Welcome to new members of my mutual funds family :-)

This month (July 2016) ends the changes I have been making to my mutual fund family. This month, I am welcoming two new members to the family. Hearty welcome to VWELX (Vanguard Wellington Fund) and VWITX (Vanguard Intermediate Term Tax-exempt fund). The obvious next question is why ūüôā

In October of 2014, I implemented my Passive Income Streams strategy. I wrote about it here. One of the six design principles was: For each risk bucket, have a minimum of two investment vehicles. I like this principle for two reasons:

  • Investment philosophy diversification
  • Investment manager diversification.

My thesis is that both of the above together will provide better risk diversification. Using this thesis, I build the following set of Passive Income streams (as of 10/18/2014).

Table 1: Investment Vehicles Update 10/18/2014
Risk Bucket Name Investment 1 Investment 2 Investment 3
Risk 1 (Cash) Smarty Pig (online) Credit Union N/A
Risk 2 (Bonds) VCAIX (CA munis) N/A N/A
Risk 3 (Balanced Funds) VTMFX (50% stocks and 50% National MUNIs) N/A N/A
Risk 4 (Dividend Investing) VDIGX (div growth) VHDYX (Curr div) N/A
Risk 5 (Capital Growth) VTCLX (large+mid cap) VTMSX (small cap) N/A
Risk 5 (International Funds) VTMGX (large blend) N/A N/A

Over the last couple months, the stock market has been on a tear. I cannot come up with any logical reason to explain why…it seems that no bad news can touch this market….it seems to go up and up and up. For day traders, this is heaven….but for normal folks like me, this seems suicidal…there is no reasonable value to any asset in my mutual fund family. Dollar Cost Averaging (DCA) is supposed to help me deal with this, but I can’t seem to pour money into vehicles which rise up like crazy. So, I have taken a few steps over the last couple months to do the following:

  • Bail out to re-enter at a later date
    • Sold VTCLX and VTMSX
    • Moved some of it to VWITX (National Munis) and some to cash
    • Cash helped me capture valuable stocks big time during the Brexit market dip.
  • Sell a portion of funds that had appreciated to capture gains
    • Sold portions of VTMFX, VDIGX and VHDYX
    • Captured gains accumulated over the last two years
  • Move some of the¬†captured gains into¬†to more solid ground
    • More on this below…..
  • Move the remaining captured gains into cash (Money market funds)
    • Basically fresh powder for the inevitable market downturn….

To redeploy the captured gains, I needed to find new vehicles that will produce passive income for me. I like all the categories I have listed in my original design in Table 1…so no new categories were needed. But some of the mutual funds did not have any competition ūüôā So, I decided to add some competition in two categories:

  • Bonds
  • Balanced Funds
  • Dividend Investing

The changes are listed in Green Color in Table 2 below.

Table 2: Investment Vehicles Update 07/30/2016
Risk Bucket Name Investment 1 Investment 2 Investment 3
Risk 1 (Cash) Smarty Pig (online) Credit Union N/A
Risk 2 (Bonds) VCAIX (CA munis) VWITX (National Munis) N/A
Risk 3 (Balanced Funds) VTMFX (50% stocks/50% National MUNIs) VWELX (60-70% stocks/30-40% bonds) N/A
Risk 4 (Dividend Investing) VDIGX (div growth) VHDYX (Curr div) VDAIX (div appreciation)
Risk 5 (Capital Growth) N/A N/A N/A
Risk 5 (International Funds) VTMGX (large blend) N/A N/A

Why did I choose those specific funds?

  • VWITX
    • In the Bonds category, I had VCAIX (CA Muni bonds). Since this was CA specific only, I bought into VWITX (National Muni bonds). Now mu MUNI bonds are spread across many states in the country. The advantage is that National Munis add better risk diversification. The disadvantage is that I lose the state tax exclusion that VCAIX would have given me.
  • VWELX
    • In the Balance funds category, I already had VTMFX…a fund split into 50% stocks (cap appreciation, low dividends) and 50% National Munis. I wanted to add a bit more aggressiveness into the balanced fund category and I chose VWELX, a fund with modest current income and long term growth. The fund invests across a broad section of the market and is known for stable returns….under performance in ¬†bull¬†markets and lower loss in bar markets but stable returns.
    • The disadvantage is that the turnover is 35% i.e. a bit tax unfriendly but short term capital gains are pretty low. So, I think it is worth it….lets see if my bet pays off in the long run.
  • VDAIX
    • In the dividend funds category, I already had two funds which I am very happy about. VDIGX is turned for future dividend growth (low current income) and VHDYX is tuned for high current income (low future dividend growth).
    • VDAIX on the other hand is a mix of both: companies that have consistently raised dividends for the last 10 years (good current income) and also the same companies have promise to continue growing the dividend stream in future.
    • One can ask….VDIGX is managed by Donald Kilbride, a super star manager who has consistently beaten VDAIX for the past few years. So, why not invest all the money in VDIGX if you do not need current income? Risk diversification and lower turnover. ¬†Donald Kilbride is one person and VDAIX is an index…no more explaining needed ūüôā
  • Money Market Fund
    • I want to start accumulating some cash to jump into the market when the markets go down “deep”. I have noticed that when DOW goes 100 pts in the morning, it is back up 200 points by end of market. Looks like a lot of people are investing on a 100 pt dip.
    • My new standard will be to accumulate cash until DOW dips 300 pts. My assumption is that the market will not be able to come back from a 300 pt loss in one day i.e. I can really get some value for money. Lets see how this goes.

Thatz it for now. Join me in welcoming the new members to my mutual fund family!!

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VDIGX….an investment decision validated.

When I was travelling last couple weeks, I got time away from the day-to-day chores of family life. I kind of enjoyed this break….ssshhhh….don’t tell this to my wife ūüôā I used that time to read up on different articles related to my current investments. When the markets went down, I wanted to feel good about my investments!

One of my investments is in VDIGX (Vanguard Dividend Growth funds). I have talked about various dimensions of this fund in this blog.

  • My original rationale on picking this fund is documented here.¬†Don Kilbride, the manager of VDIGX, is a recognized name in the industry and has done a wonderful job with VDIGX.
  • VTSMX is Vanguard Total Stock Market fund.¬†I compared VDIGX vs VTSMX here. I wrote that both VDIGX and VTSMX have their rightful place in my portfolio.
  • I definitely see a recession coming and wrote about it here. As part of that, I did a¬†Risk Analysis of all my investments here. VDIGX had the second lowest Beta Coefficient of all my investments….only VTMFX (a tax managed balanced fund) did better. A low beta coefficient means that my investments will be less volatile than the market i.e. income¬†stability will be much better.

In addition to what I thought about, some other smart people have thoughts on VDIGX too. I read one such article from Morning Star while travelling and I really liked the content enough to post a link here.

This article argues that a fund may¬†not provide the greatest current yield (usually, this implies¬†less risk) but if the fund holds¬†quality holdings, it will provide a more stable income stream and potentially lead to more capital growth in the longer term. Read more directly from Morning Star link above…it is worth it.

PS: There is good marks for VHDYX (Vanguard High Dividend Yield) also…this makes me more happy because I have invested in this also. Wish me luck for continued good success in picking good investments.

How long does it take to get to $50000 per year in dividends?

When I defined what Financial Independence means to me (here), $50000 dividend dollars per year seemed good to me….how I came up with that number is listed in that link. I did not have any notion of how to get there apart from creating passive income streams (cash from bank interest + dividends from stocks). How I designed the passive income streams is explained here and here.

The next question for me now is: how do I get to $50000 per year OR roughly $4000 per month. This post will talk about the next steps for me.

Assumptions

  • Dividend Distribution Frequency
    • Dividends can be distributed with different frequencies i.e. monthly, quarterly, half-yearly, yearly.¬†I have mutual funds with all the above frequencies.
    • So, for the entire portfolio, what distribution frequency should I assume?
      • Monthly is the most aggressive (most amount of money compounding) and Yearly is the most conservative (least amount of money compounding).
      • Most of my funds are either quarterly or less, one of them is half yearly and one is yearly.
    • So, I have decided to go conservative and assume a yearly¬†dividend distribution.
  • Dividend Reinvestment Plan (DRIP)
    • If the dividends are re-invested into the same assets that produced the dividends in the first place, we call this the Dividend Reinvestment Plan.
    • The assumption is that I am going to use DRIP as I do not need to use the dividend money right away.
  • Dividend Tax Rate
    • Dividends are taxed at a different rate depending on the tax bracket.
    • I will assume that my dividend tax rate is 15%.
  • Average Annual Dividend Yield
    • I have assumed 3%….a reasonable, middle of the road dividend yield assuming a 2% to 5% spread.
  • Yearly Investment
    • I will assume a yearly investment of $12000 i.e. $1000 per month.
    • I will assume that I will not increase this investment money each year.
  • Investment Time Period
    • I will assume 10 years since my wish is to achieve financial independence in 10 years.
  • Tool used
    • I am going to use a wonderful dividend calculator from Dividend Ladder.
    • If I had known about this tool, I would have used this when I defined my goals…I just came to know about this recently.

Case 1: Base Case

  • Starting Principal = $225000
  • Dividend Distribution Frequency = Yearly/Annually
  • DRIP = yes
  • Dividend Tax Rate = 15% tax rate
  • Investment Time Period = 10 years
  • Average annual div = 3%
  • Yearly Investment = $12000
  • No increase in yearly investment every year.

When I put the above numbers into the Dividend calculator, I got the following results:

  • New Annual Dividend Income = $12725
  • New Principal = $424176

This is a far cry from the $50000 per year dividends I need to reach. So, which of the above parameters do I need to change to get the dividends closer to $50000 per year?

Case 2:  Add 5yrs to the 10yr FI plan

  • Starting Principal = $225000
  • Dividend Distribution Frequency =¬†Yearly/Annually
  • DRIP = yes
  • Dividend Tax Rate = 15% tax rate
  • Investment Time Period = 15 years
  • Average annual div = 5%
  • Yearly Investment = $24000
  • No increase in yearly investment every year.

When I put the above numbers into the Dividend calculator, I got the following results, which is much closer to $50000 dividend dollars per year:

  • New Annual Dividend Income = $45483
  • New Principal = $909663

So, to get close to the $50000 per year, I need to do the following:

Contribute $24000 annually instead of $12000 as per Case 1.

  • If I buy a house, then this increase in money is impossible.¬†If not, then this should be doable.
  • Bottom line is that for the next 15 years, $24000 per year => $360000 investment into passive income streams.
  • How this money is spread across 15 years I am not sure yet, but it is a target for me.

Work for 15 more years instead of the 10 years I had initially planned

  • This is not acceptable, but it seems like I have no choice.

Assume a dividend yield of 5% instead of 3%.

  • This is acceptable because….
  • Some of the funds I own distribute capital gains as well. This is also re-invested.
  • Some of the funds I own and federally tax exempt and one of the them is state tax exempt also.¬†So, dividend gain of 3% and add no taxes to it, makes it equivalent to a higher yield.

Case 3:  Stick to the 10yr plan

Lets say I do not want to work an additional 5 years i.e. stick to the 10yr FI plan. If so, what numbers do I see?

  • Starting Principal = $225000
  • Dividend Distribution Frequency =¬†Yearly/Annually
  • DRIP = yes
  • Dividend Tax Rate = 15% tax rate
  • Investment Time Period = 10 years
  • Average annual div = 5%
  • Yearly Investment = $24000
  • No increase in yearly investment every year.

When I put the above numbers into the Dividend calculator, I got the following results:

  • New Annual Dividend Income = $31632
  • New Principal = $632657

So, if I can adjust my need for money from $50000 per year to $31000 per year, then I can stick to the 10yr plan.

 Conclusion

It is very hard to see 10-15 years ahead in life. Who knows what can happen in future? But, assuming that things go well (touch wood), I will continue to aim for $50000 dividend dollars per year and contribute money trying to reach it. If I reach somewhere in between $31000 to $50000 dividend dollars per year, I would be happy. If it is tending towards $31000, then I may think of increasing the yearly investment or reducing dollar requirements in future.

So, the plan is to do the following:

  • Invest $24000 per year
  • Work for the next 15 years (5 more years than my plan for FI)
    • i.e. $360000 over the next 15 years
  • Assume a 5% dividend yield instead of 3% (the safe number)

Wish me luck to finish in 10 years instead of 15!