By Charles Fournier on January 9th, 2018
Charles retired in his mid 50s in May 2016 from a career in Canadian banking. He relies exclusively on income from rental properties and a dividend income stream from a portfolio he amassed over several years.
This post is a follow up to my recent Tips On Your Journey To Financial Freedom article.
Unless you come into sudden wealth (eg. inheritance, lottery winnings), the journey will likely be lengthy and the manner in which you acquire your wealth may be varied. Not only will the manner in which you acquire your wealth take twists and turns but you may also find yourself on an emotional roller coaster. I am here to tell you that is perfectly normal and that it is extremely important that you stay motivated on your journey to financial freedom.
Set Short-Term Goals
Your patience will definitely be tested! As a result, you must set realistic short-term ‘stretch’ goals, to regularly monitor your progress, and to reward yourself for each ‘success’.
When my wife and I set out on our journey to become financially free we knew we had to set monthly goals. We knew that if we monitored our progress any less frequently than monthly, the probability of us taking our ‘eye off the ball’ increased.
As an example, we purchased our first jointly owned vehicle within 6 months of beginning our careers. We scrounged up a 25% down payment and borrowed the remainder. Our car loan called for monthly payments over a 36 month period; interest rates at the time were in the mid-teens!
Over the first few months we diligently made our monthly payments. One day, however, I looked at the balance owing on our loan and realized it had not really declined that much. After discussing the matter we decided to make additional weekly payments. In addition, we committed to making periodic lump sum payments as cash flow permitted.
Every month I would check the balance owing. It didn’t take long to notice some significant progress in the elimination of this loan. After continuing our rapid repayment program for approximately 1.5 years our car loan was fully repaid.
While the elimination of this debt was a reward in itself, we decided to establish a small monthly reward policy. We certainly had no intention of spending a fortune rewarding ourselves so we merely found some relaxing activity that allowed us to step away from the ‘daily grind’.
While short-term goals are critical in order to stay motivated on your journey to financial freedom, it is imperative that you have ‘big, hairy audacious’ long-term goals. These are the types of goals where you say to yourself ‘Can I really do this?’
For many people, purchasing their first home possibly ranks near the top of the list of their ‘big, hairy audacious’ long-term goals. Unlike all expenditures previously incurred over the course of your lifetime, a mortgage obligation will most likely be your first experience wherein full repayment will take decades.
Staying motivated when you have this ‘monkey on your back’ is going to require some real intestinal fortitude! During this protracted repayment period you will find that over the first several years only a tiny fraction of your mortgage payments will actually be applied toward the reduction of your mortgage; welcome to the world of mortgages!
In addition, you will learn that a home is a liability as opposed to the conventional misconception that it is an asset. Your home is unlikely to generate income. Instead, you will be forking out money toward the upkeep of your home.
Before you take on a mortgage, I strongly encourage you to investigate the dramatic impact weekly or bi-weekly mortgage payments can have on your mortgage. Your lender will likely quote you the monthly payment obligation but if your cash flow circumstances can support weekly/bi-weekly payments then I strongly recommend either of those repayment frequencies.
Some lenders permit lump sum prepayments at any time without penalty. In Canada, for example, some conventional lenders will permit:
- Up to a 20% increase annually on your regular payment
- Additional lump sum payments over the course of the year in aggregate to 20% of the original amount of the mortgage
Take advantage of such offerings. You will notice a dramatic reduction in your mortgage which will definitely increase your level of motivation to become financially free!
In our case, we were able to retire our mortgage within 10 years from the date we purchased our home. We cut back on things that truly were not necessities. Initially it was difficult but by focusing on our long-term goal we found that the ‘things’ we were foregoing were really not that important.
By eliminating the mortgage on our principal residence in reasonably short order, we suddenly had decent free cash flow which could be deployed toward revenue generating assets that would help us become even more motivated on our journey to financial freedom.
If you were drawn to this site it is highly likely the concept of equity investing as a method of enhancing your net worth or cash flow is appealing to you.
The challenge with equity investing is that you will require considerable intestinal fortitude to stay motivated. The reasoning for this is that:
- Stock prices fluctuate to the extent where you may feel you are making progress but then something happens causing your investments to retrace in value
- You will need to amass a sizable portfolio to generate a meaningful level of dividend income
Suppose you have a $2,000,000 portfolio on which your investments are generating an overall 3% dividend yield. This translates into only $60,000/year on a pre-tax basis.
If this level of dividend income is insufficient to meet your living expenses, you may be required to resort to the liquidation of some of your investments to make up any annual cash flow shortfall. If you are reluctant to do so, you might gravitate toward companies with higher yields (eg. high single digit or low double digit yields).
High yield investing can increase current income, but it comes with additional risks. You must give up something (growth, safety, maybe both) to get higher yields. In many cases this trade off is not justifiable.
Instead of reaching for yield, I have found that low yield and low dividend payout ratio companies can support years of earnings per share growth AND a corresponding increase in the dividend.
I recollect many energy sector Master Limited Partnerships in the 2011 – 2014 period were endeavoring to become publicly traded or to increase their profile. In several cases, money was borrowed to make monthly distributions which exceeded the cash flows generated by the limited partnership. This is clearly a recipe for disaster.
In my opinion, if nearly all earnings are being disbursed to shareholders as dividends then the company has little wiggle room for profit fluctuations.
As with any other article I write I strongly recommend readers conduct their own due diligence. In this regard, you may wish to access the following lists:
- The Complete REIT List: 167 Publicly-Traded Real Estate Investment Trusts
- The Complete MLP List: 128 High-Yield, Tax-Advantaged Securities
- The Best High Dividend Stocks: 391 Companies With 5%+ Dividend Yields
Download these spreadsheets and sort the data by forward dividend yield. Randomly select companies with yields in excess of 6% starting with the highest dividend yield companies.
Note: I used the ‘The Best High Dividend Stocks: 391 Companies With 5%+ Dividend Yields’ spreadsheet when I randomly selected 3 companies to review in my recent Chasing Yield is Fraught with Risk article.
Once you have done this, go to the ‘Investor’ section of any company’s website. What you are apt to find when you look at distribution or dividend histories and other stock information is that there were dividend cuts, dividend freezes, and reverse splits.
You may also wish to take a look at recent annual reports. Search for the company’s ‘credit rating’. In addition, look into the interest rates the companies are paying on their long-term debt.
While Sure Dividend provides these spreadsheets for investors seeking to improve the cash flow from their investments, it specifically warns readers that ‘MLPs provide much higher yields in exchange for the assumption of additional incremental risk.’
In my opinion it is sufficiently difficult to stay motivated over the long-term when investing in equities for the purposes of attaining financial freedom. The last thing I need is for a full or partial permanent impairment to my capital which is which I shy away from high yield investments.
In addition to diversifying your equity investments you may wish to consider investment properties as part of your overall income producing investment portfolio. Many investors have had considerable success investing in residential, commercial, or industrial properties. These investors, however, likely did not overextend themselves as some did just prior to the Financial Crisis in the US.
In our case, having no mortgage on our principal residence was the prerequisite to owning rental properties. We did not want to be in a position of having a mortgage on our home plus mortgages on rental properties.
Our strategy was to acquire residential rental properties close to a highly recognized Canadian university. The rentals are in low level condo buildings with on-site superintendents and a reputable property manager.
We decided to restrict our rentals to graduate students. Our rationale is that these students are likely to be less likely to ‘party’ and the maximum tenancy will be 4 years; the university’s medical school program, for example, is 4 years.
Using the rental income and personal free cash flow, we decided to fully repay the mortgages on the rental properties within 5 years from the date of purchase; we purchased them in the mid 2000s.
If you are entertaining the thought of investing in rental properties keep in mind that they tie you down. If you are young I suggest you remain flexible. You never know where your next opportunity may lie. If you own a property and an opportunity arises in another part of the world, keep in mind your flexibility is hindered if you are a landlord.
If one of your dreams of becoming financially free is to be able to ‘pack up and go’ to see other parts of the world on a moment’s notice, how can you stay motivated to become financially free if the investment with which you intend to gain freedom is going to tie you down?
We have never extended private mortgages but I know some people who have been extremely successful in this regard.
In one case, an investor had a pool of several hundred thousand dollars he was deploying in the form of private mortgages. In addition, he used his free and clear principal residence as collateral for a 6 figure line of credit.
At any given time he had over a dozen first mortgages in his portfolio. All were priced off Prime since his line of credit was Prime Rate based. If the Prime Rate increased, the rates on the mortgages would increase thus eliminating the risk of any squeeze on his margins.
- All fees were borne by the borrowers
- All terms were no longer than one year
- He made the final decision if a borrower expressed an interest to renew their mortgage at the end of the one year term
Another private mortgage investor was a lawyer in private practice. In his case he was far more aggressive with the level of risk he was prepared to take on. As compensation for the level of risk he was taking on, he was charging rates in the low 20% range when the Prime Rate in Canada was in the low teens.
I do not know your personal circumstances but if I were to adopt this investment strategy I would restrict the mortgages to first mortgages in amounts below $50,000. I would also be extremely selective as to the properties on which I would extend mortgages and I would be very picky when it came to the borrower.
My primary focus would be on the borrower’s capacity to repay. Having to rely on the liquidation of the property in order to obtain repayment is a last resort!
Regardless of the method you decide to adopt to become financial free, remember it is imperative you set short-term and long-term goals and that you remain focused so you stay motivated.
Make sure you regularly monitor your progress and try not to get discouraged if you are not making headway as quickly as you like. In some cases the execution of your game plan to achieve financial freedom might need some slight modification. Consult with someone who has already achieved the goals you wish to achieve. It is possible a slight modification in the execution of your strategy can propel you forward on our journey to financial freedom!
Finally, be sure you celebrate the ‘wins’. Paying off your mortgage definitely warrants a huge celebration but at the same time don’t forget to celebrate the full repayment of a long outstanding credit card bill. Just be sure the magnitude of the celebration is not at the same level as that when your mortgage will be repaid!