I’m going to make a fortune, effective immediately!

Screen Shot 2013-03-22 at 9.21.59 PMAs catchy as the title is of today’s post, it has very little (but not, nothing) to do with the image on the left …

… which image simply serves to illustrate my preferred – or, should I say ‘accepted’ – approach to investing.

But, wait, you say!

Surely, the quadrant to the bottom-right (where the combination of profit and risk is optimized) is the most efficient?

.

So, why would I want my arrow to hit the target in ‘no mans land’?!

Well, that’s the exact question that I threw to my readers in my last post

There were a lot of amazing comments (and, you should go back and read them all), but Dustin wins a signed copy of my book for his comment, which summarizes my views nicely:

there are significant gains to be made with a moderate increase to your risk … however the long term of the investment should moderate that for the endgame result. Technically it is a less “efficient” investment, but only statisticians care about that, not real world investors.

And, JD earns an ‘honorable mention’ (and, also wins a signed copy of my book) for his comment, which adds a crucial caveat to my views:

I worry less about potential losses for incremental investments. I may be biased since I am young enough to earn it back (I’m in my late 20s)

Whilst I would argue (as would Warren Graham who provided the source chart and much valuable commentary to my original post), that learning about the efficient frontier is valuable to investors, not just statisticians, Dustin has hit the nail on the head by focussing on the “endgame result” …

… for me, your overall investment objective drives everything.

The aim, in my opinion, isn’t to find the optimal investment where ‘optimal’ is defined as sitting on some curve, it’s to find the investment from the limited range typically available to you in the real world that delivers the result that you need.

If you’ve been following this blog for a while, you’ll realize that – in order to pin down that ‘result that you need’ – I advocate a Top Down Approach To Investing:

This means, knowing how much money you need; when you need it; and, using those answers to derive your required annual compound growth rate.

It’s this growth rate, as indicated by the horizontal line on the chart below (the positioning of this line will be different for everybody) that should dictate what investment choices you go after:

Screen Shot 2013-03-22 at 9.41.46 PM

Each of these investment choices (and, in my experience, there will be very few to choose from, since you need access, education, and aptitude in each type of investment in order to proceed) will bring with them their own risk profile …

… and, you will be amazingly lucky, if one of those choices (e.g. as represented by the black squares on the chart above) happen to fall on the intersection of the horizontal line and the ‘efficient frontier’ curve.

If not, and if you want to achieve your Number by your chosen Date [AJC: you do, don’t you?], you will go ahead and make that investment, anyway, even if it doesn’t fit neatly in the quadrant on the bottom-right of the image at the top of this post.

Because, as JD says, even if your investment fails, hopefully, you will still be “young enough to earn it back”.

We get one opportunity to live our Life’s Purpose; we get many opportunities to make investments to help us get there, but only if we have the mettle to choose the ones that have the potential to meet your minimum required annual compound growth rate.

To me, the investment choices that can help us reach our Number are the most effective of investments …

… they just may not be the most efficient 😉

.

.

 

Surfing the efficient frontier …

Screen Shot 2013-03-22 at 9.21.31 PMOne of my Finnish blogging friends shared this interesting graphic on one of their most recent posts …

The implication is clear:

The best investments …

… in fact, the ideal investment is one that maximizes profit at the lowest possible risk.

Whilst that is ideal, the real world – at least in my opinion – doesn’t work that way.

Why?

– You may not understand the investments that maximize profit at the lowest possible risk

– You may not have access to the investments that maximize profit at the lowest possible risk

In fact, the operative word here is ‘you’ …

… unless you are professional investor, who has access to – and understands fully – all of the investment choices available, you will not be able to surf the ‘efficient frontier’:

Screen Shot 2013-03-22 at 9.41.46 PM

Because of access and education you may only be able to select from a few investments that, if you are lucky and choose well, approximate the efficient frontier, as represented by the four dots in the chart, below:

Screen Shot 2013-03-22 at 9.43.26 PM

In this case, you have lucked out!

Two of your investments have hit the efficient curve smack on, and one is optimal (i.e. best combination of risk/reward), whilst the other will suit the most risk-averse amongst you, as it is efficient, yet carries the least risk (of course, it also produces the lowest return of all the ‘efficient’ choices available to you).

Screen Shot 2013-03-22 at 9.21.59 PMMaths aside, here (diagram to the left) is where I like to position my investments …

… and, where I think most (but not all) of you should like to position yours, as well.

It’s not optimal (higher reward, more risk); probably not even efficient; but, ideal … at least, for my (our?) purposes!

Any idea why?

Why do you think I actually like to assume more risk?

I’ll do a follow up post; in the meantime, I’d like to hear what you think my reasoning will be?

I might even send a signed copy of my book to the person with the best (not necessarily correct) answer 🙂

Tin Stacker or Kite Flyer? Which one are you?

money kiteI fly kites and I stack tins. But, I mainly fly kites. And, it’s all because I understand the true value of money.

Do you? Let’s find out …

The money that you save has a value today and a value in the future.

Aside from money that you save as a short-term buffer against emergencies, or to pay for a trip or other expense coming up soon, the real value of money that you save today is the value that it can provide tomorrow.

But, the ‘tomorrow’ that I am talking about is the one that comes on the day that you decide to begin Life After Work. Some call this retirement; others call it semi-retirement; I call it early retirement … but, that’s really up to you.

So, a dollar today is exactly that: One Today Dollar.

But, in the future, two things happen to that dollar:

1. Inflation erodes it – robbing it of roughly half its value every 20 years, and

2. Investment returns grows it – increasing it according to the annual compound growth rate of that asset class.

With inflation pulling one way (down), you need to find an investment that moves the value of your savings the other way (up); how fast you need to move depends on (a) how much money you need (your Number) and (b) when you need it (your Date).

So, how fast do different types of investments grow?

Well, according to Michael Masterson in his book Seven Years To Seven Figures:

Screen Shot 2013-03-09 at 6.48.05 PM

[AJC: The greater the returns – that is, the lower down the table – the more ‘actively’ this table assumes you will manage the asset e.g. you may only be able to achieve 15% returns on stocks if you follow a system such as Rule #1 Investing. And, without active management – e.g. rehab’ing, flipping; leveraging; etc. – real-estate may only keep pace with inflation]

That’s why the Future Value of $1 could be $100, in just 10 years, if you invest it in a business.

But, that same $1 could be worth only $1.45 in 10 years, if left in CD’s. Now, that’s before inflation …

If inflation runs at its historical average of 4% $1 is only worth $1 in 10 years, 20 years, or 40 years!

So, when Brooke says:

create the proper mindset. then its time to move on to more advanced lessons.

I whole-heartedly agree.

EXCEPT that the “proper mindset” that she – and most others – talk about is saving, paying off debt, saving, living frugally, and … saving.

Which is great, if you value every Today Dollar exactly the same as a Future Dollar.

But, I don’t.

And, neither should you … and, here’s why:

The very first thing that you should do when you are thinking about saving is think about:

How many Future Dollars do you need, when you stop work / retire?

I’m guessing that Number’s at least 20 to 40 times your current expenses, doubled for every 20 years that you are prepared to wait.

[AJC: Ironically, the less you are willing to risk to grow each Future Dollar now, the higher the multiple that you will need e.g. if you are content to keep your savings in mutual funds, then you will need closer to 40 times your current expenses, doubled for every 20 years that you are prepared to wait. If you are prepared to actively invest in some mixture of stocks, real-estate, and/or businesses, then you may only need 20 times]

How much is that for you?

I’m guessing it’s much more that you previously thought.

Now, what has any of this got to do with either flying kites or stacking tins?!

700-00074906Well, when you save, is it going to be so that you can line each Today Dollar that you collect by saving into a nice Today Dollar Tin with all of the others that you get, until you have enough to oil, salt and close … putting it away, with all the other tins that you collect in your working life until – in 20 or 40 years time – you pull all of those tins out of the Tin Storage Bank, dust them off, and find …

… exactly as many Future Dollars as you had Today Dollars, no more no less, and not enough?

Or, will you take each Today Dollar, and when you have enough, make a Future Dollar Kite (it can be a Business Kite, Real-Estate Kite, or possibly a Stock Kite) and let it soar?

And, if it crashes – when it crashes, because of storms and, well, kite-flying whilst you are learning is risky – will you then take a few more of your Today Dollars and make another, and another …

… until one flies, with each Today Dollar used in making it becoming 100 Future Dollars?

[AJC: Most likely, you will also be putting aside a few Today Dollar Tins of your own, for a rainy day – since it need not take many to make a few Kites, and you may as well save something whilst you are at it]

Tin Stacker or Kite Flyer? Which one you choose is up to you …

But, I must warn you – even though most of you are tin-stackers by nature, therefore, should not be surprised when your Future Dollar stock is well short of what I would consider a ‘nice retirement’ – I write solely for the kite-flyers out there!

 

The myth of the millionaire next door …

weep warning

This post will make you cry.

But, it is a post that I have to write.

It’s one that I have been putting off … and, off … and, off.

Why?

Because, I am going to tear apart one last (well, until the next) tenant of finance …

… one that even I have not dared touch until now.

But, I have finally decided to bite the bullet, because there has been a whole generation weaned on an aspiration that, in itself, is a lie.

Yes, I am talking about:

[shock]

The Myth of The Millionaire Next Door.

[horror]

In case you are too young to remember, The Millionaire Next Door is the title of a 1996 best seller by Thomas Stanley and William D. Danko that was touted at the time as revolutionary but, to me, produced a totally mundane and obvious conclusion:

Most of the millionaire households that they profiled did not have the extravagant lifestyles that most people would assume. This finding is backed up by surveys indicating how little these millionaire households have spent on such things as cars, watches, suits, and other luxury products/services. Most importantly, the book gives a list of reasons for why these people managed to accumulate so much wealth (the top one being that “They live below their means”).

[sigh]

The perception after this book was released, becoming an instant – and enduring – best-seller, is that the typical American millionaire is actually your neighbor, the small business owner who has been working for 20+ years on his business, investing (and, reinvesting) its profits rather than spending on lifestyle and luxuries.

In other words, somebody who slips under your radar; somebody you probably ignore; for good reason …

It’s all fine and dandy: like all “spend less than you earn and save, save, save”-driven strategies you, too, will no doubt become a millionaire by the time that you retire, but there are two problems:

1. What about inflation? Start now and, if you take 20 years to become a millionaire, you are really still only half of one in today’s dollars, and

2. Who says that you can wait 20 years?

I certainly couldn’t.

That’s why I call this type of ‘Millionaire Next Door’ business – an ATM business – little more than ‘a job with benefits’ …

… if you really do want to have one of these businesses, then here’s what you need to do:

Do NOT spend the spare business cashflow on personal lifestyle building (homes, cars, vacations, etc.); instead, use that cashflow to fund an aggressive investment portfolio, outside of your business: one that will one day grow to replace your personal income i.e. the amount of money that you DO take from the business to live off.

When the day comes that this passive income surpasses your personal business income, you become free.

However, this freedom does not come simply from saving and investing passively – otherwise, you are simply following the advice given in the Millionaire Next Door and you, too, will slave for the next 20+ years to get there.

Rather, this true financial freedom comes from investing your business profits aggressively and actively, with a mixture of your money and borrowed money, in things such as direct stocks (no funds for you!), and real-estate.

In this fashion, you may still need to work your business for 20 years before you shut it down, but at least you will retire a real millionaire (or better) in today’s dollars.

Far better, instead of starting a lifestyle business that relies on YOU being the front man (e.g. lawn-mowing round; accountancy practice; design studio; etc.), or a business that is tied to a single location (such as a car-wash; a restaurant; a corner shop) …

… start a business that can scale like McDonalds, invest aggressively, and you (too) may be able to do it in 7 😉

A dollar saved is a $100 earned …

A Dollar Saved

If you read this blog often enough, you may be forgiven if you leave with the impression that saving is not important.

Of course, you would be wrong!

It’s just that enough is written elsewhere about saving – too much – that little is left for me to say here.

So much, in fact, is written about saving, that you would also be forgiven for thinking that it’s the Holy Grail of Personal Finance.

It isn’t …

But, if your aim is to begin Life After Work (a.k.a. early full/part-retirement) as soon as possible, then every dollar that you save now has a far greater meaning than you may, at first think.

Firstly, though, you have to eradicate from your mind the idea that each dollar that you save is to be closeted in the warm confines of your bank, perhaps sitting shoulder to shoulder with your other dollars in a 5 year CD, locked up like sardines in a tin can waiting for the day that the lid will slowly curl back, only to be quickly consumed.

Equally, you have to eradicate from your mind that the “invisible dollars” scraped from the top of your paycheck and secreted in the mysterious 401k will somehow pop up just when needed to save your retirement, like an airbag in a crash …

No.

It’s clear – at least to me and my long-time readers – that if you need a Large Number / Soon Date (that means, retiring early with a large enough bankroll to happily sustain you until your family finally decides to park you in some nursing home for the remainder of your drool-filled days), then you need to actively manage your money.

Perhaps you need to start a business? Or, you should start rehabbing some houses to build your rental portfolio? Maybe, it’s time to plunge head-first back into that Blue Chip Lottery called the stock market?

Whatever your ‘investing poison’, it should be clear (perhaps with the aid of a few minutes and a simple online compound growth rate calculator) that you need to actively work to gain Very Large Compound Growth on your Net Worth.

So, the value of each dollar saved now is not the paltry 5% to 8% return that others expect, passively watching their CD’s and Index Funds match-racing with Inflation …

… rather, it’s the value of using those dollars to build a small war-chest (OK, a modest level of seed-capital, may be more apt for most of us) that allows you to get started on your business / real-estate / stock-based plan.

And, it is every dollar that you add, or reinvest instead of spending, that helps to fuel the flames of growth.

Once you start to see the value of saving though the spectacle of building a modest pool of funds-for-investing, you begin to realize that every dollar that you save today is really the same as $100 in a mere 10 years timeif invested in a business.

If you don’t believe me, here it is in black (well, blue) and white:

Screen Shot 2013-02-26 at 12.22.07 PM

So, slash those Coke Zero’s from your diet and start drinking tap water and, before you know it, you (too) will be a semi-retired multimillionaire, sitting on a beach in Maui …

Now, how do you feel about saving?
.

.

The myth of asset allocation …

pie 2There’s a Rule of Thumb that says that you should keep 100% – Your Current Age in stocks (and, the rest in bonds).

For example, if you are currently 27 years old, you should keep 27% of your current investments in bonds and the remainder (73%) in stocks e.g. an Index Fund that mirrors the S&P500.

There’s also a new school of thought that says the numbers should be ‘upped’ to 110% or even 120%, to ensure that you keep a larger percentage of your net worth in stocks at a young age, whilst you can still stand the volatility of the stock market (c’mon, you haven’t forgotten 2008 already?) and allow for a larger upside to help find your longer lifespan.

But, there’s a problem:

Let’s say that you want to retire at age 65, and you are currently 60; the original ‘rule’ says that you should still have 40% of your (hopefully, now considerable) net worth in stocks; the question is:

If you plan to retire in 5 years, what % of your net worth should you put in stocks?

Well, the answer is none.

5 years is too short an investment horizon to invest in stocks!

In fact, we’ve already established that the best place to keep your savings is in CD’s:

Screen Shot 2013-01-29 at 2.38.40 PM

Over 5 years, based on past performance, there’s simply too much chance that you will lose money on the stock portion of your portfolio.

But, that’s not the major problem that I have with this – or any – theory of asset allocation …

… my issue is that asset allocation theory only works in long timeframes (again, because we can’t afford risk of loss), say > 10 years, and probably greater than 20.

And 10 to 20 years didn’t work for me, because my plan was to make $7 million in 7 years.

To have any hope of emulating my outcome, you need to focus on three things:

1. Building up the largest ‘starting bank’ that you can,

2. Not spending more than you absolutely have to help build that starting capital in the shortest space of time possible, and

3. (this is the most critical of the three), investing to obtain the highest possible compound growth rate.

Sitting on a basket of stocks and bonds – no matter what the mix – probably won’t cut it.

Short time frames put a LOT of pressure on modern asset allocation and portfolio theories …

… way too much pressure, if you ask me.

 

How much do you really need?

2013-02-14 17.05.10My soon-to-be-nephew is having his wedding at our house; he’s an event organizer (amongst other things) so this is his opportunity to create his (and my niece’s) ideal wedding …

… we were, of course, delighted to be able to lend our house.

As he was supervising the erection of the marquee over our tennis court and false flooring over the pool, we were chatting about wealth.

During the course of discussion, the subject came up of how much do you really … and, ideally … need?

What is the Perfect Number?

If you’ve been following my blog for a while, you will know that I’ve said that you need as much passive income as you need to live your Life’s Purpose.

Even without knowing your Life’s Purpose, though, I can still tell you roughly what your Perfect Number should be:

You should aim to live no better than your closest group of friends.

Let me explain with a personal example …

We have a long-standing group of friends.

We eat often eat together. We party together. We travel together.

Not always. Not only. But, often enough.

Now, how would you feel if you travel coach, most of your other friends travel coach, but one of your friends is always at the front of the plane?

How would you feel if you like to eat out at a mid-priced restaurant once every couple of weeks with your friends, but one of your friends is always trying to arrange 5-star dining? And, 5-star hotel’ing?

I think your friend would eventually price herself out of your group of friends.

Well, I am in danger of becoming that friend.

Our friends are all quite well-off, because they are all professionals (both husbands and wives) drawing great incomes for many years. All of our children privately school together, and vacations are now flying coach (with kids) or business class (without kids), staying at international 4-star resorts at least once, and probably twice, most years.

But, our house is clearly the best in the group. Our cars are the best (and, could be better, but I’m starting to realize that I should hold back a little). And, we could be flying business class (sometimes even international first class), and easily stay in 5-star hotels.

In short, we have to be careful not to make the difference obvious.

That’s why I told my nephew (to be) – as I am telling you now: aim to live no better (but, no worse) than your closest group of friends, assuming that you wish them to remain your friends.

I can add a little more:

– Aim to be towards the top of your circle in terms of sustainable annual income.

– Aim to have a buffer, so that you can maintain that standard even if something goes wrong.

[AJC: This is not the same as an emergency fund: this means, for example living on the same $50k p.a. as your friends, but actually earning $70k p.a.]

– Aim to be able to maintain that standard of living (with buffer) when you begin to live Life After Work.

– Make sure that your Life After Work (i.e. very early retirement) makes you still ‘look’ busy

[AJC: Sitting on a beach all day while your friends still 9-to-5 it 50 weeks a year will just as quickly put you in the ‘former friend’ category as flashing your cash]

So, how much money do you really need?

Step 1: Take what your friends are earning and add 20% buffer

Step 2: Multiply that by 20

Step 3: Add the amount remaining on your mortgage (or, what your mortgage would be if you bought one of the better houses owned by your friends)

Step 4: Add any additional ‘crazy money’ that you need for some of your ‘keep busy’ Life’s Purpose activities.

Step 5: Double your final total for every 20 years until you expect to be able to accumulate that amount of money (or, add 50% for every 10 years), to account for inflation.

That should give you a very practical Number … you might even say your Perfect Number 😉

Now, you just need to go out and get it.

When should you take a loan instead of saving?

debt v savingsHere’s a commonly asked question:

In which cases should you take credit or a loan instead of saving up?

Len correctly answers:

When the price of whatever you are looking to buy is rising faster than the interest on the loan.

But, the answer that I want to focus on is that by popular financial blogger, Pinyo who says:

Buying a house at today’s interest rates is a good example of where taking a loan could be more beneficial than saving up.  You’re amortizing over 30 years and inflation would counter the interest expenses you paid over the life of the loan. In the mean time, you get to enjoy the house much sooner.

Whilst what Pinyo suggests is correct: real-estate is a great hedge against inflation; and, borrowing to purchase your home is probably the only way that most people will ever get to buy one …

… his comment actually fails to mention that it’s also a pretty good investment. Even your own home.

Let’s take a look at a simplified case of somebody purchasing their own first home (house or condo) for $100k, including closing costs. They put in a 20% deposit and take out a 30 year fixed loan, locking in at 3% interest.

Let’s also take Pinyo’s line that the interest rate just happens to offset 30 years of inflation (i.e. inflation also averages 3%), which is almost spot-on, based on the past 30 years’ average inflation rate.

Whereas Pinyo suggests that you are (a) offsetting inflation, and (b) enjoying your house …

… I think you are also making a great investment.

Here’s why:

– Over the 30 years, at just 3% inflation, your $100,000 home would have grown in value to $237,000

– Of course, in that same 30 year period, you would have also paid your bank $52,000 interest on that $80k loan

– Don’t forget that you put in a $20k deposit, which could have been earning interest elsewhere; let’s say that you would have averaged a 5% return on this investment, so your $20k could have grown to $86k.

The bottom line is that you will make an additional $17k profit, if you buy the house instead of just ‘saving’ the $20,000.

To me, this is a clear and tangible case where borrowing (to buy your first home) is better than merely saving …

What about the repairs and maintenance cost, you ask? And, the insurance, and the land tax?

My feeling is that these would be a lot less than the rent that you no longer need to pay …

… after all, you did just buy your own first home didn’t you? 😉

 

The best place to keep your savings …

Screen Shot 2013-02-04 at 7.46.21 PM
Where do you keep your money if you want to buy a house in, say, 7 years?

If you keep it in the bank, you’ll find rates up around 5% if you can commit to a 5 year term.

Given that inflation is currently running around 1.7%, you’re heading for a very small gain.

That’s why many choose to put their money into mutual funds

Screen Shot 2013-01-29 at 2.38.40 PM

Despite the crash, returns from investing in a low-cost Index Fund (say, one that mirrors the S&P500) have been up to 28.6% for any 5 year period that you care to nominate in the past 85+ years.

Now, that’s certainly a lot better than CD’s (long-term bank deposits).

But, there’s a catch … and, it’s a big one!

Whilst’s CD’s virtually guarantee their admittedly paltry return, there’s no guarantees in the stock market …

… and, there has been at least one 5 year period where the S&P500 has lost 12.5%.

But, let’s look at the downside v the upside: that’s a potential 12.5% loss each year for the 5 years … compounded (meaning your savings will halve in a little less than 7 years) … but, you may gain up to 28.6% annual return (meaning you may double your savings every 2 years).

Compare that to the measly 5% return (before inflation) from CD’s and it seems like no contest, which is why many Americans are opting to use mutual funds as a mid-term savings vehicle, but …

It’s a huge mistake.

You see, it might be fine if you already had the deposit for the house saved up, and you were just setting it aside for 7 years. If so, and if this were me, I might very well elect to buy units in a low cost Index Fund rather than scraping by with a CD.

But, if I had the deposit already, I would more likely just go ahead and buy the house now, and rent it out if I wasn’t yet ready to live in it.

But, the reality is that most people need that 7 years to save for their deposit. And, that’s a whole different ballgame, because now you are putting aside a little every month and, over that 7 year period, slowly building up your deposit.

This means, your money is really only going to sit in your investment or savings account on average just for 3 years.

Now, your risk of loss is up to 27%, almost as much as your potential gain of up to 31%, and that means you are gambling, not saving.

This is one of very few cases that I have found where common financial wisdom is correct …

… the minimum period for committing your funds to the stock market should be 5 to 10 years, assuming you are not prepared to gamble with your starting capital.

And, if you are prepared to play the market, well, that’s a subject for a whole other post

So – and, unfortunately – the best place (indeed, the only sensible place) to keep your money safely parked for up to 7 years is in CD’s 🙁

 

Investing for dividends is like driving half a car …

half car 2Like this guy, you could probably drive in half a car (at least, if you were smart enough to first select the best half  i.e. the bit with the engine) …

… but why would you want to?

You could take your supplements purely for the extra vitamins, and you may even gain all extra the nutrition that you need …

… but, why wouldn’t you want to take one that has all the trace minerals that you need, as well?

You could probably invest in real-estate solely for the rental income …

… but, why wouldn’t you want to get some capital appreciation, as well?

If you feel the same way as me, why should investing in stocks be any different?!

That’s what I have to ask James @ Dinks Finance who says:

Dude, dividend stocks are not substandard investments. They may not yield as much as directly investing in your own business, but they can and do produce very respectable returns for many people.

Well, dude, you probably wouldn’t choose to regularly drive half a car; you probably wouldn’t choose to take half a supplement; so, why would you choose half an investment?

And, make no mistake: selecting an investment purely on the basis of its dividends is choosing half an investment.

Why?

Well, Matt Kranz of USA Today says:

The total return [of any stock] is a tally of the net gain, or loss, an investor received by owning a stock and receiving the dividend. When you add the change in value of the stock to the dividend, you calculate the investors’ total return.

To calculate total returns on a stock, Matt says:

Start by adding the value of the dividends to the stock price at the end of the period. Subtract from that sum the price of the stock at the start of the period and divide that difference by the price of the stock at the start of the period. Multiply by 100 to get the percentage.

Here’s an example. Say a stock started the year at $20 a share, paid $2 a share in dividends and ended the year at $25 a share. The total return would be:

(27 – 20) / 20 or 35% total return

Dividend investors usually then counter with an anecdote of great personal returns, like this one from Tim:

I don’t know what sort of return you require but I have invested in a number of dividend producing stocks over more than 20 years and at least for my purposes the returns have hardly been sub-standard. Investments in MO, PM and MCD to mention several have provided very nice returns over the years.

But, Tim, if you follow my advice and look for stocks on the basis of their Total Returns rather than just Dividends, then you still may have invested in MO, PM and MCD, but you would also have invested in both AAPL (Apple) and BRK (Warren Buffett’s Berkshire Hathaway).

Westwood (a registered investment advisor) explains why chasing high dividends is not always the best strategy:

Generally, the highest yielding stocks are there because investors question (by forcing the price lower and, thus, the yield higher) the long term prospects of the business, and/or whether the payout can continue.

Current day examples include Avon Products, with its high 5.0% yield.

While Avon may be a well-known business, the company carries a lot of debt, and many speculate the dividend will need to be cut to manage this large debt load.

Or, consider the 8.5% yield of Pitney Bowes.

While the absolute yield is attractive, the level of EPS (earnings per share) is flat with 1999 and the stock is at a 20-year low. Again, investors question the long term health of the postage meter market, and Pitney Bowes’ ability to fund its dividend going forward.

So, people who look specifically at stocks that produce dividends are looking at only half the story …

… that’s why I say that investing for dividends is, almost by definition, a sub-standard investment selection methodology:

You may happen to come across the best stocks in the country, but – if you invest in the best returning stocks, regardless of what combination of dividends and/or capital appreciation produces those returns – then you are sure to!