This is a short philosophical piece that I hope will help some of you with some advance wealth building concepts.
In B’s case, he has an awakening that valuation is unsustainable right now in terms of things yielding 5% and thus it is better to sell now, keep the capital intact, so that he can redeploy later.
He is a shrewd one, but also a nimble one, who have a good philosophical high level understanding on investing and is able to execute successfully time and time again. If you would like to learn how to do that well with stocks consistently do follow his blog.
Today I will explain
- the concept of yield potential
- thinking about your wealth plan over time
- not focusing on current dividend yield
- some nuances of stock investing.
Thinking about your Wealth Machine in the FUTURE
What La Pap and B is philosophically planning is trying to find a fundamentally sound way of visualizing what is the future sustainable potential of their wealth machine (what is a wealth machine).
Indeed, there are a group of us who retreat into our shell and think about
- what is the future potential of our wealth machine
- what it could do to help us in our life
- we are then able to derive how to grow to this amount with the knowledge and wisdom we have gathered
The folks who don’t retreat and reflect, exchange their time for current gratification, without giving themselves the opportunity to think and plan for the longer term.
You need a balance of both and it is only understanding the potential of what wealth can do to your life that it gives you motivation and kick you into action to work towards it.
Your Wealth Machine’s Yield Potential
My friend visualize his wealth machine based on its yield potential.
And I do agree why he looked at it this way.
Most of us in the beginner, learning stage would want to maximize our dividend yield.
Indeed when you look at what the dividend stocks in Singapore offered on my Dividend Stock Tracker, there are a group of stocks that usually yields 4-10%.
However, you have to think about this in terms of your overall wealth plan:
- Do you need cash flow now?
- How sturdy is your job, that your wealth machine(s) need to provide cash flow?
- Grow or decelerate?
#3 is a good question because if you invest in stocks with a high dividend payout ratio, their growth rate is lower. Its challenging to find one that have both (and here is why we always try to be a value investor)
So if you are at 27 year old and have agreed to put $25,000/yr to your wealth machines and have build up $100,000, you might not need the cash flow now, you could find stocks that are higher growth so you take in a smaller dividend yield of 3% but with higher overall capital growth of 7%. Your total return is 10%.
What you are aiming for is your future yield potential.
What if you build it up to $500,000?
You could sell all these stocks and put them in dividend stocks that yield 6% on average with 2% growth due to inflation.
Your cash flow will be $30,000/yr.
That should be enough if you based on my calculation of how much you need for financial independence or financial security.
This is your focus. On the sum 15 years from now.
The potential for that $500,000 @ 6% Starting Cash Flow Yield.
Focusing Less on Current Yield but Total Return
Being an advocate of dividend investing, I am afraid sometimes I send the wrong message that we should be focused on dividends.
I cannot control your brain, and you might be overly focus on generating dividends in the near term for your wealth machine.
You have to understand that returns in stocks are made up of dividend yield you earned in a year and the average capital growth held for the period.
Some stocks such as Sheng Siong have a low 4% dividend yield but people expect their dividend capital growth to average out higher than 3%, perhaps 5% per year.
You have your large real estate investment trust Ascendas REIT (Dividend Yield 6.3%/yr) with a lower expected growth of 2% based on inflation per year.
What you have in your portfolio, firstly needs to be based on value. You do not want to buy expensive stuff even though they are good. The second is based on quality of cash flow or the sustainability of their business. The third is how they fit into what you want to achieve in your wealth plan. (You can read more about how to evaluate financial assets, comparing them on a high level in this post)
You can always shift assets from one to another
Provided the assets are liquid.
This means that, based on your wealth plan, you can optimize your current value of your portfolio, to financial assets / stocks/ bonds/ ETF that fits your future wealth objective better.
This is not the only reason for shifting:
Upon realizing you made mistakes in the way you build wealth, take stock of your current market value of your assets, shift them to an allocation that is better from this point going forward.
The challenge is always to not fall for the sunk cost fallacy. A sunk cost is a cost that is being paid in the past and can never recovered back.
In investing, if we have some stocks that are in the red, and we realize we made a mistake, we tend not to be able to sell it off and shift to another stock because we fall for the sunk cost fallacy.
The solution is to ask the question: “if you didn’t spend that sum of money in the past to purchase that stock, would you buy the stock today?”