You can't be investing for success if you don't know what type of return to expect or how to measure success. You also need a set of guidelines to guide you through the investing process so you don't make bad decisions and keep emotions out when investing.
When I first started to invest seriously with a goal to generate passive income, I hashed out a basic business plan to highlight what I wanted to accomplish and how I would do it. I wanted to treat my investing activity as running a business with all its seriousness.
Initially, all my plan had was a simple goal statement and a few guidelines and rules to follow. Over time, as I got smarter and more experienced in investing, my investment business plan also matured. Whenever I learned a new investing concept or lesson, I tried to make a rule out of it and added it to the the plan guidelines. Similarly, when I made a stupid mistake or a misinformed investment decision, I added it to the Never To Do list.
Over the years, the plan has kept me moving in the right direction and has helped me avoid mistakes or repeat mistakes. In all, this plan has helped me reach my goal of financial independence and early retirement by providing a stable, dependable, and growing stream of income.
I am sharing my Investment Business Plan with you in its current state to give you an example of what a business plan may look like for your own investment portfolio. The guidelines and rules I highlight in my plan are based on my own risk tolerance, goals, and preferences. It is by no means perfect.
When making a plan for yourself, you will have to decide goals and style of investment that is appropriate for you. The key is to have at least a basic plan and a few guidelines to start with and then over time add more to it. Happy Investing and Good Luck!
Goals: To build a passive income stream by investing in a portfolio of quality dividend stocks and ETFs for life. Become an Intelligent Investor by educating myself about basic finance and accounting and by reading books, articles, and investment analysis from other experienced investors.
Dividend Stock Portfolio Characteristics
Dividend Stock Portfolio Characteristics
- Must have an average dividend yield of greater than 4%.
- Must have an average dividend growth rate of 5% or greater.
- Must have an average annual return of greater than 7%.
- No stock in the portfolio should be more than 10% of the total portfolio market value.
- Highly diversified across all sectors of market with no more than 25% in any one sector.
- Limit number of stocks to less than 50.
- Only invest in US based companies or foreign companies that trade on US exchanges as ADRs (American Depository Receipt).
Individual Stock Purchase & Ownership Guidelines
- Buy with the mindset of long-term investment and never sell unless fundamentals deteriorate or there is a dividend cut.
- Must have and maintain an investment grade credit rating.
- Must have market cap greater than 3 billion.
- Must be at fair-value at the time of purcase as determined by valuation ratios.
- Must pay a dividend and have at least 5 years of dividend payment and growth history.
- Dividend should be at least 3% and no more than 5% for regular companies.
- For regular companies, 5 year dividend growth rate (DGR) should be greater than 3%.
- Utilities should have a starting dividend greater than 4% and dividend growth rate of at least 2%.
- Reits should have a starting dividend of at least 6% with 5-year DGR of at least 3%.
- Dividends must be fully covered by FCF (free-cash-flow), only exception is for utilities.
- Debt to Cap/Equity should be at reasonable levels for the given industry.
- Must have ROE of 10% or higher and ROA of 5% and higher.
- Always understand tax implications of buying certain types of investments (MLPs, REITs, etc.) and how the dividends are taxed.
- Each stock must be actively managed by tracking earnings reports, corporate presentations/filings, and news.
- Keep a diary of all investment mistakes and review them often.
Individual Stock Sell/Trim Guidelines
- Immediately sell full position if dividend is cut. No exceptions!
- Immediately sell if a company is involved in a fraudulent business activity. No exceptions!
- Sell or Trim if credit rating is downgraded to below investment grade.
- Trim if stock is in an overvalued territory as determined by valuation ratios and future estimated earnings.
- Sell or Trim if dividend payout ratio exceeds 95%.
- Sell if dividends are not covered by earnings and/or FCF.
- Sell or Trim if earnings and operating cash flow continue to decline for three consecutive quarters.
- Trim if company fails to increase dividend in the last 12mo period.
Rules for Retirement Accounts (401k, IRA, HSA)
- Only invest in two to three low cost dividend paying Index ETFs or mutual funds.
- Always re-invest dividends using dollar-cost-average technique.
- Avoid transaction fee by selecting ETFs or Mutual Funds that are offered as zero-transaction-cost by the brokerage.
- Treat HSA account as a retirement account and invest all HSA monies in low cost dividend paying ETFs. Pay medical bills out-of-pocket.
- For all the retirement and HSA accounts, leave the monies invested and growing tax-free till needed in retirement age.
Things to Never Do
- Never buy shares of Master Limited Partnerships (MLPs) or Limited Partnerships (LP) due to tax complications.
- Never buy high yielding Close-Ended-Funds (CEFs) without understanding their composition and risk. High yielding CEFs are likely to own below investment grade (junk) securities or risky investment derivatives.
- Never buy a stock with negative earnings. Negative earnings mean company is operating at a loss. Only exception are companies with seasonal earnings.
- Never buy a stock that has a payout ratio greater than its earnings or FCF.
- Never buy a stock that has a S&P credit rating of less than BBB-. Anything below BBB- is considered to have a Junk investment rating and is considered to be very risky.
- Never buy a stock without researching its fundamentals. Fundamentals is what defines the quality and valuation of a company's stock and its business.
- Never buy a stock at its peak valuation when compared to its 5 year average valuation.
- Never buy a stock with market cap of less than a billion $.
- Never buy a stock based on a tip. Always do your own homework.
- Never buy a stock in a company whose business and/or balance sheet is overly complicated and difficult to understand.
- Never buy/sell a stock in a hurry. There will always be other opportunities in the market, so don't fret if you miss buying a certain stock.
- Never chase a yield, no matter how tempting it looks. A very high yield is likely a function of depressed stock price as a result of deteriorating fundamentals.
- Never try to beat the market returns. Though following above rules should provide comparable if not superior results to the overall market.