Dividends4Life: The First Steps To Investing

The First Steps To Investing

Posted by D4L | Wednesday, May 21, 2008 | | 6 comments »

I am not a licensed professional and I don't know your specific situation, so I can't tell you how to invest. However, you can listen in on the advice I will give my kids when they go out on their own.

  1. Emergency Fund: Before you invest a penny anywhere, you need to set aside a minimum of $1,000 in a high yield money market account with check writing privileges. Dad is not always going to be around when trouble strikes. Have a plan to add to this account each month until it reaches 4-6 months of your living expenses.

  2. Index Funds: After your emergency fund reaches $1,000, you can divert a portion of your savings to a good solid index fund that will serve as your foundation. I suggest the Vanguard S&P Index Fund (VFINX). This will provide you a benchmark for future investments. If you can't beat this fund over time, close out the investment and put your money in the index fund.

  3. Actively Managed Funds: Once your index fund reaches $5,000, it is time to start trying to beat its return with a couple of actively managed funds. Over the years Davis Selected American Shares (SLASX) has done this for me. More recently I dabbled in FundX Aggressive Upgrader (HOTFX) with excellent results. I would target $5,000 in this SLASX and if you choose to invest in HOTFX, I would limit it to $1,000.

  4. Asset Allocation ETF Investing: Asset allocation is the cornerstone of successful investing. As I mentioned in "Process Overview and Asset Allocation", this strategy is based on an MSN Money article by Richard Jenkins titled "A simple ETF strategy for beginning investors". Although the word "beginning" may chase some people off, I don't mind labels when something is performing well. Year-to-date this investment's return is +3.2% and since I started using this strategy (8/7/2007) its return is +6.2%. Note: Both of those returns are positive. Many investments over this time period were not positive.

  5. Dividend Income Investing: After accumulating $5,000 in 4. above, you may be ready to take on some additional risk and (hopefully) enjoy some higher rewards! Here I would suggest you use the tools provided in the Dividends4Life Toolbox, such as the D4L-Prescreen.xls model, and evaluate stocks in the the S&P 500 Dividend Aristocrats to begin with. You need to invest more slowly in this area than the previous four because up to now someone else was managing your money. You are likely to make some mistakes (I still do) and lose some money. Nurtured properly, dividend investing can ensure a bright future.
Kids, there are no guarantees in life and what happened in the past probably will not happen the same way in the future. What I have presented to you above, has worked for me over the years. If you follow this advice, it will likely work for you going forward.

Now go out and make your Dad proud!

At the time of this writing, I owned shares of VFINX, SLASX and HOTFX.

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6 comments

  1. Anonymous // May 21, 2008 at 3:23 PM

    About your Vanguard Index Fund. I don't like anything priced in USD. Compared to Gold. Yes I am Gold Bug but gold is money!!!

    In 2000
    Gold $250 / 1 share VFINX 120 = 2.08 Oz. of Gold

    In 2008
    Gold $ 930 / VFINX 130 = 7.15 Oz. of Gold

    for Vanguard to keep up with inflation and devaluing of the USD. Vanguard Index would have to be 1860. The index should be worth 2 Oz. of gold to be of anything of value. Compare it with OIL

  2. Dividend Tree // May 21, 2008 at 9:18 PM

    D4L,

    One of the major issue I have with ETFs (including dividend focused) is their distribution is "ordinary income" which is taxed higher. This reduces the real return. While a "carefully invested" same amount in group of dividend stock, I would "tend" to get similar returns with less tax. So diversification through ETF comes at cost. Question is how to balance it ?

    Excellent post. I like your overall approach.
    DT

  3. Unknown // May 21, 2008 at 9:30 PM

    I don't understand exactly what all the hype is about ETF other than the fact they appear to be more tax-friendly.

    Is there any projections for how an ETF would accumulate over 40 years like they do with the mutual funds?

    Great series of advice.

    I don't know about 1K in an Emergency Fund though. How old would you consider your kids to be starting out to have 1K in an emergency?

  4. Anonymous // May 21, 2008 at 10:14 PM

    @Anon: I am not that familiar with gold investments.

    Dividend Tree: ETF distributions are categorized by source. Based on my 1099, I received qualified dividends from IYR, IYM, VIG, VFH AND VTI.

    @TheLocoMono: ETFs will perform exactly like a mutual fund. many ETFs are managed by the same company with a similar fund. The upside to ETFs is that they are more tax efficient, the down side is that they incur commissions when buying or selling.

    1k emergency fund is a good place to start for someone just coming out of school - as long as they continue to build it. Given the power of compounding, it is imperative that they start investing as soon as possible.

    Best Wishes,
    D4L

  5. D // May 22, 2008 at 11:32 AM

    I think that D4L touched great on most of the questions that readers had asked him. As far as the Gold investments are concerned, yes over the past 9 years GOLD has indeed outperformed the S&P 500. But you know what? Gold has been a terrible long-term investment for many decades. Asides from the 1970's and early 2000's gold investors have had their nerves tested with long periods of flat or negative returns. In addition to that, gold does not earn any return whatsoever unlike stocks or even bonds which pay you dividends/interest. Gold could be a good diversifier in part of your portfolio, but it is just another asset class.

  6. Unknown // May 22, 2008 at 7:28 PM

    Interesting point on the gold, it makes me think of how some investments are better for mid-term than long term. Kind of like the S&P 500 performance the last couple of years.

    It sounds like ETF is no different than stocks because of the commissions involved.

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