Thursday, September 29, 2016

September Portfolio Actions

The end of the month is generally when I review portfolio holdings and reinvest dividends and, occasionally, make adjustments to holdings. The Model Portfolio's lead over the S&P500 has continued to widen, and now stands at nearly 16%. The recent uptick in performance of the Model Portfolio seems to have quite a bit to do with the recovery of oil prices. We purchased an ETF that tracks a broad index of master limited partnerships (ticker AMLP) which were (and remain) very cheap. As oil prices firm, new investor money is pouring into the yield-rich sector, and our holdings have reaped the benefit. We have also seen a strong flow of capital into Chevron (ticker CVX) and Kinder Morgan (ticker KMI). Higher stock prices mean that it will be less profitable to reinvest dividends in these areas of the portfolio, so I view the chart shown below as terrible news.



Fortunately, we had some good news this month. Foremost, we earned a very pleasant raise from American Express (ticker AXP) , which raised it's dividend by slightly over 10%, from .29 cents per quarter to .32 cents per quarter, or $1.28 a year. This comes to an increase of $14 a year for the Model Portfolio - about .09%. The increase seems hardly worth noting when you simply look at the immediate cash in hand this dividend increase gives us, but becomes more exciting when you consider the effects of how this raise will compound over the next 20 years. Prior to the American Express dividend increase, the Model Portfolio expected roughly $1,004,807 in dividends to accrue over the next 20 years. But after the dividend increase, thanks to the impact of compounding and the slightly higher portfolio yield, the total expected dividends for the Model Portfolio surged to $1,006,536. That represents an increase of $1,729 over the next 20 years, and as long-term investors, the focus is on cumulative income and not simply the immediate increase of $14.

Alas, that good news is offset by a genuinely troubling development with Wells Fargo (ticker WFC). Over a period of years, the bank cheated customers, opening unauthorized accounts the customers never asked for or needed, simply to generate bonus awards for bankers who appears to have brought in more business. Worse, the bank attempted to obfuscate this fact, hiding it from shareholders and from the board of directors FOR YEARS. My general rule is this: I never do business with anyone I don't trust. I don't care whether the opportunity appears golden or not. The same rule applies when I buy or own stock. The shares could be trading at wildly cheap levels, and if it's shares of a company that lies to shareholders and cheats customers, I want nothing to do with it. I will not own or buy the shares at any price.

I have opted to liquidate our position in Wells Fargo bank, and to divide the proceeds among Extra Space Storage (ticker EXP), American States Water (ticker AWR), and a new position: AT&T (ticker T). As a result of these adjustments, the income sources of the Model Portfolio are now slightly more balanced, we've spread exposure from one line of business (banking) to three unrelated businesses (water, phones and storage space), and increased the income of the Model Portfolio to $14,678 per year - a gain of about $78 per year or roughly half a percent. The composition of the Model Portfolio is now thus:



Going forward, as dividends poor in at the end of the month, I'm going to simply put them into more shares of American Express, and will adjust the Model Portfolio accordingly. I will also look to retain approximately 60 cents, to buy myself an espresso at my favorite cafe where I do most of my investing work: The Cafe Brasilliero in the heart of the old section of Lisbon. Nothing beats doing the work you love in a space you love to be in.



Saturday, September 24, 2016

Teaching Kids How To Invest

Would it surprise you to know that one of the very finest investors I know is my 11 year old? I say this not because his investment results are higher than the broader stock market (which is not something he could control) but because of his attitudes and behavior (which he can and does control).

One of the very first lessons I taught him about investing is that what you own isn't a piece of paper called "stock." What you own is a share of a business. To demonstrate this, I took him to McDonald's. We ate lunch, and I explained how the company buys supplies, hires people, cooks food and sells it for more than it cost to make. The company then takes these profits and opens more restaurants, so it can earn even MORE profits. The company also pays some of the profits to the people who own the company, and that is called a dividend. I explained to my kid that he owned a piece of McDonald's, since I had bought him some stock in McDonald's. He completely understood the idea that part of the table we were sitting at belongs to him, and all the people standing in line to buy Big Macs and fries - some of that money will belong to him, too. And he completely understood that if he wanted to own even more McDonald's, he could always save his money and buy more stock. You can buy the Happy Meal, or you can buy the company.

As the years went by, I'd sit down with my kid once in a while to look at his accounts, see how many dividends had come in, and then talk to him about how to use those dividends to buy more stock in businesses that he knew. He likes Starbucks, so we bought him some stock. He loves Star Wars, so we bought him some shares of Disney. He loves Coke, so we bought shares of the company. My main goal was to get him thinking about businesses, and what makes the businesses good or bad to own, and to really look at his portfolio as a portfolio of businesses, not a bunch of red and green arrows next to ever-changing numbers (which don't make much sense to an 11 year old, anyway, and should make even LESS sense to an experienced investor).

The most important thing I taught him was the idea of what capital is. I used an analogy that made a lot of sense to him as a 5 year old. I told him that money is like an apple. You can eat the apple, or you can plant it, grow an apple tree, and in a few years, you end up with supply of lots of apples that the tree will keep giving you. THEN, you can eat a few of those, and plant the rest, and instead of one apple tree, you have a whole farm with lots of trees growing lots and lots of apples. In the same way that you can plant apples to grow yourself a bunch of apple trees that will give you all the apples you will ever need, you can plant money into businesses like Disney, McDonald's or Starbucks, but instead of apples, they give you money in the form of dividends. You can plant those dividends into more shares of these companies, and then you get even MORE dividends. Investing is just like growing yourself a forest of apple trees.

From the time he was about 6, my kid completely understood that money can be used to grow more money, and you can reinvest that money and grow more money still. He understood that the longer you do this, the more you get. His entire concept of investing is based around compound income - he has no interest in buying low and selling high and in fact, he has never sold a single share of stock in his entire life.

My young friend does not hover over his brokerage accounts. Actually, he doesn't even bother to check them unless I remind him. When he looks at his brokerage accounts (once every month or quarter), he sees how many dividends he has earned, and then goes about deciding where to invest those dividends (although I oversee what he's doing).  He follows the same routine more or less each month or each quarter, and the sum total of his time spent as an investor is dedicated to just reinvesting his savings, and growing his apple orchard bit by bit by bit.

This seems simple enough to do, but in fact, many adults would struggle to match my young friend's discipline and utter lack of emotion when it comes to investing. He has seen certain shares of stock he owns crash by 90% - like his stock in Reed's (REED), a boutique root beer and ginger ale maker that my friend picked on his own for his investment account when he was about 5 years old. At one time, the stock was up 600%, but my friend didn't get remotely excited about that. Now that the stock has crashed and may never regain it's bygone heights, my friend doesn't seem to pay that much mind either. He seems to have a "win some, lose some" attitude. If you were to ask him about REEDs, he'd probably give you the "don't put all your eggs in one basket" talk. I haven't asked him directly, but I also sense that the Reed's stock crash taught him that there is a difference between a great product and a well managed business.

My young friend has done extremely well for himself, by any measure. As a parent, what is most important to me is that he is completely stress-free about investing, doesn't think it is too complicated or that he needs to pay someone to do it for him because he doesn't know enough (granted, the bulk of his portfolio was picked by someone else, who also happens to oversee what my friend actually does with his portfolio). He is very rational about it all. When prices are low, he buys more, and then he gets out of his own way and let's his investments work for him. I wouldn't say that investing is terribly interesting to my kid, but that's maybe why he's been so successful about being patient and disciplined.

Some parents may want to teach their kids about investing as well, and some may want to talk to their kids about investing in some of the ways I talked to mine. If so, I have created a special online tool that readers may copy and use. It is similar to one my kid has, and it's designed to do one thing: to show how much money a portfolio will pay you in twenty years if you reinvest dividends. It is, in essence, a spreadsheet version of an apple tree farm.

The key to this approach is that it becomes very obvious that saving small amounts today produces enormous amounts of income in the future. While stock prices whip around at random and don't give a continuous sense of progress, looking at portfolio income over time is much smoother and predictable, and can give a kid a better sense of progress.

Here is what the tool looks like.



What you could do is to open a brokerage account for your kid, and buy a few stocks. Using this Retirement Clock tool, you enter the ticker symbols for your kid's stocks in the top row. I added 8 columns, but you can add more based on the contents of your kid's portfolio. In the second row, enter the number of shares you have bought for your kid. The tool will calculate the total income the portfolio should project this year, and will automatically calculate the average dividend growth for each of the companies you bought, based on the last five years' worth of dividend growth (I caution readers to review this dividend growth area carefully - if you see something unrealistic, just insert your own estimate). The tool will also show how many dividends the portfolio should generate in 20 years, assuming you reinvest dividends at whatever today's portfolio yield is. I added an area for spending, so you can show what happens if you spend some portion of the portfolio income from time to time. As you see from the example, below, spending $5 in the first year, and saving the rest, produces a total of $14,995 of dividends after 20 years.  Spending $100 in the first year takes the cumulative dividend income down by over $200.

 

After you have input the ticker symbols and the number of shares, the last thing you will need to do to set the tool up is go into the chart that shows a dial with a projection for 20 years worth of dividends. What you want to do is to customize this dial so it goes from zero to whatever number of future accumulated dividends you want. To do so, click on the triangle button (shown below), hit "advanced edit".

Next, it will take you to the screen you see below.



Where it says "gauge range", put in zero to whatever number of future accumulated dividends you want to track. I picked $100,000. You see that there is a number $14,963 - that is the projected 20 year accumulated dividends for the portfolio I picked in this example. Where the chart editor says "Colored ranges", I picked zero to $14,963 as the red zone, and from $14,963 to $100,000 as green. The reason why? Going forward, as I help my kid reinvest dividends and buy more shares, and as companies I own increase their dividends, the total dividends I expect to earn over 20 years should go up from where it started ($14,963), and I can help my kid visualize her or his progress away from the red zone, and deeper and deeper into the green zone. The idea is that over time, the more dividend apples I help my kid plant, the larger that green forest of future dividend income will grow.

If you wish to use a copy of this tool, here is a link. Click it, and it will take you to Google Sheets. Once there, click "File" and then "Copy." That will give you an exact copy, which you can modify as you see fit, adding your own ticker symbols, number of shares, or any other changes to the functionality of the spreadsheet.

https://docs.google.com/spreadsheets/d/13da6TxVqDrc7muwXyzUmkO3aZRUUxC-N_VZfh3lLUNE/edit?usp=sharing

Monday, September 19, 2016

Enhancing Diversification and Income

In the last post, I detailed the reason why an investor only needs to get lucky once or twice in his or her investment career. Nobody can control whether they will get lucky at investing, but you can certainly control what to do with your lucky streak, if you have one.

Let's suppose that your stock portfolio outperforms the S&P500 by some reasonably margin. In the case of the Model Portfolio, we are about 16% higher than the S&P500 since I launched the experiment last November. The first step in the analysis is to figure out whether, in fact, your portfolio performance is due to luck or something else. If your portfolio performance is due to something other than luck, you have a choice: either (1) keep doing whatever worked until it stops working, and then do something else; or (2) quit while you're ahead, unless you can't. On the other hand, if your portfolio performance is due to luck, then you can't actually chose to keep "doing whatever worked" because you didn't DO anything that worked in the first place. You simply got lucky. I'd argue that means quitting while you are ahead, unless you can't.

I believe that most of the reason why the Model Portfolio outperformed the S&P500 is, sad to admit, due to luck. The first lucky break was investing in Valspar paints, which was bought out by Sherman Williams for a huge premium. I guarantee I did not have any way to know that would happen. True, I picked Valspar because it has steady and growing earnings, and happened to be a small but dominant player in the paints and coatings business. It makes sense that the company would become a takeover target, but frankly, you never know where and when lightning will strike. It struck Valspar and the Model Portfolio got an immediate boost - which I promptly locked in by selling Valspar stock at a huge gain. I reinvested those proceeds and the Model Portfolio income leapt higher as a result.

Another stroke of luck is that dividend investing suddenly came into vogue this year. As detailed in other posts, the price of various dividend focused funds has far exceeded the S&P500 since last November - which is not usual. I doubt it will last - most dividend stocks trade at a very high premium now compared to non-dividend paying stocks. Historically, that's actually the opposite of what you typically see. Suffice it to say, I guarantee that I had no idea this would happen, and no idea of how long it will last, either. Luck.

Finally, Brexit gave the Model Portfolio a very large bump higher. Events like Brexit by definition take the market by surprise. They are fundamentally unpredictable, and the outcome is more unpredictable still. When I sold some of the top performing stocks in the Model Portfolio, I put the proceeds into European index funds that had crashed by over 10% or more in view of the uncertainty unleashed by Brexit. I had no idea whether these fears reflected in the price of European index funds were justified or irrational. I took a gamble, bought the European index funds, and earned a dramatic and very speedy windfall in the process. Skill? No. I gambled and won.

So like I said.  The Model Portfolio is 16% higher than the S&P500, and I couldn't replicate that performance if I tried. In fact, trying would be completely irrational on my part - I am completely sure that my special investment savvy had little or nothing to do with where things stand today in terms of the price of the Model Portfolio.

If I were to sell off the Model Portfolio and place the gains into an index fund, I'd be guaranteed to keep that 16% lead over the S&P500, and that lead would grow at a compound rate. I wouldn't just stay ahead of the S&P500 - I'd become increasingly MORE ahead with each reinvested dividend.
The problem I see is that the yield on the S&P500 is half the yield on the Model Portfolio. If I sold out, I'd take a massive pay cut, and the whole purpose of the Model Portfolio is to beat the S&P500 based on earnings and cash flow growth, not price performance. In other words, selling everything and investing in the S&P500 isn't a viable option, based on my investment goals. That is why I've opted to do the next best thing to selling everything and investing in an index fund: diversify the portfolio holdings.

Last week, when I reinvested dividends, I added a small position in Extra Space Storage (ticker EXR), a company that operates and, in many cases, owns, self-storage units. EXR  has experienced explosive earnings growth due to demographic trends that are likely to continue for years. This week, I will add shares of American States Water (ticker AWR) which delivers water to homes and businesses located in California. The company has raised dividends for no less than 61 years, and the service is both essential to life and enjoys monopolistic benefits.  Appropriately, I can say that this business has a wide moat. Today, I will sell some shares of Apple (which now accounts for nearly 6% of the Model Portfolio by price) and MMM (which accounts for almost 6% of the portfolio by price). I will parlay those gains into AWR and EXR in the shares and proportions set forth below. As a result of this move, the portfolio will gain diversification AND enjoy a nice income raise up to $14,601. That extra cash flow should compound over time, and the total dividends I expect over the next 20 years should go up (the Retirement Clock tool estimates the 20 year dividends should go from $1,036,000 to $1,104,636 - but that assumes I can keep reinvesting dividends at a 4% yield, which may turn out to be far from true).

Thursday, September 15, 2016

Quitting In Stages As The End Game Approaches

In the real world, my investment approach with my actual portfolio is fundamentally very different from the Model Portfolio approach I write about here: I own blue chip dividend paying stocks, I collect the dividends, spend less than I own, and reinvest the balance into more blue chip dividend paying stocks. I rarely sell shares unless they become obviously overpriced - like if the average five year PE ratio hits 30 but the long-term average earnings growth is less than 8. I primarily favor lower priced shares of blue chip companies with a PE ratio in the area of 15 or even less. It's more or less exactly what you read about here.

The main difference is diversification. My vision is 100 different, unrelated sources of income, each contributing no more than 5% of my total portfolio income. The core of my approach revolves around the blue chip dividend paying stocks, but I also add preferred stock funds, real estate, bond funds, etc.  I'm less concerned with dividend growth or even maximizing portfolio income - more concerned with enhancing reliability and safety, and reducing financial stress.

At the moment, the Model Portfolio comprises 21 different companies. The income growth and capital appreciation is substantially higher than the overall stock market, and the stated goal of the Model Portfolio (produce $30,000 of income each year) is not terribly far off (maybe about 5 or 6 years, I'd guess). Some suggest that on Wall Street, you do well by doing what worked yesterday, and to keep doing it until it stops working, and then do something different. For me, the better idea is to start changing up your strategy once it's succeeded in getting you close to where you want to be. We aren't in the end game, but since we are in the halfway point a little less than a year into the Model Portfolio project, it's time to think about the end game with fresh eyes.

If this was the real world, my goal for the Model Portfolio would be, of course, to produce the $30,000 of reliable dividend income, but I would also want that income to be pouring in from at least 100 different unrelated sources, each contributing about $300 worth of dividends or distributions. There is safety in numbers. And frankly, I'd want to "lock in" the performance of the Model Portfolio relative to the overall stock market - the Model Portfolio income growth has been hundreds of percentage points higher than the income growth of the S&P500. One of the things you learn about investing is that you don't need thousands of investments that modestly beat the S&P500 year in and year out. You can do dramatically better than average with just one good year, or maybe two or three home-run investments over your lifetime.

A personal anecdote. In the mid 1990s, I bought a loft in a dirty section of lower Manhattan. There were abandoned buildings, and at nights, large rats scampered around in the gutters. It was a part of town where you don't go out at night.  The loft was cheap - about one year's worth of a first year lawyer's salary at a typical New York City law firm. Fast forward 7 years, and it was (and remains) the single most desirable and chic area in all of New York City. The price of that loft soared by nearly 700% over that time period. It was pure, dumb luck. A windfall, never to be repeated. I sold the space and found another apartment to rent nearby. I put the proceeds from the sale into some dividend stocks and watched my portfolio income quadruple right then and there. The internet bubble had just burst, and at the time, dividend paying stocks were selling at rock bottom prices - basically, I got lucky twice in one go.

The point of this story is that all it took was one well-timed windfall for me to be in a position where I could retire at age 35 if I wanted. Consistently picking stocks that beat the market year in and year out isn't how most people do it. One year where your portfolio is dramatically higher than the market can be that one-off, well timed windfall that turns into lifetime of steady, reliable income. An acquaintance once outperformed the stock market by nearly 36% one year. In early January of the following year, he sold the portfolio and bought an S&P500 index fund, and thirteen years later, he STILL boasts one of the most successful investment track records on Wall Street (the greatest investor in history, Warren Buffett, has outperformed the S&P500, assuming dividends are reinvested, by around 22% since 2003).

This is the most important point I can emphasize.  The thing about starting from a point 36% higher than the overall market is that my friend earned 36% more dividends that first year, which left him that much more to reinvest.  This created a mathematical certainty that his 36% lead over the stock market the first year would equate to a 36.72% lead the next year, 37.45% the year after that, and so on and so forth each year. Notice that the lead expands at a geometric rate each and every single year?  And notice that this guaranteed and growing lead over the stock market involves nothing more than owning precisely the same stocks as the S&P500??? It seems unfair that one investor can do exponentially better and better and better than another investor who owns precisely the exact same asset, but the power of compounding guarantees that a small head start can translate into permanent and permanently growing advantage. I'd argue that this explains why there is a growing wealth and income disparity around the Earth. Spending less than you own and reinvesting the balance has the unrelenting gravitation power of a black hole. My acquaintance understood that, and had the humility and common sense to act rationally as an investor.

The moral of the story is that knowing when to quit was far more valuable than knowing which stocks to pick. If you outdo the stock market by 16% this year, and you want to guarantee that you will outperform it next year by 16.32%, and 16.64% the year after, and to continue outperforming the stock market at an exponentially increasing rate for the rest of your life, sell everything and invest the proceeds into a broad S&P500 index fund and reinvest the dividends. I'd do that with the Model Portfolio, but then, what would I write about? Actually I'm kidding - I wouldn't because I could care less about beating the stock market and frankly, I don't like the way the stock market index funds are managed. They buy stocks when the price is rising, and sell when the price is dropping - the exact opposite of how I like to invest.

Getting back to the matter of knowing when to quit.  My story about the apartment is actually quite illustrative because of what I haven't told you yet.  As it happens, my choice to sell the apartment was nothing short of disastrous from the perspective of maximizing returns. The price for that space continued to soar and is most likely two to three times higher now than it was when I sold it. It's fair to say that I took my chips off the table way too soon, but I have always felt that having one penny more than you need is no blessing, whereas having enough is the greatest financial boon available. To risk sacrificing the latter in order to potentially achieve the former is my definition of irrational financial behavior.  This explains why I will never be a fabulously wealthy investor that anyone will ever read about in the Wall Street Journal, but I hope to always pay my bills on time.

If you stay in the investment game long enough, whether in real estate, stocks, or starting a business, you may eventually have a glorious and sudden stroke of luck. If this happens to you, remember that you can use just one lucky windfall or one really great year on the market as a toe hold to climb much higher, just by using the power of compound returns to your advantage.  By quitting too soon, you may forego further heady gains, but as long as you can pay your bills each month, who cares??? The income growth of the Model Portfolio is not quite the same level of windfall that I enjoyed with our apartment in Tribeca, but it's enough that I am thinking ahead now as to how I would "lock in" that performance if I were managing a portfolio with only these 21 stocks. I wouldn't do anything drastic, like sell it all and invest in an S&P500 fund. Instead, I'd undertake a slow and steady process of building out more and more diversification.  In other words, I wouldn't entirely abandon the approach that brought success, but I would evolve the approach towards the end goal I'd ultimately want to reach - in this case, $30,000 a year of reliable, steady income from 100 different unrelated sources.

My plan now is to continue reinvesting dividends for the Model Portfolio, but to add multiple new positions into other shares that I am personally familiar with - Phillip Morris International, the Royal Canadian Bank, McDonald's, Pepsi, Disney, and so forth. We may run into a limit with the Retirement Clock tool - I am unsure how many different positions the tool will track before getting glitchy. Ideally, I would think a stock portfolio of 50 different stocks in unrelated industries would be very diversified and safe, and that is what I will aspire to build (subject to the technical limitations previously mentioned). To the extent that I succeed in my diversification strategy, the implication is that we will see less of the explosive income growth in the portfolio that we enjoyed over the past year. They say that diversification is a terrible way to get rich, but the only way to stay rich. The same is true of income growth. 100 income sources can never produce the massive income growth of one carefully picked income growth stock. That's a trade off I'd be willing to make in the real world, and the purpose of this exercise is to demonstrate a real world approach that has worked well for me over the last 20 years... but hopefully sparing some readers the time-consuming (and occasionally expensive) learning curve that I laboriously ascended over that time period.

So, expect to see some new names added to the Model Portfolio. Today, I saw there was about $150 in new dividends, which I have invested into Extra Space Storage (ticker EXR). This is a small REIT that specializes in renting out short-term storage space near major metropolitan areas. The space is clean, the customer service is excellent, and the prospects for massive industry growth are pretty compelling. The price for the stock is expensive - translating to a PE ratio of 20, but the revenue growth is so high that actually, the valuation of the shares is fairly low.  The dividend growth is in the range of 40%, too - and there is plenty of room to grow from here.  By the end of this month, the Model Portfolio should produce a veritable flurry of dividends, some of which may find their way into EXR, others may find there way into some other new names I would like to add in order to diversify the business operations of the Model Portfolio.

Wednesday, September 14, 2016

Compound Return Investing and Bear Markets

Stock prices go up, stock prices go down. Knowing how temporary and fleeting stock prices can be, why is it SO bothersome to many investors when stock prices drop? I suggest that the answer can be found deep in the human brain. We feel that a current state of affairs is or may become permanent, or at least very long-lasting.

Is it rational to imagine that today's conditions might persist for the rest of your life? The answer, in fact, is yes.  Imagine you bought shares of the Dow Jones Industrial Average in 1906. By the time you reached 1942, you would have earned zero price appreciation. Collected nothing but dividends, and watched inflation devastate your economic return over a 36 year period. Or suppose you invested in the Dow Jones in 1962. By 1980, you'd have earned zero price appreciation - and you'd be left with the utterly devastating impact of a full decade of runaway inflation during the 1970s. Sadly, for a capital gains investor seeking to buy low and sell high, stock prices can stagnate or drop over 20, 30 or even up to 40 year time periods. Today's conditions can and sometimes do persist for the rest of your entire investing career.




To a compound returns investor, the prospect of a 40 year bear market is cause for absolute jubilation. Unlike a capital gains investor, a compound returns investor seeks to collect dividend income, reinvest it into more dividend paying stocks, and thereby collect a slightly larger amount of dividends in the future. And to repeat this process as frequently and for absolutely as long as possible. There is a fundamental difference between a compound return investor and a capital gains investor: the compound returns investor is a permanent net buyer of stocks, whereas the capital gains investor seeks to one day liquidate all or some portion of his or her stock portfolio, and is thus neither a net seller nor a net a buyer of stocks. Buyers of any description, be they buyers of stocks or cartons of milk, always cheer lower prices. This is the fundamental reason why a compound return investor yearns for a 40 year bear market as the ultimate financial boon.

The Model Portfolio is a perfect example of how investors can approach the question of capital gains investing verses compound return investing. Yesterday, we see that the Model Portfolio lost over 1.6% - on top of the more significant losses we saw last Friday. This translates to a capital loss of $5,923.



A capital gain investor may very well feel nauseous looking at these figures. True, the prices might bounce back at any given moment, but what if today is the start of a 20 or 40 year bear market? If so, then the capital gains investor will NEVER be able to reclaim that lost $5,923. The money is gone, it is gone forever, and the market could go even LOWER from here, resulting in dramatically larger losses that could also be permanent. This notion, which is perfectly rational, feeds the temptation to sell, and that temptation grows stronger and stronger with each tick lower of the market.

By contrast, the compound return investor sees a potential to buy more shares at ever lower prices, resulting in larger amounts of dividend income. The prospect of the market staying lower for 20 years or more is not only welcome, but secretly something the compound return investor prays for. The longer the market stays lower, the larger the amount of dividends the compound return investor will collect over time. Thanks to the collapse in certain share prices of stocks in the Model Portfolio, the Portfolio now carries a yield of nearly 4% - an astonishing 50 basis point leap over where the portfolio yield stood just one week ago. If only the stock market stays low for another 20 years, every time we purchase more stock with dividends we reinvest, those reinvestments will carry a yield of around 4% on average, and as a result, the impact of compounding will reverberate through time. Today's ripples will translate into tomorrow's tsunamis, and we will collect an additional $6,843 of dividend income over the next 20 years, compared to the dividends we'd have otherwise collected had the market not sold off yesterday.



I won't lie. I feel greedy when I see market prices swirling down the potty. I wish it weren't true, but watching the cumulative dividend dial tip into the green zone makes me want to rub my hands together. Such a pity that today, the Model Portfolio contains a cash surplus of only $29. I can't do much with that.

This is the most frustrating aspect of compound return investing:  the requirement for patience. Every month, dividends come in, but on some days, you experience a sell off in the stock market and have no cash on hand to invest. You find yourself hoping that the stock market will not rebound before you receive more dividends to reinvest, and consoling yourself with the notion that with any luck, perhaps the market will drop EVEN MORE by the time your next dividend payment rolls in.

Tuesday, September 13, 2016

A New Feature To The Retirement Clock Tool

I designed the Retirement Clock specifically to help investors focus on steadily rising portfolio income levels, instead of whimsically fluctuating portfolio price levels. I have now added a deceptively simple feature to the Retirement Clock: a new gauge that projects the total amount of dividends the portfolio may pay me over a 20 year time period ASSUMING I reinvest some portion or all dividends at TODAY'S portfolio yield. This new gauge is designed to accomplish two things.
First, the cumulative dividend gauge quantifies the cumulative benefit of reinvesting even small amounts. If I reinvest $100 worth of dividends today, I may generate an extra $4 of dividend income this year (not too exciting), but if I continuously reinvest that extra $4 dividend amount over the next 20 years, I could almost generate an additional $400 worth of dividend income (representing a 400% gain over the initial $100 reinvestment, which is rather exciting). The cumulative dividend gauge keeps my investing attention riveted on the single most important aspect of investing to me: ignore the nonsensical babble of stock market noise and meditate deeply on the issue of compound income growth.
Second, the new cumulative income gauge enables me to do what most investors cannot easily do: to feel greedy when others are fearful. Since the cumulative dividend gauge assumes that I reinvest dividends at TODAY'S portfolio dividend yield, I get far more bang for my buck when my portfolio price level is lower (which is when my portfolio yield will be highest). During a bear market or violent market selloff, my brokerage statement will be festooned with terrifying red arrows, but not the cumulative dividend income gauge. To the contrary, the harder stock prices fall, the higher my projected cumulative dividend income will soar deep into the green, replacing the endorphin-fueled flight instinct my brokerage statement inspires with the giddy hoots and squeals of greedy delight that come from watching portfolio income levels explode higher when I reinvest dividends into the maw of a bear market.
Let's use a visual example. Into the version of the Retirement Clock shown below, I have input my Model Portfolio of dividend stocks. In the first gauge to the left on the Retirement Clock, you can see that the Model Portfolio started with $10,000 of portfolio income when I launched it, and that the dividend income has grown to about $14,500 a year. The first gauge visually shows my progress towards my portfolio income goal of $30,000.
The second gauge shows how many years it should take my portfolio to generate $30,000 of income, based on the average dividend growth rates of the component stocks I own. When I launched the portfolio, the tool assumed I would reach $30,000 of portfolio income in 12.03 years, but I have cut that time down to 9.26 years.
(click to enlarge)
The third gauge all the way to the right details my current cumulative dividend projection as of yesterday, which is $1,036,259. I have set the gauge levels at $500,000 on the low end, and $2,000,000 on the high end. Over time, as I reinvest dividends, my cumulative dividend projection should tend towards the $2,000,000 mark. Also, the cumulative dividend gauge will either tip towards $500,000 or $2,000,000 depending on which direction stock prices happen to be going. Today, for example, the Dow Jones is crashing by 150 points as I write. The price of the Model Portfolio is down as well by over $2,196.
So, have I lost money in today's stock market fizzle? The answer is no. Look at the cumulative dividend section of the Retirement Clock. Thanks to the lower price on my portfolio, and higher yield at which I might be able to reinvest dividends, I see that today's stock market crash has EARNED me $3,335 in future dividends accumulated over the next 20 years.
 

True enough, the apparent benefits of today's market sell off may easily evaporate - the market could rally back long before I enjoy the benefit of having dividends to reinvest, costing me the chance to invest at lower prices. To that extent, the cumulative dividend meter is somewhat of an illusion, but I could just as easily ask whether the fallen prices of the portfolio's investments are EQUALLY illusory? What is the loss I suffer if a stock I owns drops in price, and I don't sell? The answer is NOTHING. Falling stock prices simply cost me the immediate opportunity to sell at higher prices, but if I never planned to sell in the first place, that cost is just as much an illusion as the cumulative dividend meter's projections about what dividends I might earn over 20 years if market prices remain at today's levels. Before you knock what I'm saying as a buch of mysticism, the theory is actually well grounded in quantum mechanics. All around the universe, particles flit into and cancel out of existence in a continuous quantum flux, but unless observed, the quantum fluctuations have a zero net effect on the level of mass in the universe. So too does the price of a portfolio flit into positive and negative territory. Ignore it or simply fail to take action based on it, and it is very much like the price fluctuations never even happened. 

You are welcome to use a copy of the Retirement Clock tool as a template to create your own spreadsheet. You can input your own ticker symbols, number of shares, change the number of positions, change the desired level of portfolio income, change the readings on the gauges and dials, input whatever "start date" you'd like to use to start tracking your portfolio income progress. You may even think up different features to add, or different ways to use them. If so, I invite you to discuss such new features or uses of existing features in the comment section so other readers can benefit.
To create your own Retirement Clock, use this link to go to Google Spreadsheets. If you don't already have one, you may have to create a free account for yourself on Google.
This link is in "view only" and you will not be able to make any changes. To create your own version that you can edit and update, when you access the Retirement Clock, go to the "File" key, and hit "make a copy." The screen should look like the image shot, below.
(click to enlarge)

And here is a recent painting.

Monday, September 12, 2016

Dividend Investing and Beachcombing at the Praia da Ursa

The Federal Reserve hints at raising interest rates a full 25 basis points, the the market sells off to the tune of nearly 400 points. Needless to say, the experts on CNBC are proclaiming a good deal of doom and gloom, and in typical form, they are generally congratulating themselves for having foreseen and foretold all.  This has grabbed the headlines, but in fact, is entirely irrelevant to investors who focus simply on generating compound returns.

What these "compound return" investors do is they own shares of dividend paying stocks, they collect the dividends, they reinvest those dividends into more dividend paying stocks, and thereby generate even higher dividends next time. Then they repeat the process over and over again, as many times and for long as possible. Why? Simple. The power of compounding is a direct function of time - the more often and longer a series of numbers compounds, the larger the numbers get. Knowing this, a compound return investor wouldn't wait around trying to guess whether the stock market will be up, down or sideways over any given period of time. The dividends come in, they get immediately reinvested into the best businesses the investors can find at the best price then available, and that's pretty much the end of the story.

We had some dividends trickle into the Model Portfolio last week, which I duly reinvested. Today, I see another $436 has come in.  The timing couldn't be better. Today, I have decided to reinvest that into more shares of Emersen Electric (ticker EMR), one of the oldest industrial production technology companies in America with a multi-decade track record for raising dividends. The business is currently in the process of repositioning it's high margin businesses, and looking to divest the lower margin areas. EMR will become a leaner and more profitable company as a result, but currently, there is a good deal of uncertainty about it's future profits and, predictably, the market has left the shares in the wastebin. To a value investor, snooping around dumpsters for bargains on high quality businesses surrounded by a miasma of question marks is what investing is really all about. Thanks to the stock market sell off on Friday, EMR now yields 3.74%. When the company completes the various spin offs and acquisitions it has planned, that dividend yield may or may not change - I would be looking at the combined yield for the parent company as well as the division that will be spun out to shareholders as a separate stand alone company. I will probably sell the spun out shares and just reinvest back into the parent company - which may cut dividends since part of it's profits will be carried along to the spun-out company. Depending on what the stock market does to the various prices of these companies, I may take a paycut or get a raise, and only time can tell.

The current composition of the Model Portfolio is as shown below.



You can also see the price performance of the Model Portfolio relative to the S&P500.  It fell 2.6% on Friday, compared to the S&P500 which fell about 2.38%.  You'd expect the Model Portfolio price to be more sensitive to potential fluctuations in interest rates - many investors use dividend stocks as a surrogate for bonds that they'd otherwise prefer to hold. If interest rates rise, the urge to own these stocks as opposed to bonds can quickly evaporate, causing wild price swings. Obviously, it is silly to own dividend stocks instead of bonds because equity is not remotely the same thing as debt. But many investors simply look at the yield and can treat the underlying assets generating such yield as fungible. Stupid, I know, but that particular form of stupidity is very good news to us. Lower prices on dividend stocks helps us grow our portfolio income that much faster.



Do you notice any similarity between the price chart for the Model Portfolio and the praia da Ursa that my wife and I climbed down last week? It's a stunning beach, and if you visit early enough in the morning, almost nobody is there. It is a very steep climb down to the sand, which you can infer from the massive rocky hills that border the sand. Like so many things in Portugal, it can be a bit difficult and time consuming to get to, but once you are there, you will feel that there is no better place on Earth.



Look! Nobody is here! We had the place to ourselves, almost. And if you were wondering, YES, the sky over Portugal actually is this color blue. This country is magnificent, and the natural beauty you find here is unlike anywhere else.




Wednesday, September 7, 2016

Reward Yourself For Being Lucky This Time By Being Safer for Next Time

The Model Portfolio consists of shares of 21 different companies, all of which offer long histories of solid earnings growth (whether as stand alone companies or businesses that were spun out from other entities), solid dividend growth, and each operating in different industries with key competitive advantages. The aim of the portfolio is to generate a reliable and consistently growing stream of income, which is why the portfolio holds shares of businesses that raise dividends regularly and have strong prospects to continue doing so for the indefinite future.  The reason for this goal is that by living off portfolio income alone, fluctuations in stock prices become irrelevant, which enables an investor to hold shares of a business for an extremely long period of time - potentially for multiple generations. Time is very much the friend to investors who rely on the power of compounding, and long holding periods go hand in hand with that.

A secondary aim of the portfolio is to own these sorts of steady businesses when the price of the stock is either a bargain or simply reasonable. Expensive stock is particularly risky, even if its a great business.

To help manage risk, the Model Portfolio is weighted so that each position doesn't contribute too large a share of the portfolio income. When a business cuts it's dividend, the overall impact on the portfolio will not be so much. We saw that when the Model Portfolio was launched last year and one company, Kinder Morgan, promptly slashed it's dividend by 75% despite repeated promises to shareholders that the company would INCREASE the dividend by 10% a year. The loss of income to the Model Portfolio was a few hundred dollars, and within a relatively short period of time, the portfolio income rose far above where the income started. Diversification of income sources helps insulate shareholders from losing too much income from the inevitable dividend set backs that occur every so often (and that usually are accompanied by robust price declines in the stock of any company that slashes it's dividend).

While the portfolio weighting is largely determined by portfolio income, I don't actually ignore stock prices entirely. Sometimes, share prices can get ahead of you, as we've seen with Stanley Black and Decker (ticker SWK). The stock is reasonably priced in my view, and the company has one of the safest dividends that exists. SWK has paid dividends every year for well over 120 years, through wars, depressions, recessions, boom times. It doesn't matter. They make great hammers, and everyone always needs a good hammer.  The Model Portfolio now holds nearly $28,000 worth of SWK, and the position now accounts for over 7% of the entire portfolio which strikes me as somewhat over-allocated. This is not surprising - SWK has surged 25% since last November. Another reason I contemplated selling a bit of this stock is that I tend to think that if you own something that has surged in price (but not necessarily value) over a very short period of time, you do well to use some of that gain to buy yourself more diversification and safety. Think of it as rewarding yourself for being lucky this time by being safer for the next time.

Something else I have been looking at is American Express Co. (ticker AXP). In the real world, I bought shares of Amex last year, mainly because the future of electronic cash payments is bright, and Amex has decades and decades of history of consistent profitability, and consistently above average dividend growth. I have avoided the stock for years because I always felt it was too expensive, but now, it trades at a PE ratio of close to 11. It has all the hallmarks of what I look for as an investor: a great company at an exceptionally cheap price.

I am selling 60 some odd shares of SWK and adding 111 shares of AXP to the Model Portfolio. The move will do nothing in terms of boosting portfolio income, but that is not the point of today's decision. The move will enhance the diversification of the Model Portfolio, which in my view makes it safer and a more reliable source of steady, growing dividends. The composition and price performance data for the Model Portfolio now follows.





In other news, we discovered a lovely hidden gem about 45 minutes outside of downtown Lisbon: Ursa Beach. Like many beaches in Portugal, the sandy part down by the water is only accessible by means of a thin rocky path that winds down a steep cliff.  From on top of the cliff, you can see there is a tremendous view. The wind is strong and the air is cool, but the sun is brilliant and strong and will keep you warm once you're down by the water.



We started our hike fairly early in the morning, and so when we reached the beach, we were almost the only people down there. There are explosive waves, extremely fine white sand, and plenty of shade thanks to the immense rock formations. This would be a very fine place to bring a picnic, have a late dinner on the sand and watch the sun set over the horizon.

Here is a close up photo of the two crags featured above.








The Dividend Stock Investment Fad.

The price performance of the Model Portfolio is now almost 16% higher than the S&P500 since November of 2015, when I first launched the project. Some of this is due to the fact that several components of the Model Portfolio surged in price, prompting me to sell the shares and replace them with cheaper shares in similar quality businesses. Some of this is due to the fact that during the Brexit panic, I sold some expensive "safe haven" dividend stocks and purchased shares of a European total stock market ETF, that was very cheap at the time and that subsequently surged in price. I sensed a mild financial panic during Brexit, and eagerly bought those assets that the market was eagerly selling in indiscriminate fear. It's hard to not get a bargain when you buy into a generalized panic. Part of the performance of the Model Portfolio is due to the basic investment strategy behind the Model Portfolio: buy shares of companies that are likely to raise their dividends, buy those shares when the company's stock is cheap, collect and reinvest the dividends into more shares of cheap dividend paying companies, and if ever the stock starts to trade at insanely high prices (say, with PE ratios above 25), sell it and find some cheaper business to own.

This, however, does not tell the whole story.   Some of the price performance of the Model Portfolio has nothing to do with any decisions I made, and is based on the fact that at the moment, the global stock market seems to have developed a passion for dividend paying stocks. This is a direct consequence of bond yields. For many years now, bonds have offered investors no real return - inflation rates are generally higher than yields on most safe bonds. With negative interest rates spreading around Europe and Japan, investors now must literally pay for the privilege of lending their money to others - an irrational undertaking at best. Rather than purchasing bonds, many investors have opted for dividend paying stocks instead, particularly those with a history of raising dividends faster than the prevailing rate of inflation. And like anything else you see in the stock market, part of the flock towards dividend paying stocks has to do with fads and performance chasing, which exacerbates the price move until... the fad stops. When the fad stops, crashing stock prices are pretty normally what happens next, and one day (I have no idea when), I expect the price for all the shares in the Model Portfolio to do exactly that. Crash.

You can see the impact of the market's newfound love affair with dividend stocks in the chart below. Here, I contrast the price performance of the Ishares Select Dividend ETF  (ticker symbol DVY) which tracks a basket of dividend stocks with strong dividend histories, with the broader stock market (represented by the SPDR S&P500 ETF, ticker symbol SPY).  The price of DVY shares are are fully 9% higher than the price of SPY shares since November.

That dividend stocks have vastly outperformed the broader stock market is not, in itself, cause for alarm. What I do find more concerning is that many dividend paying stocks are now outrageously expensive. The simple solution I've adopted is to sell shares once the price rises into the level of utter insanity, but that leaves open the question of what to do with the sales proceeds. The higher the price for dividend stocks, the harder and harder it becomes to find an answer to that question.



I think it might be fair to say that managerial decisions and stock selection for the Model Portfolio account for about 8% of the Model Portfolio return, compared to the S&P500. The remaining 7% outperformance is due to luck - the fact that I launched the project at a time when, it just so happens, the stock market has decided to reward dividend paying stocks with excessive valuations (and I will note that such excesses rarely last forever). The chart comparing the performance of the Model Portfolio against DVY and SPY sums up my rationale in one single picture.



Since I believe that the price for stocks I own might crash, you might wonder what I plan to do? The answer is nothing. I don't sell stocks because I think the price might drop, any more than I would buy stocks simply because I think the price might go up.  I buy stocks when I think they are cheap and when I think the business will produce strong earnings for the next ten or twenty years.  I sell stocks only when the stocks in question are insanely high priced (for example, with PE ratios over 20 or 25). Generally speaking, when stock prices crash, that makes the shares cheaper and that makes me more interested in buying, not selling. My plan is to do what I always do, irrespective of what the stock market does or does not do. I will keep reinvesting dividends in the cheapest shares of high quality businesses I can find. The moment I can't find well priced shares of high quality businesses, I will stop investing and consider selling.

Tuesday, September 6, 2016

More Dividends and More Drawings



Here we are, on the hunt for more juicy dividend morsels, trolling through the alleys, among the filth, grime and garbage, the foul stench of of sewers belching steam. When at last, we see it. Shares of Kinder Morgan (ticker KMI), floundering about near the shore.... but not near enough.

The Model Portfolio has received $341 of dividend income this weekend, and is hungry. Accordingly, I have purchased an additional 14 shares of KMI and raised the Model Portfolio income to $14,200. That is a far cry from the $15,000+ of income we had not so long ago, but remember that safety always must come first. Dividend cuts, catastrophic losses, great white sharks. They're real, they're out there, and diversification is the only way to repel them or at least limit the carnage. I had to sell some shares of Allianz SA (ticker AZSEY) in order to unwind the excessive income concentration we had in that name, and to buy Verizon (VZ), a dull, somewhat overpriced stock in a business that if anything looks like something I'd care to avoid. The dividend is stable, though, and the PE ratio reasonable, and the business itself has nothing to do with any other business held in the Model Portfolio. So I held my nose and bought it. Now we are on track to rebuild the income, and reinvesting a few hundred dollars of dividends into KMI is just the way to do it.

The composition of the Model Portfolio is now thus:



The price performance of the Model Portfolio has started to catch up with the income growth performance. I have a theory about this. I believe that in time, unless the stock market is truly and really insane, but in time, the price of a portfolio should track the income growth of the portfolio - assuming that the quality of the businesses the portfolio owns remains constant. Look, you could start with a portfolio comprised of shares of stock in a great company like Starbucks (ticker SBUX), with a yield of 1.42%, purchase shares of American Capital Agency (ticker AGNC) with a yield of 11%, and you would absolutely not expect the portfolio to somehow drift up 10% as a result of the transaction. AGNC is not a good business, SBUX is, and the difference in yield will never make up for that fact.

But, if you own a portfolio of high quality blue chip companies, then it seems like a good hypothesis that over very long stretches of time, the portfolio price ought to more or less track the earnings and dividend growth of the underlying businesses. If you swap out shares of one blue chip business for shares in other equally high quality businesses and gain an income boost in the process, I am guessing (and it is only a guess) that the price performance will ultimately reflect that income boost as well. I've seen it over the last 20 years as I invest my own portfolio - we shall see what happens with this Model Portfolio project.



And for my last drawing, I have made a painting of vulnerability and solitude. It is a drawing about gender identity, personal image, inner demons, lust for power standing in stark contrast to flaccid desolation.  You might think this was a painting of Donald Trump and the rise of the so-called "alt-right" white power nationalist movement in the United States - but it isn't. Any similarities between Donald Trump and the characters featured in this drawing are entirely unintentional, and the characters in the drawing are purely fictitious.

 


Friday, September 2, 2016

I caught a mistake

In the real world, I would never allow one position to account for more than 2% of my total income - ASZEY accounts for over 10% of the Model Portfolio income. That is WAY too much concentration risk. I don't even remember what I was thinking when I pigged out on such a massive position in this one single stock. Probably I was anxious to generate excessive income growth for the portfolio, and was tantalized by the very high yield AZSEY has to offer. It also looks like the Retirement Clock tool was off - the correct dividend payment for US ADRs in Allianz is $.83, paid only once per year.
So now, with these errors out of the way, I feel that it is time to scale back, and frankly, I should never have gotten into this situation where so much of the portfolio income was tied to just one single name. This was due to greed for more income. At least this didn't end up costing the portfolio anything - actually, there is a 3% gain since I tanked up and overdosed on AZSEY. Luck, it is so rare that the story of greed ends that way. I have sold 700 shares of AZSEY, and the position is now worth roughly $14,000 rather than $24,000. And I have placed the proceeds into one of the dullest businesses I can think of - with an essential service, zero threat of competition from new entrants into the market, a regulated oligopoly's market, long-term contractual income, supremely high cash flow and a PE ratio that sits just under 15. Verizon (ticker VZ). Ho hum... but that's really the point, isn't it.
Today's move will result in an immediate and very substantial pay cut. Fortunately, the dividend pay cut is offset by a fairly good day in the market today. For the first time, the Model Portfolio closed 16% higher than the S&P500 since I launched the project last November.
(click to enlarge)
The composition and income generation of the Model Portfolio is now as follows:
(click to enlarge)

Month End Portfolio Reinvestments

This month, we received a total of  $130 in dividends. In looking down the list of income sources for the portfolio, it seems to me that the position in KMI is not contributing very much income, overall, to the portfolio. As it happens, KMI is very cheap, when you look at the multiple of price to distributable cash flow. The PE ratio for KMI is an unreliable indicator of value - the company claims such extraordinarily high accelerated depreciation deductions that they obscure how much actual free cash the company is capable of putting into shareholders' hands. Last year, the distributable net income per share for KMI came out to $2.14 per share, and is on track to produce over $2.2 of distributable net income per share for 2016. At current prices, that puts KMI at a price/ distributable net income ratio of about 10 - less than half the current PE ratio for the S&P500.  For a company growing earnings at 7% a year, that's cheap.

In addition to being cheap, KMI's business model is based on extremely long-term leases, and faces little competitive pressure. That makes the earnings highly secure and stable. A low risk business with stable and growing earnings at a very low price is more or less EXACTLY the sort of business where I like to reinvest dividends.

With this addition of 6 new KMI shares, the new annual income expected of the Model Portfolio is $15,930. The total portfolio's annualized income growth so far is now roughly 71%.  By contrast, the last four dividends for the SPDR S&P500 Index ETF equal $4.40, compared to $4.03 over the immediately preceding four period dividend cycle, implying a 9.2% annualized dividend growth rate. That puts the Model Portfolio income growth at roughly 700% higher than the S&P500. The price appreciation of the Model Portfolio is about 15.6% higher than the S&P500.







And here is a painting of the Campo Orique Mercado. It's really one of the finest neighborhood spots to grab a quick, informal dinner. Most of the restaurant stalls here use fish, meat, produce and other ingredients that are also available for sale within the market. You can be very sure that you're eating some of the freshest ingredients available, always at a very comfortable price, and always well prepared.




Wednesday, August 31, 2016

One year into our ex-pat adventure

It's been slightly over one year since my family and I packed up and moved from the Washington, DC area to Lisbon, Portugal. My wife and I retired in our early 40s, and were looking to go on an adventure with our ten year old child. We were also interested in downsizing, going from a large house and two cars to a more modest 2 bedroom apartment and no car (granted, our 2 bedroom apartment is located in an immense walled convent at the center of Lisbon, with gardens and fountains, and is anything but rustic). We don't buy many things because we don't have the room for more stuff.

We have learned a great deal of valuable lessons over the past year. They are as follows:

(1) In Portugal, everything that is supposed to happen eventually does happen, but it takes much longer here than in the USA and there's widespread use of makeshift solutions. For example, our residency permit expires in September, but the immigration service cannot grant us a new one until November due to backlogs. So, they sent us a letter stating that we have a meeting scheduled in November, and we can present this letter in lieu of a valid residency permit. Lesson number one: to live here and comply with the law, you simply must be willing to take on faith that it will all work out. Throughout most of Europe, government agencies do most things strictly by the book and to the letter. In Portugal, the government is so leanly staffed that they have to improvise with work-arounds.

(2) It is very cheap to travel around Europe once you live here. Flights out of Lisbon to almost any other city on this continent can cost $100, if you time them appropriately. Air B&B and Homeaway provide access to thousands of reasonable short-term apartment rentals. If you own an apartment in Europe, you can often swap it out for a rental elsewhere. In effect, you can take a week's vacation anywhere in Europe for nothing more than the cost of airfare - and again, that can be negligible. The availability of cheap travel is perfect for parents who want to do frequent travel with children to show them the world.

(3) Education in cheap in Portugal. Private language tutors cost $10 to $15 an hour, and an elite private middle school or high school costs about $12,000 to $14,000 a year in tuition. University level education, ironically, costs only a fraction of private middle school or high school costs. The quality of education is absolutely first rate, and education is very highly prized and valued in Portuguese culture. In fact, the definition of "good manners" and "well educated" is the same phrase in Portuguese: "Bem educado." An American kid thinking about getting a great education without going into a mountain of debt could consider traveling to Lisbon, spending a year mastering the language, and then going to university here.

(4) Buying real estate in Lisbon is now preposterously expensive. There is a growing influx of immigration to Lisbon from France and China. The French come here because it is possible to obtain a status as "an habitual non-resident". If you have never lived in Portugal at any time over the past five years, you can come here and live full time, and pay NO income taxes on your non-Portugal source income for 10 years, and a greatly diminished rate on certain categories of Portugal source income. Coming from a country like France with a 75% income tax rate, the tax savings arising from moving to Portugal are enormous. Americans can apply for this status as well. We filed our application early this year and still have not heard back. Our accountant suggests it could be a year before we do, on account of backlogs. Over 30,000 new applications for non-habitual tax status were filed in the early part of 2016 - mainly by French nationals.

Much of the fuel behind the surge in real estate prices is due to the much touted "golden visa" program. Purchasing a property worth 500,000 Euros entitles the owner to a Visa in Portugal.
In fact, if you come here, the golden visa program could be a mistake for you to avoid. There are processing delays, endless delays. We have friends who have been here a year, and are STILL waiting for their golden visa (they rely on the sort of work-arounds I described earlier). It costs 5,000 Euros per application for the golden visa, and lawyers who push these visas on their clients will charge additional fees in the thousands range. Then there is the cost of the real estate itself.

A quicker, cheaper way to sidestep all of this is to apply for a "pensioners visa." This cost 40 Euros, and we obtained ours in a couple of weeks. We paid lawyers nothing to file this application, because it was so simple we did it on our own. You do NOT need to purchase real estate in Portugal in order to apply for a pensioner's visa, so an American retiree could easily just come here and rent. Rent is cheap - even in a posh section of Lisbon.

We do not, by the way, have any pension - it's not necessary with a pensioner's visa. In lieu of a pension, I showed a copy of a bank statement with about $30,000 in my checking account.

(5) The tax savings here are, potentially, too good to last. Portugal's government bond ratings are in jeopardy, and the largest bank here (Caixa Geral do Depositos) just got another multi-billion Euro bailout. Beggars can't be choosers, and at some point, all the countries writing checks to the Portuguese government may take issue with the tax-free status of millionaire immigrants to Portugal. If so, I could see further bail outs being conditioned on Portugal CANCELLING it's habitual non-resident tax program. If that were to happen, an American residing in Portugal may be liable for Portuguese income tax on US source income - and would have to rely on the US/Portugal tax treaty to avoid double income taxation (and to tally up which jurisdiction is entitled to which pound of your flesh). Just like you'd have to do if you were an American living in France, Germany, the UK, or any other European country.

As an American, you pay income tax to the Federal government no matter where you live. The benefit to an American of the non-habitual tax resident program in Portugal, however, is that you don't pay European income taxes. America has a very low tax rate on dividend income, for instance. Move to Spain or Italy or Germany, you'd see your effective income tax rate on your dividends spiral higher. Not so in Portugal... not yet, at least. If I were a betting man, I'd say that the tax clock here is ticking.

Bottom line: for an American looking to retire to Portugal, view the tax benefits as potentially fleeting, and don't build a budget around them.

(6) Medical services and costs in Portugal are astoundingly good deals. We use the Hospital da Luz in Lisbon for all our medical needs, and carry insurance through Multicare, which is a national provider here. We've gone to specialists and paid $15 per visit. The service is prompt, there is no paperwork, and the level of care is superior to what we experienced in the USA. Our insurance coverage is entirely comprehensive, and costs $200 for an entire family. In fact, for an older retiree or someone with medical issues, medical services and costs are, on their own, enough of a good reason to move here.

(7) You can get by speaking nothing but English, but only when it comes to eating in restaurants or doing turisty things, like renting a car. Doctors and nurses and most professional service providers are fluent or conversant in English. When it comes time to repair a refrigerator or get a cell phone, you must speak Portuguese or bring a friend who does. The Portuguese language is not similar to Spanish. There are a few words in common, but more words in common with English than Spanish (which is to say, not many). I've taken a year of Portuguese lessons now, twice a week. Last week I sent an email (in Portuguese) to the manager of our condominium to let her know I want to replace some floor tiles. She came to our apartment in a tizzy, convinced that my e-mail said that I was going to replace the tiles on the roof of our building. Portuguese is a tricky language.

(8) The weather in Portugal is temperate, 82 degrees in the hot summer months, 50 degrees in Winter. Air conditioning is rarely used. The problem is that you get these evil hot days once in a while, where temperatures soar to 95 degrees. Most restaurants still will not switch on the AC, even if they have it (and many buildings don't). Prepare to suffer, or rent a car and drive to the beach in August.

(9) Beach culture is rampant in Portugal. It's what people do. The coast comprises a large bit of the country's physical land, the beaches are spectacular, and quite popular. The water is cold, but the sun is brilliant. Surfing is extremely popular here. By far, our favorite surf/beach town is Ericiera, located about 40 minutes by car outside of Lisbon. Like many beach towns, it's perched high above the sand, and you have to climb down a steep embankment to get to the water.

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(10) Portuguese people frequently ask me why I moved to Portugal. I typically gush about the culture, food, weather, architecture, friendly people. This goes over extremely well. There is a lot of national pride here, which is well hidden. Portuguese people often complain about the country, it's lousy economy, lack of opportunities. Partly this is due to modesty, I suspect. Not false modesty, mind you. This is not a flashy society in the least, nobody appreciates a show off here. It's easy to be confused about this modesty, because to a person, every Portuguese person I have met is deeply proud of their country and culture, and takes it as a personal compliment if you tell them this is the greatest place on Earth.

(11) Many business people here are simply naive. If you hire someone to replace tiles in your bathroom, for example, they won't ask for a deposit up front. I have had people refuse to charge me for work they have done what they see as inferior. You have to take the moral high ground, and if an electrician refuses to charge you for three hours of work, INSIST on paying. I suspect that from a cultural perspective, the Portuguese tend to be uneasy about money. Perhaps it's that famous Portuguese modesty I mentioned before.

(12) There is a gradual cultural shift underway here. Younger people realize that they will never find a job where their employer will just take care of them for life. More and more young people are going into business for themselves, and succeeding (Portuguese people are very hard working for the most part). At the beach, you see Portuguese women going topless - which would have been absolutely unimaginable a few years ago. Traditionally, there are few self-made wealthy people here (like much of Europe, you're born into wealth or you just don't have any). That is changing. Lisbon has celebrity chefs, and real estate developers are making millions or tens of millions of dollars on refurbishment projects. I saw my first Aston Martin snarling it's way down the street the other day. Unimaginable a few years ago.

(13) Local produce, fish, vegetables and beef is absolutely first rate. The finest beef and tuna comes from the Azores - you can find it at any local grocery store such as the Corte Ingles. Portuguese bread is excellent, and dairy products are also great (especially butter from the Azores). Local cuisine is based on very simple preparations - olive oil, salt, not much else. By cooking at home with local produce and ingredients, but using Italian or Thai recipes, you can make astonishing meals.

Eating at Mercados is a great way to experience Portuguese food. The vendors at the Mercado sell fish, meat and produce fresh, and you'll find small restaurants in the Mercado that use the very same fish, meat and produce in their meals. The best Mercados are the Time Out Mercado (which is full of tourists and where you can literally buy a Michelin star rated dish for under 10 Euros), and the Mercado Campo do Orique (which is strictly local, and where people congregate to eat shrimp, drink Sagres beer and scream at the futbol game showing on the giant TV screen).

Portuguese wine is miraculously good for the price. A 6 Euro bottle of Tons tastes like a $50 wine. If any reader has serious interest in wine, write to me and I'll list the top 10 bottles I've found. Getting Portuguese wine outside of Portugal, however, may be tough. The vinyards are tiny, and don't have the scale to export in any cost effective way. So they don't. Any wine drinker coming to Portugal should leave plenty of empty space in their check-in luggage to bring back bottles that otherwise you just can't get elsewhere.

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(14) Portugal is very family-centric. People here adore children. It is socially acceptible for an elderly person to pat your kid on the head, pinch their cheeks. When toddlers throw tantrums, nobody looks away in disgust or annoyance. On the contrary, I've seen strangers walk up to try and help the mom or dad calm the toddler down. Most children do not leave home for college. At the Mercado Campo do Orique, I have seen families with up to 4 generations sitting at tables eating.

(15) Throughout many parts of Europe, banks will not open accounts for American citizens (due to IRS regulations and compliance costs). We had a very straightforward time opening an account with Caixa Geral - we simply needed to obtain a tax ID number in Portugal (a so-called "contribuint") which our lawyer got for us in under 5 minutes with limited paperwork. Caixa Geral, as I mentioned, just got another bailout from the EU - I don't keep much cash there and don't recommend others do, either. But it is imperative to have a bank account in Portugal if you live here. Many services are paid with debit cards or wire transfers. Your phone bill, water bill, electricity - expect to pay them all by wire transfer and expect that you will not be able to even sign up for the service without a local bank account. Caixa Geral offers one enormous benefit - there are no exchange fees. I can switch dollars to euros and back again with no fee, and at the exchange rate I see quoted on Bloomberg. I've been very happy with the service, overall.

(16) The Portuguese prize good manners. In day-to-day speach, if I were speaking directly to you I would refer to you as "o senor" or "a senora" - roughly translating to "the Sir" or "the M'am." The use of "voce" or "tu" is common in Brazil, but rare in Portugal unless you are speaking to family or friends who are close enough to be considered family (in which case, you're still going to be falling all over yourself to be polite). One notable exception is when driving - especially with cab drivers. Something radical changes when people get behind the wheel of a car, and overall, we've had very negative experiences with some cab drivers.

The other day, I was having an exchange over Yahoo with someone who feels strongly that inter-racial breeding between white and non-white people is akin to the slow ethnic cleansing of white culture. My wife, my kid, and I are all racially mixed - a hodge podge of latino, white, Asian, with extracts of who knows what from which part of Europe. It was difficult to hear someone attack my kid as being the embodiment of ethnic cleansing (he's a really, really nice little kid). Hard not to become angry. Political discussions these days... unimaginable what you can hear.

You don't hear explosive arguments in Portugal. In fact, there is actually NO WORD IN PORTUGUESE for "argue". It's called "discutir" - roughly translating to "discuss". An American following the tone of American politics can quickly appreciate how wonderful it is to live in a place where there is no word for "argue." There are two statues at the offices of the supreme court, standing side by side on either side of the building entrance. The engraving on the bottom of one says "hard work" and the other says "logic". These statues say a great deal about local culture and political norms.

You'd capture a great deal more with a couple of statues with engravings that read "good wine" and "Futbol."

(17) As an immigrant, you'll feel wanted here. All the more so if you do what you can to try and speak the language, and partake in all that the culture has to offer. The anti-immigrant strife in France and Germany and the UK is entirely absent here - perhaps because immigrants here for the most part are rich and help create jobs.

So, after one year, I'd say our move to Portugal has been exciting and more than lived up to expectations. As a retirement destination, or a place to come and start a business, there are many benefits and opportunities. We haven't had any nasty surprises so far - knock on wood. If that day comes, you're sure to read about it here. In the interim, any reader who is thinking about expatriating and wants to hear more about Portugal as a possible retirement destination, you are free to send me a message and I will answer your questions if I can.