With the launch of the new income investing advisory, Total Income, one question that has come up is how much money you would need to invest to earn an income from my recommendations.
Further to this, some readers have also asked how many recommendations I’ll send out, so that they might have an idea how much to put into each one.
Those are good and important questions.
So let’s run through these to help clarify the situation…
How many recommendations?
The main aim of the service is to provide one useful and practical recommendation every month that is actionable. The last point is important because I want to avoid the situation where I provide analysis and advice that you can’t put into action.
One of the issues that arose when I wrote the special reports that Total Income subscribers receive as soon as they become a member was that some of the stocks I picked had rallied strongly (along with much of the overall market, I must add) over the time it took to do the research.
So we had the situation where some of the recommendations were trading above the price I was prepared to pay for them — the ‘buy-up-to’ price.
The reason for having a ‘buy-up-to’ limit is to avoid paying too much for a stock. As we’re investing for income, this is important. Because the more you pay for a stock, the lower the yield you’ll receive given its dividend. So we want to avoid chasing stocks.
That said, each month I will send subscribers a recommendation that can immediately be put in to action. Of course, that doesn’t mean you have to blindly follow every stock pick. After all, it’s your money you’re investing. You have to make sure the analysis seems reasonable to you.
I want to stress that. If a stock idea doesn’t fit in with your objectives, then please leave it. It won’t be long before I send you the next one.
How much do I need to invest?
This is the harder question.
In the promotional material, subscribers would have seen a lot of different numbers, but the biggest one was for $71,232. So the first question is obvious. Where did we get that number?
The example we used was the Commonwealth Bank [ASX:CBA]. What I wanted to do was highlight the effect of buying a stock and collecting the dividend over a period of time. In 2001 you could have bought CBA for around $25.
Let’s run through the numbers. In the example we buy 1,000 shares. That means our initial investment is $25,000. In the 14 years since, CBA has paid out $35.65 in dividends per share. So if you owned 1,000 shares, you would have received $35,650 in dividends over this time.
Note that the dividends received have surpassed the original price you paid for the stock. So in effect, the stock has paid for itself, and is still generating income.
Over the same time, the stock has risen from $25 to over $90 — a gain of $65,000 in capital if you’d bought 1,000 shares. We used a conservative stock price in the promotion, but if you added the dividends and capital gains together today, you’d be up close to a hundred thousand dollars before tax.
Compare that to a term deposit and see how you go.
And in this time, the GFC happened. The CBA shares that you could have bought for $25 back in 2001 got as high as $60 in late 2007 before falling back to $24 in early 2009 at the peak of the GFC. That means that the price has moved around a lot. But it also means you’ve had more than one chance to pick them up for a reasonable price.
So for this example, you would have needed to invest $25,000 to produce these types of returns. But you don’t have to invest that much. A $12,500 investment (500 shares) in CBA would have resulted in a $35,616 return. A $6,250 investment (250 shares) would have resulted in a $17,808 return.
That’s the beauty of investing in shares for income, you can invest almost any amount in order to start building long term gains.
Now, the next point I want to focus on is yield…
The next generation of high yielding companies
In the last twelve months, CBA has paid out $4.16 per share in (fully franked) dividends. At the current price of $94, that puts it on a yield of around 4.4%. After the run up in price it has had, I’d be a bit nervous about buying into them right now. Any hiccup has the potential to cause a decent sell-off.
But if you’d bought them for $25 and kept them, you’d now be enjoying a yield closer to 16.6% on your initial capital.
Yes, the example is historical, but it gives you the idea of what we’re aiming for. The aim of Total Income is to focus on finding the next generation of companies that have the potential to produce these types of returns.
Your job is to figure out how much you need to invest in order to achieve a certain level of income. The maths for this are simple. If your portfolio is yielding an average of 5%, it means that you’d need to invest a $100,000 to generate $5,000 in income.
Naturally, most people will need an income of more than $5,000 per year. So the longer you have to build up your capital, the better. However, I’ve also received queries from those that have retired and don’t believe that they can wait a long period to earn these types of accumulated returns.
That’s why I’m also hunting for companies that pay a high yield right now, and have the potential to keep growing this over time.
Take my first recommendation that came out on Tuesday, April 14. This company has paid out fully franked dividends regularly for 15 years and is currently trading on a yield of 6.9%. If you buy shares in it before Friday April 17th, you’ll be eligible for the next dividend to be paid out on April 30th.
An investment of $10,000 in this company would pay you around $690 per year (providing they maintain their dividend). Put this in a term deposit with Westpac for a year and you’d earn around $270.
That’s a big difference.
Most of the companies I recommend in Total Income will be a straight stock pick. Others might be a listed investment company (like a managed fund but listed on the ASX), where you can gain exposure to a broader section of the market.
These can be particularly useful in that they will give you exposure to a large number of shares without needing to buy each stock individually. This is especially helpful when you have limited funds to invest, but you want to diversify.
Of course, share investing comes with risks. And to repeat, the purpose of Total Income is simply to provide investors with investment ideas. Not every idea will suit you. It’s up to you to figure out if a specific recommendation fits in with your investing goals.
for The Daily Reckoning Australia