How to Get On the Path to Financial Freedom

In our culture we are presented with many prerogatives and choices (‘freedoms’, if you will). In this discussion I’d like to focus on the ‘financial freedom(s)’ subset of this. Unfortunately ‘freedom’ can be exercised to our severe disadvantage just as readily as to our advantage. We live very close to the consequences of this double-edged aspect of freedom when it comes to our personal money management practices. Our natural inclinations toward self indulgence, played upon by sophisticated marketing, too often lead us into forfeiting the many advantages of freedoms exercised well. Let me assure you that I believe that ‘sophisticated marketing’ is morally neutral and necessary for a healthy economy. The counterpoint is that we should strive to be responsible within the context of our individual financial circumstance when responding to marketing.

When I was invited to guest post on this blog it immediately occurred to me that this might be an opportunity to encourage some, especially my grandchildren, with some perspectives on financial affairs that might serve them especially well from this point forward in their young adult lives. A first principle of financial planning is that time especially favors enlightened money habits; the longer you practice a good habit, the more substantial the good results (the math of compounding works to your advantage).

So here’s the deal … Following are some financial ‘realities’ of life and snippets according to your grandfather.

  • Debt is slavery. The extent of indebtedness you incur is the extent to which you have forfeited/sold your prospects of financial freedom to someone else.
  • The path to ‘financial independence’ is one of living within your means and investing yourself (your time) and your money wisely. The concept of “stewardship” seems to apply here. We will expand on principles of wise investing as we develop this blog.
  • Time and money are limited resources. Managing both wisely is the stuff of a healthy life. Managing either unwisely inevitably leads to grief.
  • Strive early to invest your efforts and finances toward the goal of financial freedom. The extent to which you remain payroll dependent is the extent to which you are forfeiting opportunity (to maximize benefits to yourself and to those you serve). Let me propose that creation of ‘value’ (in both a financial and social sense) is the truest measure of success. Don’t we all want to succeed? Working for someone else is not wrong just second best. When salaried, however, bear in mind that even in that circumstance you are ultimately working for yourself. Anything less than best effort is a sorry default.
  • Creativity. We are all blessed naturally with some expression of ‘creativity’; it comes in all kinds of interesting flavors. It is the stuff of inspiration, energy, ambition, progress, fulfillment, etc. Discover the your particular flavor(s) and cultivate it. It is an important part of your unique ‘talent set’ (the tools for life that are your individual birthright).
  • Make ‘I am responsible’ (for what you achieve or fail to achieve) your guiding principle.

Now that we’ve gotten past that preamble, let’s get down to the nitty gritty. You know that I am allergic to debt and that I value a financial wisdom I am going to share with you a picture of my present persuasion(s) with respect to investing (of finances). Keep in mind that I still consider myself a ‘student’ of these disciplines, not an expert (hopefully as you look into these things you will become the experts). However, the extent to which I consider myself as having made progress down this path I want to share with you. Let me say at the outset that practically everything I have to share I must attribute to more expert sources. These I will cite as often as possible. There are some foundational principles to get on the table to begin. Foremost, please consider that there are two paths you may take through the money maze. The first path is labeled “investment”; the second is labeled “speculation”. I soundly endorse “investment” and conversely eschew “speculation”. Let’s talk about the differences.

We’ll define ‘investment’ as the process of buying into good (better yet, excellent) business opportunities. Our goal in this endeavor is to reap the benefits of business ownership, usually in the form of appreciating value and/or dividends. For the present let’s recognize that although there are many other types of investment opportunities (bonds, real estate, real estate investment trusts, business development companies, etc.) we will limit our present discussion to common stocks. Let me suggest that our goal as investors here is to discover excellent companies and to buy portions of them (stock) when the marketplace offers them at on-sale prices. Buying these makes us business owners. Buying these at on-sale pricing means we are minimizing our risk of capital loss and increasing our prospect of capital gain. This introduces the concept of ‘margin of safety’ (MOS) an idea probably best articulated and used to advantage by such financial leaders as Benjamin Graham (1) and Warren Buffet. There is a statistical concept of ‘reversion to the mean’ that seems to prevail in the market over the long haul. This is, simply put, the concept that when something is over priced it will eventually settle lower in the direction of its average pricing (you lose money). On the other hand market underpricing can be expected to eventually resolve by appreciation toward average pricing (you make money). Consider the average pricing to represent a composite of many business and market factors but ultimately to be an expression of ‘fair value’. This is the basis of MOS.

I will not dwell on the second path, ‘speculation’, because although it has its place in the market, it is anathema to me. To those of us that are persuaded into the camp of value investing, ‘speculation’ is the equivalent of gambling in the market. It may satisfy the inclinations of some, but for me it has no justifiable appeal. I must grant that there is always an element of speculation in our financial lives, just as in our non-financial lives, but we rely on established principles and wisdom to minimize its impact. The activities of market speculators do create opportunities for a value investor, such as I fancy myself. They often create mispricing opportunities for the value investor to snap up. Enough about the path of speculation.

Let me now expand on a characterization of the investing style that I have gravitated to over the years. I now judge a company and invest for a growing stream of dividend income per the following guidelines:

  • First of all, I want ownership stake only in really good businesses. Enterprises that demonstrate compelling evidence of being engaged in business that satisfies fundamental demand(s) in ways that even a grandfather can understand.
  • That it enjoys significant competitive advantage(s) in the business arena.
  • That it can demonstrate an enduring culture of competent, responsible, management (of both its enterprises and its finances).
  • That it is really good at making money and at putting the money it makes to work.
  • The businesses I’m most interested in are ‘efficient with their capital’. They are very good at maximizing their profits versus the amount of money needed to keep things running. Airline or automobile companies are often cited as examples of poor capital efficiency. These require huge investments in capital assets to stay in business relative to the profits they are able to make. On the other hand companies such as Hershey and Coca Cola are often cited as outstanding cases of capital efficiency. They make lots of money year after year on a relatively small commitment of new money.
  • Strong history of commitment to dividends.
  • Strong history of commitment to regular increases in dividend payouts.
  • Strong evidence of continuing ability to maintain an attractive dividend policy.
  • I look forward to market downturns as opportunities to buy stuff I want.
  • I favor dividend yields greater than 3% but allow for exceptions of less than 3% if other factors are compelling (eg., high and consistent dividend growth rate; compelling margin of safety)
  • I gravitate to a portfolio of 30 to 40 different holdings and actively limit any particular holding to no more than 5% of the entire portfolio value. At the same time I actively target bringing any worthy individual holding to a 3% minimum. I am persuaded of the wisdom of reasonable diversification.
  • My professional training has instilled in me a strong bias towards looking at things statistically. I think in terms of probabilities of success and try to allow for experiencing rude surprises in market behavior.
  • I endeavor to buy into companies that are demonstrably stable regardless of current market gyrations. The holdings in my portfolio have been chosen for their business qualities and as such for the expectation that they can successfully weather the rude surprises of the economy or the market. I consider it a rare circumstance that I will sell off a holding merely because of a market downturn if the company fundamentals remain intact.
  • I actively minimize transaction costs by using an automatic dividend reinvestment strategy (DRIP) available through my brokerage firm.
  • It has been a long time since I have had a non-dividend stock in my portfolio. I regard dividend policy as a strong indicator of the ‘quality’ of a company I wish to own.
  • It has been a long time since I’ve had any kind of mutual fund in my portfolio. I have been solidly persuaded that such funds are blatantly inefficient with my money (4).
  • I am persuaded that if I consistently adhere to these principles it will be hard for me to lose the money game, regardless of the twists and turns of the market or the economy. The biases of the marketplace and human behavior favor success. The risks of politically imposed disaster are beyond the scope of this plan.
  • Time is on the side of this agenda. Many studies have demonstrated the long- term probability of significant gain associated with the disciplined application of these principles (2).
  • This is not a get rich quick plan, but it is the path with the prospect of most reliably accumulating for and maintaining financial independence.
  • The wealth compounding consequences of persistent saving and dividend reinvestment can be impressive (2). However, the investor needs to be thinking in terms of at least a 20 year program and a slow start. Compounding works slowly at first but gradually gains momentum. Do the math.

If I had gotten on board 30 – 40 years ago with these principles I would, no doubt, now be plagued by an embarrassment of wealth (which might have introduced a whole new set of risks). Suffice to say that I would recommend emulation of this strategy to my grand children (with whom I’m always available to discuss details, of which there are many).

I should acknowledge here that some could make a well reasoned argument that investing for growth presents better opportunity than the dividend-growth, value, scenario I’ve outlined. ‘Growth’ infers an investing style that depends principally upon stock-price appreciation and minimally upon dividends. Reflecting on my guidelines above you should see that while I give dividends priority the discipline of ‘margin of safety’ creates a satisfactory growth bias as well. In the end, I’d consider the distinction between growth investing and dividend investing to be primarily one of how you choose to move the needle between these two poles. With my conservative nature I find that a steady and increasing flow of dividend cash into my bank account is a comforting offset to the entertainment value of a manic/depressive market.

The following references are a valuable part of my resource set:

  1. The Intelligent Investor: The Definitive Book on Value Investing. A Book of Practical Counsel (Revised Edition) by Benjamin Graham
  2. Stocks for the Long Run: The Definitive Guide to Financial Market Returns & Long Term Investment Strategies, 4th Edition
    by Jeremy Siegel
  3. Active Value Investing, by Vitaliy Katsenelson
  4. F Wall Street, by Joe Ponzio
  5. Value Line Investment Survey, this is a fairly expensive subscription service but I can access its content via internet through my library (the cost to me being the library card)
  6. I have found to be a consistent source of useful insights via contributions of a large number of seasoned financial professionals.

Author’s mini-bio and attending thoughts:

Perhaps sharing something of my personal history will help you make connection with the content of my posting(s). So in the spirit of encouragement I give you the following.

I was born 16 months before the Pearl Harbor attack precipitated our country into World War II. Our family was not ‘well off’, but on the other hand we were not destitute. Our family lived paycheck to paycheck, as did most of America in that era. Financial sophistication and the habits of attaining and managing affluence were beyond my family experience. There were examples of limited affluence in the extended family and in the community around us that struck me as worthy of emulation. The specifics of how to best manage my financial affairs for a properly resourced future was left to me to personally discover. An important counter factor early on was, however, that I was encouraged in the direction of a college education (engineering). A college degree was an unchallenged expectation set by my family. For my generation college, was considered an absolute requisite to making your way ‘successfully’ in the world.

As it happened, I met a girl. As things often worked out in those days, we decided that college could be done just as well married as not. Neither of our families had any money to spare to even partially bankroll our further education, so we set out to make the way on our own. So, that’s the way it happened and we’ve been happily married now for 54 years. I would have to say that I was extremely fortunate in my choice of bride because the path we chose was quite the ‘hardscrabble’ budget experience early on. Along the way we have raised a family that we are glad for, experienced a reasonably gratifying career, and learned important lessons for managing our money. I retired early from Hewlett-Packard Co. in 2000, by which time we had made sufficient financial progress to support the retirement life style that worked for us. Over the years we have come to appreciate some key concepts:

  • The benefits and satisfactions of a lifestyle of living below your means and saving for the future.
  • The wealth erosion cost of debt.
  • The wealth erosion reality of inflation.
  • The hidden cost of financial opportunity lost in the acquisition of nonessentials (we’ve learned that big toys cost much more than the sticker price).
  • The wealth compounding consequence of enlightened saving.
  • We’ve come to define ‘financial independence’ as the absence of ‘financial dependence’. We see it as having adequate resources to do what needs to be done, without a requirement of gainful employment or the charity of others. We do not confuse financial independence with undisciplined spending. I concede that one person’s ‘necessity’ is another’s ‘indulgence’ and that definitions here become personal preference.
  • ‘Wealth’ is an illusion since regardless of the amount of discretionary money at your disposal you are only financially independent to the extent that you can manage it in a way beneficial to sustaining a healthy, godly, life in perpetuity.

Most of what I’m able to share in this blog is a reflection of our personal journey from financial naiveté from those early years to a somewhat better informed present. Most of all, I hope what I share will help others find the vision for a sustainable path to a healthy financial independence. I’m convinced that this is the path I’d want to be on regardless of the starting point (whether privileged or austere). More specifics to come in the future perhaps.

Read about DIY investment to help with the goal of financial independence here.