Joshua Kennon » millionaires

The Joy of Cash Dividends

Joshua Kennon — Fri, 12 Mar 2010 19:12:17 +0000

If you owned $2,000,000 worth of Campbell Soup Company stock, you would receive $64,000 a year in cash dividends mailed to your home or office, or directly deposited into your bank account depending upon your preference. How did someone come up with the $2,000,000 to begin with, though, given that we know 90% of wealth is self-made in the United States? Here are some thoughts ...

Over the years, I’ve written a lot about dividends on the Investing for Beginners site at About.com. In fact, over the past few years it has been one of my absolute favorite topics to cover because through the Great Recession of 2007-2009, those who owned a collection of high quality dividends stocks were better able to ignore market fluctuations and avoid selling their ownership to pay their household bills.

It isn’t an infrequent thing I’ll hear people opine, “yeah, but who has money sitting around to invest enough to matter?” It’s then that I realize the wisdom of Solomon when he said, “Do not despise the day of small beginnings.” Most people don’t even try to begin collecting assets because the dividend checks start out at only a few dollars each quarter. But money is like a farmer growing a crop. It only takes a few seasons for the seeds you planted to begin to throw off enough seeds of their own for you to drastically increase your yield per acre.

Hard Work Isn’t Enough – You Need to Own Cash Generating Assets

It is almost exhausting reiterating this point, but let’s imagine that you owned $2,000,000 worth of Campbell Soup Company common stock. Regardless of what the stock price did, you would receive $64,000 a year in cash dividends mailed to your home or office, or directly deposited into your bank account depending upon your preference. That works out to $5,333 per month. Dividends are taxed at 15%, meaning you would only pay $800 to the government, resulting in $4,533 per month in cash income.

This money should come as long as Campbell’s products are still popular and generating profits, even if you don’t get out of bed in the morning. It is your reward for not spending the money and instead investing it in companies that create jobs and grow the economy. (After all, you could have taken the whole investment and gone to Vegas, or redecorated your kitchen, or bought new cars, installed a swimming pool, etc.)

Since We Know That Most Wealth Isn’t Inherited, How Do You Get the Money to Invest?

We know, from virtually every study ever done on wealth in the United States, that 90% of American millionaires did not inherit their money. They are first generation rich, with a vast majority coming from the middle class or lower class. Most put themselves through college, and most are married. Since they all started out exactly like you, how did they get the money to buy the $2,000,000 worth of Campbell stock? It isn’t like the tooth fairy just showed up and dumped a pile of cash on their doorstep.

The Millionaire Next Door Method (Good Defense)

The most popular way is the so-called “millionaire next door” that Dr. Thomas J. Stanley discussed in his books. These are people that never made a lot of money but played good defense – that is, they spent less than they earned and invested the surplus in stocks, bonds, mutual funds, and real estate. This route can certainly make you rich (but not super-rich, which we will discuss in a moment). It’s relatively easy, it just takes a long time to achieve financial independence this way. If you are doing what you love for a living, this won’t matter because you’re happy anyway and one day you wake up to find you are loaded.

Take someone who is 27 years old. If he were to cut expenses and save $1,000 per month (I have family members who are not college educated, in their twenties, and single parents that are capable of doing this so I don’t want to hear it isn’t possible – they are no better than you are, they are just making better choices), by the time he reached 65 and retired, he’d have $4,368,521 at a 10% rate of return. At a 4% withdrawal rate (this is the level most academic research shows allows you to never run out of money, even if we were to go through another Great Depression), this would bring in $174,741 in annual household income, or $14,562 per month. That’s an after-tax figure, by the way. If inflation runs 3%, this would have the same purchasing power as earning $4,736 after taxes each month today. You’d be in the same position as our Campbell Soup investor, plus you’d still have another couple of decades to live, statistically, and you’d have a huge pile of wealth to give to your children, grandchildren, or charity when you leave this world.

The High Earning Method (Good Offense)

One of the reasons we bought so many stocks during the Great Recession was because we knew that the dividends, which had been turned off in some cases to protect the company and build cash reserves to make it through the down cycle, would likely be restored for many of the stronger corporations. With General Electric trading at below $6 per share, for example, it doesn't take a rocket scientist to figure out that even if it took 5 or 10 years to get the dividend back to $1.24 per share, you'd make a hell of a lot of money when it was restored. It would work out to a greater than 20% dividend yield on cost!

Those with specialty degrees in medicine, law, engineering, or finance are often able to earn six-figure salaries (or better depending upon their skill and career path), allowing them to spend large sums of money, while still putting aside money for saving and investments. An interesting fact, though, is that very few high earnings show up in the millionaire rankings where they should. That is, they have far less wealth than one would expect.

The general consensus among those who study the affluent is this is the result of the psychological concept of social proof. Doctors, for example, very rarely have the emotional strength to drive a ten year old Honda. Instead, they feel pressure to drive what the other doctors are driving so as not to stand out from the crowd. (Hence my note that most people would rather fit in than be exceptional.)

The Business Owner Method

The biggest percentage of millionaires comes from those who own businesses and the vast majority of super-rich and billionaires also own businesses. The reason is something called earnings capitalization. If you are a doctor and you earn $1,000,000 a year, that’s it. You pay your taxes, you’re lucky to be left with $600,000 net, and if you die tomorrow, your family is out of luck.

If, however, you had built a plumbing business that generated the very same $1,000,000 per year in operating profit, you could sell it to investors or private equity groups. If the company has modest growth, you may expect a 10x multiple. In other words, these investors would be willing to pay you $10,000,000 for your company (as the founder, you own 100% of the stock), because that generates a 10% pre-tax earnings yield. If they think they can use their marketing skills or other holdings to increase profits further, they can make a lot of money themselves.

The same income, in other words, results in $0 in net worth for the doctor and $10,000,000 in net worth for the business owner (to be fair, let’s say $8,000,000 because you have to pay capital gains taxes). Same income, vastly different wealth.

This is precisely the reason that I chose to go into business ownership rather than law or medicine. God blessed me with an extraordinarily high intellect (for which I can take no credit), just like he blessed others with different abilities – some are athletic, some are extremely patient, some are natural leaders. I wanted to know how to get the most benefit for each unit of “work” I put in (as measured by total hours invested) and that would allow me to live the lifestyle I want – no demands on my time, total freedom to do what I want when I want, and still be able to afford the things I like.

The Super Rich Are Usually a Combination of the Three Methods

Take someone like Warren Buffett. He owned the general partner equity of his partnership, which entitled him to a big cut of the investing profits. This made him a de facto business owner. He rarely spent money, meaning he played great defense. As his stature rose, he sat on multiple boards of directors, earning millions of dollars a year in director fees and income, making him a good offensive player, as well. If you look closely, most of the super-rich combined all three methods into a hybrid that fit their personality. Even if they drop $10 million on a yacht, it represents a fraction of their net worth and is like you going out and buying a new Playstation 3.

In our case, we own businesses. When opportunities are attractive, we take the profits from the businesses and buy stocks. When stocks are overpriced, we’re open to selling them and buying real estate. We may take the cash dividends from our stocks to expand our wholly owned businesses. We are an integrated investment vehicle designed to grow our shareholders’ wealth. It just happens that right now, all of the shareholders are members of the Kennon and Green families, respectively.

Misconceptions About Wealth

Joshua Kennon — Mon, 08 Feb 2010 11:12:58 +0000

How The Marketing Industry Continues to Convince Average Americans They Know What a Millionaire Looks Like

The average American millionaire owns less than 6 bottles of wine in his or her home, and paid $13.09 to $14.54 or less for each bottle. They shop at stores like Costco, Target, and Wal-Mart.

A few days ago, I quoted something from one of Dr. Thomas J. Stanley’s books: “In the United States, there are three times more millionaires living in homes that have a market value of under $300,000 than there are living in homes valued at $1 million or more.” For the past few days, I’ve been studying more about average household income in the United States and, specifically, the purchasing habits of the wealthiest Americans. It is exactly what I’ve experienced in my own life, and fits precisely with those I know. Yet, so many of my friends and family continue, almost obstinately, to attempt to emulate a certain “lifestyle” by building a bigger house or buying a nicer car, without first getting their financial foundation set.

Most Millionaires Never Made More than $80,000 in Annual Income

A perfect example: I see friends in New York order Grey Goose vodka, which Stanley discusses in his book. Chemically, it is virtually identical to every other vodka brand because almost all vodka companies use a “base” from one of three suppliers (with Archer-Daniels-Midland being the largest), with the base shipped in giant tanker trucks across the highways, or in railroad cars. So, for all intents and purposes, “the Goose” is identical to Smirnoff. Put plainly, that $60 bottle you use to signal that you are wealthy when, in fact, you are broke and have credit card debt? It wasn’t that long ago it was sitting in the back of a chain-smoking truck drivers’ cab at a dirty rest stop in the middle of Nebraska.

Buying the luxury items does not make you a success. The success comes from having lots of cash coming in, little debt, and the ability to be financially free so you can take control of your own life and spend time how you want with your family and friends. You are not a success because you wear Chanel glasses. They actually get you further away from your goal. You are a success if you have the cash to pay for the Chanel glasses using dividends, interest income, and profits from your investment holdings. The difference is like a war hero. It’s against the law to wear medals you didn’t earn in combat (seriously). In the economic world, however, you can fake it by purchasing the “badges” even if you do it on credit at 30% interest and haven’t earned them. Prada, Gucci, Montblanc, Grey Goose, Burberry … it doesn’t matter. If you are financially independent, these are legitimate, wonderful ways to award yourself. I actually own $200 Burberry ties and $1,200 Montblanc pens. The point is, those things came long after I had built my first business and was on to my second and third, my retirement accounts were funded, my taxes were paid, and I had money saved for an emergency.

Sometimes, I seriously ask myself why I’ve written more than 10,000 articles on investing, saving, and wealth management over the past 10 years. Doing so has consumed a huge part of my life and, although I’ve made a nice chunk of change in royalties and advertising revenue sharing, there are better uses for my time. And then, something like this keeps me up – it’s 5:02 a.m. now – because I can’t stop thinking about how I wish that I knew this stuff when I first started out on my own. I’m putting this all out there so that someone, somewhere, will see that it is possible and that most of the stuff you see on the news or in magazines about the wealthy is a lie. I do it for the same reason I plan on someday wrapping my holdings up in a single investment vehicle and letting friends and family buy shares – I know how good it is to wake up in the morning and decide how you’re going to spend your day. I want you to have that same freedom because it is wonderful and we live in the greatest country in the world, judging by our opportunity to create our own destiny relative to the historical alternatives.

How to Know Someone Is an Idiot (It’s Not About the Money!)

The argument that infuriates me more than any other, and lets me know that I’m dealing with an idiot, is when someone says, “I don’t care about the money.” You know what? Neither do I! I care about having control over my life and not being subject to someone else’s arbitrary decisions. I care about having money to give to charity. I care about knowing if something happened to my family, I could support them. I care about knowing that through the operating businesses, we create jobs so that people feed their family and save for retirement. I love knowing these things.

Whether you are a composer, a computer programmer, a school teacher, or a social worker, if you don’t retire wealthy, it is your fault and your fault alone. Hell, an 18 year old saving $300 per month until he’s Warren Buffett’s age at 10% compounded would end up with more than $12 million. That’s why I started working on this when I was 10 years old! It’s. Just. Not. That. Hard. (Note: There is one notable exception: A health crisis. More innocent people declare bankruptcy due to health problems than almost any other cause in this country and it’s a shame. We’re better than that. Someone who is in that position has done nothing wrong.)

I have a family member who came to me when he or she (I’m going to say “he” because I don’t want to keep repeating that) was 18 years old. He wanted to do exactly what I had done and began putting aside $850 per month, split between a brokerage account and a Roth IRA account. On top of this, he saved 10% of his pay through his employer’s 401(k). He never earned more than $28,000 per year. A few years later, he had nearly $35,000 saved. He could never save another penny, and at a 10% return, he’d have just over $6 million by the time he’s Buffett’s age. That is what I’m trying to get across to people. If you get it done right, and early, and spend less than you make, compounding will do all of the heavy lifting. In fact, educators (public school teachers in general) are disproportionately represented among the ranks of millionaires relative to their population due to the frugality common in the industry! There’s no pressure to show up to work in a BMW 9 Series.

The next time you drop $50 or $100 for a bottle of wine, just remember that statistically, most American millionaires shop at Wal-Mart, Target, and Costco, paying less than $15 for their wine collection (which consists of roughly 12 bottles, on average). Millionaires are, by definition, millionaires because they spend their time focusing on prudently spending less than they earn, generating new sources of income, and earning a good return on their investments. As a group, they would rather own an extra 30 shares of Wal-Mart Stores, Inc. common stock, giving them a bigger share of the retailer's profits and cash dividends, than a case of Dom Perignon. That is why they continue to earn money as they sleep or spend time with friends and family, while most people have to wake up each morning and drag themselves to a job about which they have very little passion.