We added some shares of Campbell Soup Company to the Blue Chip Reserve portfolio today. They are fairly conservative; I don't expect more than 8% to 11% compounded out of them over the next decade.

Aaron and I are wrapping up all of the tax documents for fiscal 2009 before shipping them off to the accountants, listening to the new Goldfrapp album, and tweaking the investment portfolio a bit.

I liquidated a respectable portion of the LEAP stock options we bought on General Electric during the crash now that it is approaching $19 per share, or at least was during today’s trading session.  The time premium was no longer adequately reflecting the risk, in my opinion, especially relative to the deep-in-the-money options in the same series.

I also added some Campbell Soup shares to the blue chip reserve portfolio (this is the “dumb money” collection of high quality, dividend paying stocks we build as an insurance policy in the background of some of our operating businesses where we anticipate no more than 8% to 11% returns compounded, but that serve as a backup source of high quality liquidity and long-term compounding).  The company is silently and secretly using almost as much cash repurchasing shares as it is paying cash dividends.

There are so many projects going on right now that I don’t know where to start … I feel like I’m running from fire to fire trying to figure out where to devote our energy.  I think the end of the 1st quarter will help us re-evaluate our progress for the year.  As I’ve been saying for six months, 2010 is going to be the year we transform the company, consolidate certain operations, and begin evaluating our options to get into the asset management business by launching a mutual fund or hedge fund at some point in the future.

Today just feels really … weird.  I can’t make myself jump in and get stuff done and I don’t want to do nothing.  This is why I need to focus on money management.  I could make myself read a few annual reports.  That’s how I know it is the industry we ultimately need to focus upon.  It’s what I think about when I sleep (literally … I woke up the other day and realized that in my dream I was actually analyzing a real stock report I had just read, valuing it.  I was working as I slept).

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The original $62,295 investment in Coca-Cola stock grew to 30 million shares worth more than $1,700,000,000 and generated $52,800,000 in annual cash dividends for the bank. That was before the idiots that were put in charge of the asylum decided to sell it, destroying nearly a century of tradition and turning Sun Trust into another pointless, nameless banking commodity.

I’m reading the Sun Trust annual report and I realized that many, if not most, of you are probably unaware of the Sun Trust connection to Coca-Cola and how it gave rise to one of the greatest investments in history.

When Coca-Cola went public in 1919, the underwriting was handled by two institutions, one connected to J.P. Morgan and the other to a predecessor of Sun Trust bank.  The former took their fee of approximately $100,000 in cash.  The latter took their fee in shares of Coca-Cola common stock.  After taxes and other adjustments the cost basis of these shares ended up being $69,295.

The Coca-Cola stock certificates were locked in the Sun Trust bank vaults along with Formula X, the secret recipe to the original Coca-Cola beverage.  For 90 years, they have compounded in value and have grown to 30 million shares worth more than $1.7 billion.  The bank collected roughly $52.8 million in cash dividends each year.

That, of course, was before the idiots that run Sun Trust decided to desecrate nearly a century of tradition and sell the Coca-Cola stock, triggering a huge tax liability but bolstering Tier 1 capital. 

They chose, in other words, accounting over economic reality – the precise opposite of what Buffett and Munger have said you want in a management team.  When I think about it, I can actually feel my blood pressure rising.  Imagine how an art lover would feel if a newly minted millionaire decided to buy a Picasso and rip it to shreds in the middle of Times Square just to make a point.  That is the business equivalent of what just happened.

To be fair, the transaction is slightly more complicated than a simple sale of Coca-Cola stock.  Basically, Sun Trust entered an agreement that allows it to sell the Coke shares for no less than $38.67 per share and no more than $66.02 to $65.72 per share, while still receiving dividends until it actually completes the disposition.  These agreements were then treated as Tier 1 capital by the Federal Reserve because theoretically, Coke stock could fall to $10, say, whereas the agreements set a guarantee sales price floor.

One of the so-called justifications the bank management gave was the desire to focus on banking.  How are they doing with that?  They reported more than $1.7 billion in losses for fiscal 2009.

If there were a capitalism hell, they would deserve to go there.  That’s just my opinion …

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A pleasant bit of nostalgia today.  I was researching Papa John’s and it reminded me of the last time I read the report.  I was in 7th grade in a small town called Savannah (again, most of you know I lived in seven or eight different places  before I finished middle school so it’s sometimes necessary to clarify).  I was doing something for the student government association and was in the journalism room on the third floor.  We were there after school, the sun was starting to set, and the windows were open.  I had a copy of a Value Line report covering Papa John’s I had taken from the local public library (it cost, if I recall, 3 cents per copy) and was looking over the figures before deciding that it was “overvalued” based on Benjamin Graham’s approach.  I didn’t buy any, and haven’t in the years since.  That same day, I also read Applebee’s Value Line report (I must have been working my way through the restaurant group…).

As I sat here going through the cash flow statement, it was strange because it was like I was sitting back in that room, reading the report.  It’s funny what is locked away in our memories we don’t recall until something triggers it.

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Some time ago, a family member of mine decided to take a tiny portion of his speculation portfolio and trade options on Citigroup.  This wasn’t his investment capital, he was fully aware it could totally and completely blow up, but thought it would be interesting and great entertainment, plus he figured that he was right.  With the rest of his “financial house” in order, so to speak, and conservatively managed, it provided far more enjoyment for him than, say, a cruise or blowing the money in Vegas.

He bought $5,338.68 worth of call options (technically, LEAPs, which stand for long-term equity anticipation securities) that expire in January of 2011 with a $5.00 strike price.  This allowed him to control 5,000 shares of Citigroup common stock at a total premium cost of $1.07.  To break even, then, Citigroup would have to be at $6.07 by January of 2011.  If it went to, say, $10, he would be able to cash out for $25,000, or 500% of the original investment.

He may turn out to do well on them despite some crazy initial volatility.  Citigroup is now around $4 per share and according to a recently released report, it expects to earn $20 billion in sustainable profit by 2012.  The market always prices those factors in ahead of time.  By next January, it is entirely possible he will have exceeded both his strike and break-even price if that turns out to be true.

Either way, he has a lot of fun tracking it and studying the bank.  It’s not quite as aggressive as Warren Buffett’s secret copper futures trading operation (talk about risk – that is jet fuel poured on volcano lava!), but at the very least, he is good enough any more at trading options that he could recover at least some of the capital.

Needless to say, I don’t own any Citigroup options.  I tend to be active in shares of U.S. Bancorp and Wells Fargo from time to time (for example, buying a lot of it for the accounts of my brothers and sisters during the crash when it was at $8 to $12 per share compared to $26 today).  Like clothing companies or musicians, we all develop certain stocks with which we feel comfortable and understand.

Warning: Unless you have a ton of cash, no debt, a steady stream of household income, and understand the risks, do not EVER trade options under ANY circumstances.  You will lose everything.  Your family will despise you.  Your financial life will be over.  Okay, maybe it’s not all that bad, but you could suffer some catastrophic losses because you don’t know what you’re doing.  Just say no, like to drugs.

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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.

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A Three Minute Guide to Understanding Stocks

Head over to the Investing for Beginners site at About.com, a division of The New York Times, to see my newest special.  It started because last week, I sat down to create an updated version of The Beginner’s Corner, which answered basic questions such as “what is the ask price and bid price of a stock?” and “what does a market maker do?”. As I kept writing answers to the questions I’d received from readers over the years, what started as a brief update turned into a week-long project that culminated in a new feature called 101 Things Every Investor Should Know About Stocks and the Stock Market.

This new special contains more than a hundred pages of content, each answering a specific question in only two or three sentences with links to additional information if you want to learn more.  You can click through it in under 3 minutes if you want the brief version.  This alone should put you years ahead of where most investors are because you’ll be able to answer questions such as, “What is the Dow Jones?” and “What is private equity? Or a hedge fund?”  Do yourself a favor and become educated on the 101 things that every investor should know. It could help lay the groundwork for a much better understanding of the rich, robust collection of articles you’ll find on the site after you’ve finished.

The special on investing in stocks and the stock market was designed for complete beginners that have absolutely no idea what things such as "assessable stock" or bid and ask spreads are. It lays the foundation for understanding the stock market so it's not overwhelming when you are confronted with these terms at your broker's office.

Read 101 Things Every Investor Should Know About Stock

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One of the Things That Helped Me …

I thought of this "stupidity insurance" as writing my own self-insured retirement plan or insurance policy that would guarantee that by the time I was ready to stop working, I'd be able to take $21,422.71 per month after taxes WITHOUT EVER SAVING ANOTHER DIME after my 30th birthday. Anything else I built up - my businesses, my houses, my art collections, my brokerage accounts, my main retirement accounts - is extra (and, frankly, where the *real* money will be). The account should maintain its value of $6,426,814 over time, meaning that the whole sum could be left to my heirs or given to the family foundation for charitable purposes.

From time to time, you may come across reference to my “stupidity” insurance or my “reserve” fund.  I’ve had a bunch of readers write me over the years and ask about various comments I’ve made so I thought it might be useful to explain it.  My parents, siblings, and Aunt Donna have always known about my investing but virtually no one else did when I was a child (by the time I got into high school, though, it was all I talked about so hiding it was no longer an option).

For those of you who are older than 14, this isn’t going to do any good unless you have children or grandchildren that may benefit from some personalized version of it (which is why I’ve never written about it).  By the time I was older, we had put almost all of my siblings on a modified system that helped to guarantee they would enjoy the same outcome in their own retirements.  This plan has some resemblance to the dividend trust program I described in an article on student loan debt.

How the Stupidity Insurance Fund Came About

One of the first things I did when I was a child and figured out the time value of money, and how powerful it could be, was to create a plan that would ensure that no matter what I did or how successful I was, that I would retire rich.  For years, I called this my “stupidity” insurance or my “reserve” fund because it was designed as a sort of self-written insurance policy that no matter how royally I screwed up or how bad things became in life, there was a huge “compounding machine” working in the background for me.  I started toying with its development when I was in 4th grade in a tiny town called Savannah (before I was in 7th grade, I had lived in seven or eight different cities because we moved a lot).  I think it came about because of the biographies I read where you’d have formerly successful business people that lost everything, or millionaire rock stars that ended up bankrupt and broke.  My goal was to do everything possible to make that a virtual impossibility.

The program worked like this: If, starting at 14 years old (which was 4 years in the future at the start of the program), I could save $500 per month by working after school or doing side projects for people, and I could park the money at 5% until I was 30 years old, I would have roughly $141,945 in this insurance fund.  I’d kick in the extra $55 to make it an even number, so let’s call it $142,000.

This $500 was my “insurance premium”, so I didn’t think of it as saving or investing because that is what my brokerage accounts were for – for all intents and purposes, this money didn’t exist to me.  I treated it like an expense, or a car payment.  I did everything possible to get it into tax-advantaged accounts such as a Roth IRA or SEP-IRA because I wanted the money to be able to grow tax-free when it reached what I called “the vesting date”, which was my 30th birthday.  This was the date at which I would stop contributing money to the fund and split everything that had built up since I was a kid into different asset classes (stocks, bonds, mutual funds, real estate, options, etc.) and invest it in such a way that it could be passively ignored for years.  In many cases, the law requires you to take distributions from your retirement accounts by the time you are 70, so that would be 40 years of compounding.

By putting money into assets that generate cash and grow in value over time, like businesses that are attractively valued, the money in this self-created retirement plan or retirement insurance policy silently compounds for decades in the background as we all go about our lives.

If this passive money earned 10% (I have a history of earning much more, and I planned on utilizing things such as self-directed IRA accounts that would allow me to actually buy an apartment building or hotel, for example, as the money grew but I’m keeping it there for the sake of conservatism; most people should bet on 7% to 8%), by the time I reached 70 years old, the “insurance fund” would have $6,426,814 in it.  There would be virtually no taxes owed on this money because of the types of accounts in which I had placed the funds.

Most research shows that even in a Great Depression scenario, withdrawals of no more than 4% per year mean that you’ll never run out of money.  At a 4% rate, I could take $257,072.56 in dividends out of the account each Christmas for the rest of my life.  That’s $21,422.71 per month after taxes that I could live upon, simply because of money I saved from the time I was 15 to 30 years old without ever contributing another penny.

To put it another way: I would never have to save another penny beyond my 30th birthday, and anything else I built up such as businesses I started, retirement plans, brokerage accounts, home ownership, etc., would all be extra (and, if I did my job correctly, would dwarf the insurance fund in value at retirement). But if I utterly, totally, and completely screwed up life and blew everything I ever made and became a total profligate, I’d still retire with a monthly income of $21,422.71 after taxes plus any social security for which I qualified.  That’s why I called this my “stupidity” insurance.

The Psychological Effect of Having Your Own Stupidity Insurance

Some psychologists and money managers have written about similar programs, which they call your “go to hell” money.  They call it this because you know that no matter how bad things get, whether or not you lose your job, change careers, or get divorced, if you are unhappy, you can get up, walk out of the building, and tell everyone to go to hell.

The main benefit of the program is intellectual freedom to pursue what you want to do without fear.  It could be argued that one of the reasons I launched companies after graduation, rather than take a job at Merrill Lynch or Goldman Sachs, was because I knew if I failed, I’d still end up rich and I could always get a job tomorrow.

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By simply putting $300 extra each month into shares of U.S. Bancorp, the firm that owns his mortgage, instead of paying off principal each month, this family member should end up with an extra $535,000 net in 30 years, plus own his house outright, and be collecting approximately $33,000 annually in cash dividends.

A member of my close family has been using a technique to build substantial wealth that doesn’t require a high income or any specialized knowledge, extra work, or effort.  I was so impressed by the way he implemented this program, I thought I would share it with my other family and friends (as well as anyone else who reads my blog) without giving away who it is.

Each month, he has a house payment of approximately $1,500, payable to U.S. Bank.  He decided that instead of making an extra $300 payment along with his regular mortgage bill to lower principal and pay the debt off early, he would instead establish a direct stock purchase plan and have that same amount automatically used to buy shares of U.S. Bancorp.  He was convinced the balance sheet of the bank was strong, and the fact that the CEO earns more in cash dividends from his outright ownership of U.S. Bancorp stock made him feel confident that management would act in the best long-term interest of shareholders compared to other banks, where huge bonuses and perks rewarded failure.

The commissions charged for this service are negligible, typically $2 per transaction.  This means that every year, he is investing roughly $3,600 in U.S. Bancorp common stock, with instructions that all of the dividends should be reinvested.  The mortgage on his home loan is roughly 5.5%.  How much will he make in extra profit from this transaction?

Let’s assume that shares of U.S. Bancorp will compound at 10% per annum, with the dividend reinvested, over the next 30 years.  Based on his special “savings” program, when he pays off his home, the deed will be mailed to him and he will be completely debt-free.  At the same time, this small direct stock purchase plan will have nearly $600,000 worth of shares of U.S. Bancorp common stock!  Based on its historical dividend yield, this will generate roughly $33,000 per year in pre-tax income, or $2,700 per month. He will have paid an extra $100,000 or so in tax-deductible mortgage interest, so a net $65,000.  Thus, this move gained him roughly $535,000 30 years from now simply because of how he invested his money.

To recap, he’ll own his home outright, have $600,000 in this account virtually no one knows about, and be earning $33,000 per year from checks getting mailed to him.  This is on top of his businesses, retirement accounts, savings, and “real” money.  You’d never know it.  He drives a 10+ year old Ford, eats at McDonald’s, and lives on very little money each year.

This just goes to show you that most millionaires are regular people, statistically, that invest their money well.  They are teachers, dentists, bankers, coaches, and business owners.  Yet, when you tell people in the lower classes this, they refuse to believe it because of the image that Madison Avenue has sold them.  They don’t realize that they are likely living in the same neighborhood as a millionaire, who drives a pickup truck and has more money than many of the professional sports players on the local NFL team.

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. – Dr. Thomas J. Stanley, Stop Acting Rich … And Start Living Like a Millionaire

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