I have been long struggling to set targets that feel challenging but still achievable for my investments. When I first started 2012, I just tried to put extra money to work and get some decent returns instead of just laying the money to standard bank account with low interest rates. Shortly after I started this blog which was absolutely one of the best decisions related to my investments. Writing down ideas, goals and targets helped me to find out what I am looking for and expecting from investments. Right around the time my son was born I felt an urge for safety and thus somewhat added focus to risk management. This feeling has not gone away especially in this geopolitical situation, we have war in Europe, and I still feel that I am missing some important aspects from my goals and targets.
In this text, I try to justify to myself the adequacy of my plans in relation to the goals and targets for investing.
Status quo
Currently, my goal is to get 400 euros per month in net income or cash flow in year 2025. I am targeting to reach this with my rent apartment (net cash flow about 200€/month) and with my dividend growth portfolio (net dividends about 200€/month). I call these assets as Freedom Apartment and Freedom Fund.
For long I have been working with projects which are always somewhat uncertain and there is increased risk for unemployment from standard engineering jobs. If the project I am currently working on is decided to be cancelled for example due to geopolitical reasons, it may be such that my employer does not find another one and ends up laying me off. In a way, this would be quite a disaster because I would say that my expertise is really focused. So it would not be easy to find another job, at least one paying as well as the current one. Thus, I have been preparing for this by saving and investing.
Due to war in Ukraine, which is very sad and shocking, the above-mentioned risk for unemployment is more real than ever. Urge for safety is also more real than ever. Moreover, there is uncertainty on inflation, interest rates and low demand on single room apartments in Helsinki area. Partly due to pandemic and the massive relief measures taken by central banks. Also the law environment is about to change. All in all, my current investments are subject to many different risks that I feel are elevated now. Mainly these are affecting to my rent apartment which is mostly funded with debt.
Plans for Freedom Apartment
As brought forth above, there are several risk related to the Freedom Apartment. Main problem with these risks are that I have no control over them:
- I cannot control the interest rates,
- I cannot control demand and supply for single room rent apartments,
- I cannot control laws related to capital taxes and allowed deductions,
- I have very limited control over maintenance charges.
However, there are some countermeasures to control these.
Apartment is partly funded with my personal loan and with debt of the condominium. I can change to fixed rate on my personal loan and through the board of condominium I could propose to do the same with debt of the condominium. However, I assume this would require approval by the general meeting of the participants of the housing cooperative. Also, there is the option to sell the apartment. All these should be done now before the expectations for future interest rates are increased.
For the demand and supply, the only thing I can effect is to set rent price to be desirable i.e., cheap. Also, I can offer something unique, like excellent land lord services and communication or furnishing by taking into account needs of a tenant. This is actually something I already had to do when finding reliable tenant few months back. If the demand is low for renting, option to sell the apartment is also valid here at least if the buy demand is higher.
There has been discussion by Finnish politics that they would like to change the allowed deductions in relation to real estates. Currently, the interest and principal payment for debt of the condominium (funding charge) can be fully deducted from the rent income when the taxable income is calculated. Currently, this can be done if funding charges are recognised as revenue by the condominium. If the deduction would not be anymore allowed, this would increase tax payments, like a lot. Effect of this change could be minimised by paying down the principle in full and take personal loan instead. However, in this case only the interest would be deductible and tax payments would still be increased but not that much. Once again, option to sell the apartment is valid to get this risk out of the way. If one is buying the apartment for a home to live in, one would not be effected by this. However, I suppose there would be increased supply of apartments and once again this would be required to be done before the legislation is changed.
Through the board of the condominium, I have some control over the maintenance charges. However, significant part of the charges consist of electricity, waste treatment and rates of estate manager. So maintenance charges will most likely go up inline with inflation and energy prices. I don't see this as a big thing but is it easier to sell apartment when buyer can see low maintenance charge.
Current rent income is following:
- Rent 640 €
- Maintenance charge 100 €
- Funding charge 270 €
- Personal loan interest 20 €
- Personal loan principal 178 €
- Taxable income 250 €
- Tax (30%) 75 €
- Net cash flow -3 €
- Net rent income 411 €
For now, I have rented the place out with fixed term contract until summer 2023. I feel that I have found reliable tenant and I am quite confident that none of the aforementioned risks related to rent apartment could be realised during the following dozen of months. Thus, summer of 2023 could be optimal time to sell the apartment.
If I would sell the apartment for example in august 2023, the numbers could look like this:
- Selling price 150 000 € - 166 000 €,
- Personal loan 40 400 €,
- Condominium debt 47 300 €,
- Expenses for selling (decoration, broker fees, etc.) 5000 €,
- Net proceedings 57 300 € - 73 300€.
If I would sell, then I would have a new problem. How to invest the net proceedings to support my goal?
Plans for Freedom Fund
This is the one I feel is going to solve all the problems and provide adequate risk management by generating "passive" dividend income from diverse sources.
First lets go through the current status of the Freedom Fund. Current portfolio value is about 116 000 € out of which about 3 000 € is in cash. Forward dividend yield is about 2,5 % which mean about 180 € net dividend income per month. About 80 % is nominated in U.S dollars and about 60% is invested to companies with consequent dividend increase history of more than 10 years. Overall, I expect that portfolios dividend income will increase about 6,5% annually. This would translate to ~210 € net dividend income per month in year 2025.
Of course this will not happen certainly and there are some risks to consider. I feel that these are much more manageable than the ones effecting the Freedom Apartment. However, these are also much more probable to occur, I would say. First of all, companies can decide to cut down the dividend fully or partially. Also, they can choose not to increase it at all or just with very limited increments. Just to give few examples from the Freedom Fund, Disney suspended the dividend fully, Strategic Education has not continued to increase it and 3M has managed to increase it only 1% per year or so.
For all these cases, one has to remember that there are about 10 000 publicly traded companies so this can be managed by selling the dividend cutter and buying something else to replace it. However, even now I have about 10% of my portfolio invested to companies which don't pay dividends. So there is already possibility to do the trades if I would like to maximise the yielding positions. All in all, the most important aspect here is that there are means to limit and effect to these risks by myself.
Current position which don't pay dividends:
- Booking Holdings 4000€,
- Disney 3700€,
- O'Reilly Automotive 3700€.
If I would re-invest these with yield-on-price 2,5%, I would receive additional 18€ net dividends per month. I leave this idea brewing because I think these belong to the top operators of their industries. It is never only the dividends but also the quality. I would like to prevent trade offs and have both i.e., dividend and quality if possible. I am lucky, that most of the times these two go hand-in-hand :)
I have made a follow-up list which includes about 50 companies and their discounted cash flow and dividend valuation models. Most of the times, there is only limited number of undervalued companies. Thus, there is basically a risk related to re-investments with adequate pricing. In case I would liquidate my Freedom Apartment, I have been thinking to put money to ETFs if individual stocks cannot be purchased with decent pricing. When pricing is once again decent in my follow-up list, I would transfer funds from the ETF position to individual stock. At least with this kind of solution, capital would be exposed to market returns and not be just swiped away by (currently increasing) inflation. Other option would be also to find new stock picks to follow which would allow more possibilities to find adequately priced investments.
When going back to the beginning of this chapter i.e., to the target which is to generate passive NET income from dividends, one cannot forget the taxes. Normally in Finland, 85% of the dividends are taxed at 30% capital tax giving effective tax rate of 25,5%. When receiving dividends from U.S. there is 15% tax going to U.S. and Finland taxes the remaining 10,5%. This is based on tax treaty to limit double taxation. In some case however, tax treaty is not followed because of asset manager, custodian or sub-custodian. For example, Finland and Ireland have tax treaty: dividends shall be taxed at 0% in origin country. In this case, Finland as receiving country is taking the full 25,5%. However, due to above-mentioned reasons my Irish Medtronic dividends are taxed at 20% or at 25% (depending on custodian) which is not in-line with the tax treaty. So the overall tax rate on Irish dividends is 45,5% -50,5% which is way too much in my opinion. To limit excess taxes, one could recover the taxes from Ireland but I think it is too much of a hassle for limited gain. Same with Denmark and Novo Nordisk and even there is clear guidelines for recoving, there is no guarantee those can be collected back. Thus, I am planning to focus purely on U.S. based companies and also use approach above and go with ETFs instead if there is nothing to replace with.
Currently I have only two position with excess taxes: Medtronic and Novo Nordisk. Average dividend tax for these are 48,5% and 37,5% with the yields-on-price (YOP) at 2,37% and 1,41%. My plan is to exit fully from my Medtronic position and hold but not to add to Novo Nordisk position to limit excess taxes. Novo Nordisk is just too wonderful business to sell. And to be honest, excess tax accounts for only about 13€ per year currently.
The biggest hurdle I see is definitely investing the proceedings from the Freedom Apartment if I end up selling it. What should I target for compared to keeping the Freedom Apartment?
Let's assume that I would pay down my personal loan just like I would be investing in stock (no leverage personally, but companies I invest have it). This would mean from net cash flow point-of-view as follows:
- Rent 640 €
- Maintenance charge 100 €
- Funding charge 270 €
- Taxable income 270 €
- Tax (30%) 81 €
- Net cash flow 189 €
Basically, by replacing this Freedom Apartment with stocks, I need to target at least 190€ net dividend income per month. What would it then mean from dividend yield? Let's see.
Assuming net proceedings between 57 300 € - 73 300 and 25,5% dividend tax, pre-tax dividend should be at least 255€ per month and 3060€ annually. Depending on the proceedings, YOP should be between 4,17% - 5,34% in order to receive same amount of passive net income. This is basically double compared to my portfolios current YOP.
Where can I find yields like this?
Oh, wait, just recently (only in Finnish) I covered several REITs as potential investment candidates. Average yield of O, NNN, WPC, STOR and STAG is about 4,7%. That fits just in the middle and looks promising. If ESS is also accounted for from the top 6 triple nets, that would bring down the average YOP to 4,3%, give or take.
In addition, there are still the 10 000 stocks to choose from. I can also go with Nordic companies which does not have possibilities to invest as much for growth and prefer dividends over buybacks, thus providing quite high yields. But then again, I prefer quality and diversification. Nevertheless, I feel I have several ways to play this and most importantly, it's me who is doing the decisions and really effect to the outcome.
Other topic to consider is that I receive the proceedings instantly and depending on the market pricing, re-allocation of capital could be timely diversified. Other option would be putting everything in ETFs while waiting decent prices of the individual companies I would like to own, just like above.
Well, I guess we will see what happens. At least I feel comfortable with the plans and possibilities it provides.
Plans for sudden unemployment
First things to do would be to cut back on expenses and apply for new jobs. I have already updated my curriculum vitae and identified interesting companies to work for, partly which I have contacts which I could use like under the table job application. Actually, there are also other things I have already started and will continue to execute in order to prepare myself for sudden unemployment.
Cash is king they say. Well, exactly that.
I have started several activities to ensure adequate liquidity. I am saving cash from wages and planning on tendering current expenses and to apply for "payment holiday" for my personal loan related to Freedom Apartment.
I am saving all the excess I get but I am not really focused on this. I take full responsibility to support my family on all the needs we have. Currently, rate of savings is something above 500 € per month. I most likely will tender the standard set of expenses which can be easily tendered in Finland i.e., insurance, internet connection and interest margin on loan. We have been looking also cheaper apartment to rent for our home with poor success. Pandemic has increased demand for bigger apartments which we also need as a family. But there is no reason to stop the search but instead maybe we should figure out some new ways to find it.
In addition to tendering, in case of sudden unemployment it would be wise to really cut back expenses. There are several ways to do this but it is important to apply here the old proverb: Small streams end up to a big river. One can cancel monthly subscriptions, put car on seasonal insurance and avoid (excess) driving, instead of restaurants make more food at home and avoid buying alcohol, candy, sweets, sodas or any other discretionary groceries.
Also I know there is possibility to apply payment holiday for like 2 years during which there is no need to make payments towards principle but only interest fees. This will provide about 180€ per month flexibility if approved (but will cost once 100 € which can be paid from bank bonuses).
Conclusion
Writing down ideas, goals and targets has helped me to find out what I could be looking for and expect from my investments. I try to continue that because thinking is not easy. It's really not and writing really helps. This time I wanted to try it out in English which I have tried to continually improve.
To conclude, I am preparing for the worst and hoping for the best. Basically I am saving all the excess to ensure flexibility and financial security for my family. I have plans for the Freedom Apartment and for the Freedom Fund. By selling my Freedom Apartment, I get rid of most of the risks which are not in my control. At the same time I can switch fully to dividend growth investing following K.I.S.S. principle.
I am really looking forward what does the future has for us even though I am quite happy with the current situation. Nevertheless, I want to keep improving and take full responsibility of my actions. I would like to finalize this self-critic rant with a quote from Jordan Petersson:
Pick something up and carry it, make it heavy enough so that you can think, ‘Useless as I am at least I could move that from there to there'