

Almost like magic, every single name ramped higher by 15-25% within three weeks after publication while the broader markets climbed 2%. It was almost as if someone got a hold of my article and forwarded it around, causing a buying frenzy. If there’s a chance this is true, is there any wonder why hedge funds keep their holdings as close to their chests as possible?

Since publishing my post on China, my IRA grew by roughly $40,000. Sounds OK right? Not really since I started off with $400,000 at the end of April. I will usually take a 10% gain for the full year any day. However, a 10% gain is a 5-15% underperformance of my stock picks, equating to roughly $20,000 to $60,000 in money left on the table.

So what the hell happened to cause such a leakage in performance you ask? Ill-timed accumulation and exiting of positions as well as FEAR. Remember, I am the King of bad trades. The below chart shows the value of my IRA portfolio today. The pending activity is pending cash as a result of $209,913 worth of stock sales as I’m continuously worried about a market correction. I already sold $168,006 worth of stock several days earlier. At the same time, I’m not willing to place massive short bets either because the market is being artificially propped up by the Fed.

Current IRA portfolio.

IRA portfolio 5/22/13

MY IRA PORTFOLIO BEFORE THE BAD TRADES

The Ideal Withdrawal Rate For Retirement Does Not Touch Principal

Resting Old Man Of SantoriniIf you have tremendous money strength, you will never have to draw down on your retirement principal. Your goal, if you choose to accept, is to create an estate that will provide for your loved ones long after you are gone. This is what endowments do. Why not consider doing the same if you are a magnanimous and financially savvy individual? You’re reading Financial Samurai after all!

I always scratch my head when I hear advisors talk about the “4% withdrawal rule” or any withdrawal rate that’s greater than a risk free rate of return for that matter. Times have changed folks. Interest rates are close to zero, the stock market isn’t a slam dunk, and we are living much longer now.

There are so many variables that it is impossible to calculate a bullet proof withdrawal rate rule unless that rate is 0%. Sure, there’s a 99% chance you will die before 110 and a 99.9% chance you’ll die before 150, but who really knows? We might be one with machines by the year 2030 and live forever!

Instead of thinking about how much you can withdraw to bleed your retirement funds down to $0 by the time you die, I highly encourage everyone to think about leaving a financial legacy for your loved ones that is so great you’ll never run out of money. Even if we fail to come up with a perpetual giving machine to leave for others, the end result will be much better than if we only focused on ourselves. Related: Is Not Wanting To Be Rich Selfish?

BREAKING DOWN THE IDEAL WITHDRAWAL RATE

Use Rule 72(t) To Withdraw Money Penalty Free From An IRA

View from Koko Head, Oahu

View from Koko Head, Oahu

After rolling over my 401(k) into an IRA, I’d like to focus on potentially the single most beneficial reason why everyone should convert their 401(k) into an IRA after they leave their jobs: Rule 72(t).

Rule 72(t) allows for penalty-free withdrawals of your IRA account before the age of 59.5 provided that the IRA holder take at least five “substantially equal periodic payments” (SEPPs). The amount depends on the IRA owner’s life expectancy calculated with various IRS-approved methods.

Three IRS approved methods to calculate SEPP:

1) Required minimum distribution method: This method takes your current balance and divides it by your single life expectancy or joint life expectancy. Your payment is then recalculated each year with your account balance as of December 31st of the preceding year and your current life expectancy. With this method, your payments will change depending on your account value.

2) Fixed amortization method: This method amortizes your account balance over your single life expectancy, the uniform life expectancy table, or joint life expectancy with your oldest named beneficiary. Such a method is more stable.

3) Fixed annuitization method: This method uses an annuity factor to calculate your SEPP. It’s hard enough calculating life expectancy and portfolio performance, let alone forecast interest rates for annuities so let’s skip this method.

The most common withdrawal calculation method is #1. I’d like to use my example for how using Rule 72(t) can help an early retiree extract more income and lead a more comfortable financial life.

TAXES BAD, MORE INCOME GOOD