I am not going to argue that motor vehicle transportation isn’t convenient, or even necessary in some circumstances, but it certainly is a bad investment in most cases. As a site that focuses on cash flow, unless you have tens of thousands in credit card debt, having a car payment is quite possibly the worst debt you could have.

Let’s Examine Vehicle Ownership

A car loan is typically amortized over anywhere between 4-6 years. So, for half a decade you are paying off a car that also costs you money in fuel and maintenance. Even if you have a warranty, you still need to replace the tires, filters, fluids etc.

From a cash flow perspective, depending on where you live, it is quite feasible that a vehicle loan plus the additional costs of ownership could eat as much of your monthly cash flow as a mortgage payment would. Yes, there are the associated costs of home ownership as well, but with a home you are making payments on what is (in the vast majority of cases) a long term appreciating asset that will also have utility long after your precious car has driven it’s final mile.

My household does use two vehicles, both 10 year old Hondas, that are owned outright. I do commute to work from the suburbs, so I am not as hardcore as some others, like Mr. Money Mustache, who bike almost everywhere. However, I do own a functioning bicycle and view it as an excellent means of transportation when the weather allows. I digress.

If you do need, or want, a vehicle I highly suggest buying a safe, reliable used vehicle for cash and driving it for as long as possible. Limiting your vehicle expense will allow you to focus your cashflow on gathering appreciating assets like real estate, dividend paying common stocks, and businesses. Don’t concern yourself with keeping up appearances with your vehicle. If it is -30 degrees outside and someone needs a ride, trust me, they aren’t going to care what kind of car you drive as long as they aren’t walking!

Plus, imagine how quickly your investment account will grow when you put the equivalent of a car payment on top of your regular savings each month.

This advice is especially true for new college graduates. Even though you’ve done a great thing by graduating college and landing that new job, please don’t go out and get yourself committed to six years worth of car payments on top of trying to pay back your student loans and save up for a down payment on a house… it just isn’t worth it in the long run.

Remember – you can have anything you want, you just can’t have everything you want!
(At least not right away)

Because I was paying just 2.5% on the mortgage proceeds, it was a very difficult decision to sell off some of my equity holdings and liquidate some of my savings to pay the mortgage out completely.

At the beginning of March 2012, I started selling off some stocks and finally paid out my mortgage on March 16, 2012.

Why Paying Off The Mortgage Was Right For Me

The one constant that we have in personal finance is that everyone’s situation is different. That is, in effect, what makes personal finance “personal” after all.

In my particular situation there were a few things that seemed to align, leading me to the conclusion that paying the mortgage off completely was the right thing to do.

1.) Variable Rate Mortgage

While I was paying just 2.5% on my mortgage, it was a variable rate mortgage (Prime – 0.50%). This means that the rate could change in the future, and at this point, rates really have nowhere to go but up!

That said, I had paid down the mortgage enough that even a sharp increase in the rate wouldn’t make or break my ability to service the debt. However, any increase interest rates would result in me sending more money to the bank – I think we can agree that sending more money out is not the ideal situation.

2.) Cash Flow Analysis

Cash flow is the ticket to play the game!

You may have heard me say that before, but it is absolutely true. Regardless of your balance sheet, if you are not generating enough cash to service your expenses (liabilities) then you are drowning.

In this case, it wasn’t that I was not able to service my expenses, but the fact that the amount owing on my mortgage balance required more in cash out-flow each month than the corresponding savings/investments were producing. Put another way, my monthly mortgage payment was higher than my average monthly income stream from my savings and equity holdings.

3.) Emergency Fund

As you know, it is very important to have an Emergency fund. Many financial gurus suggest 3-6 months of living expenses.  I am more conservative than that and preferred to wait until I had an emergency fund of 12 months of living expenses.

What is important to note is that my mortgage payment was my largest monthly expense. Once I had amassed enough to pay off the mortgage and still have 12 months of living expenses covered (not including the mortgage payment, obviously) I felt I would have enough liquid cash available for emergencies to pay the mortgage off completely.

4.) Stock Market Rally

Over the course of the previous several months, the stock market had been rallying without any signs of retraction. Many of my holdings had been reaching 52 week highs or all-time highs and the metrics did not seem to justify that kind of steep advance in price.  In addition, any rally of several months without a pause or retraction is generally unsustainable.

Note: I am far from a successful technical analyst or market trader, but the length of the rally and the fact that I was finding it hard to justifying adding to existing positions or entering in to new ones, led me to believe that the market may be over extended and it might be a good time to cash out and pay off the mortgage.

As you can see, it wasn’t just one factor, but a number of factors that came together at the same time that led me to believe that paying off my mortgage was the right decision.

It should also be noted that none of the equities or savings that I liquidated to pay off the mortgage came from retirement accounts or my retirement pension/employee savings accounts.  It is of the utmost importance that those accounts stay in tact.

As with all decisions related to personal finance, everyone’s situation is unique. This post is not advice for you to pay off your mortgage, or follow the same path that I took. The above set of circumstances just happened to come together for me  and led me to the decision to pay off my mortgage.

If there is enough interest, I will provide a follow up post with the dates, prices and names of the stocks that were sold to pay off my mortgage.

If you have paid off your mortgage, or are planning to in the near future, I would love to hear your story in the comments!

Cheers!

In bear markets there are great buying opportunities for dividend growth stocks that are offering yields above their historical averages.  Opportunities to buy great dividend growth stocks at above average yields is a great way to finance your retirement and increase the compounding effect of your future income from these stocks.

Here are the 3 most essential reasons that I prefer dividend investing: 

1.) Dividends offer investors fantastic flexibility.

Dividends give you tremendous financial flexibility throughout your investing life. While you’ve got an income from working, you can reinvest those payments to speed the process of compounding your wealth. Once you’ve decided to retire, the cash thrown off by dividends spends just as well as any other source of money!

What is even better, a rising dividend payment can help you fight inflation by providing you more cash every single year.

2.) You can’t fake money in your pocket. 

Dividends also have the added bonus of being exceptionally difficult for companies to fake. After all, it’s difficult to convince lenders to loan money to a company if that company is going to turn around and hand it over to its shareholders.

As a result, to sustainably make and increase those dividends, the business needs to generate serious cash on both a regular and repeatable basis.

3.) Dividends are paid from the company’s cash flow. 

Perhaps most important, a company’s dividend payment comes from its operational success and not from the panic, hype, or analyst interpretations that influence its stock price. Throughout these rocky market periods, dividend payments allow us to make money even when the stock price moves lower.

Why Invest In Dividend Paying Stocks?

• Quicker compounding.
• Increased financial flexibility.
• Cash in your pocket without selling.
• A hedge against inflation.
• An check on the company’s accounting.
• Cash Flow in a down market.

With all of the benefits of dividends, it’s obvious why they can be an integral component of one’s portfolio.

Did I miss any benefits of dividends?  If so, let me know in the comments! 

A Variable Dividend

Progressive introduced the idea of a once-per-year variable dividend that will be based solely on the performance of the company.  This type of dividend will award shareholders for their belief in the company and appears to actually treat shareholders like owners by offering up a piece of the profits in good years and leaving them high and dry in bad years.

Here is what Progressive CEO Glenn Renwick has to say about the dividend policy that he championed:

“If the business has a good year, the owners should share in the profit, and if the business has a bad year, why should the owners get anything?”

An excellent observation–one that’s so obvious, it makes one wonder why everyone’s not thinking that way.

My contention is that investors, including myself, are fickle.  As investors we really have no control over the operations of the company and when our cash flow (dividend) is not paid, the only recourse that a dividend investor has is to sell the stock.

Conversely, when there is a big dividend to be had, I would want as many shares as possible.  One may think that this will lead to erratic cycles in the stock price of Progressive as “yield hunters” trade the stock over the course of time.

How The Variable Dividend Works?

Progressive’s board has opted to pay a variable dividend based on the firm’s after-tax underwriting profit. That means the premiums Progressive takes in, less claims paid out and expenses of running the business. Shareholders will get 40 percent of those profits in a great year, 20 percent in an average year, zero in a bad year.

So, what consitutes a Great Year, Average Year, and Bad Year?

It’s not entirely carved in stone , but It helps, of course, that Progressive is solidly profitable and generates far more capital from its operations than it can profitably deploy in its business. But should things turn bad, which has happened to many once fine companies, Progressive won’t be stuck trying to defend an unaffordable cash dividend that shareholders have come to expect. In these volatile days, locking yourself into a significant fixed dividend can be a bad idea.

Could This Dividend Policy Work For Other Companies?

If other companies could stomach what seems to be the inevitable swings in stock price, then this policy may work for them because they would pay out what dividend they could afford and no more.

While this would produce stronger companies in that sense, investors who are seeking regular income (who, as our population ages are more and more), may steer clear from companies offering an unpredictable payout.  This lack of investor confidence could ultimately result in a lack of capitalization that would ultimately harm the operations of the organization.

Because the strength of a company and the performance of management is ultimately gaged on the price of the company’s stock, this dividend policy seems risky for those managers, investors and companies that are more conservative.

I guess we will have to wait a couple of years to see how this policy plays out for Progressive.  While it seems very good in theory, it certainly bucks the trend of traditional dividend theory.

First, let’s talk about why we like stock buybacks.

Advantages to the Investor

1. Buying back stock means that the company earnings are now split among fewer shares, meaning higher earnings per share (EPS). Theoretically, higher earnings per share should command a higher stock price which is great!
2. Buying back stock uses up excess cash. The returns on excess cash in money market accounts can drag down overall company performance. Cash rich companies are also very attractive takeover targets. Buying back stock allows the company to earn a better return on excess cash and keep itself from becoming a takeover target.
3. Buying back stock allows a company to pass on extra cash to shareholders without raising the dividend. If the cash is temporary in nature it may prove more beneficial to pass on value to shareholders through buybacks rather than raising the dividend.
4. Buying back stock can increase the return on equity (ROE). This effect is greater the more undervalued the shares are when they are repurchased. If shares are undervalued, this may be the most profitable course of action for the company.
5. When a company purchases its own stock it is essentially telling the market that they think that the company’s stock is undervalued. This can have a psychological effect on the market.
6. Stock buybacks also raise the demand for the stock on the open market. This point is rather self explanatory as the company is competing against other investors to purchase shares of its own stock.

What Management Doesn’t Want You To Know!

There are several reasons why management would prefer to buy back stock rather than raise the dividend.

The first reason is that upper management typically will receive compensation that is tied to the company stock price. What this means is that they typically make more money when the stock price goes up. This compensation may come in the form of stock options, rights or other forms.

In the short term management believes that dividends may work against the stock price of a company by reducing the book value of the stock. In addition, if managers have stock options, they do not immediately benefit from dividends as their options do not qualify for dividend payments.

On the other hand, when a stock buyback occurs the short term implications on the stock price are typically positive (due to the previous listed reasons). And, since this allows management to see the most immediate results to their compensation, it is no wonder that managers prefer stock buybacks as opposed to dividend increases.

What to Watch For

As an average investor, it is beneficial to us to look for companies that have both the cash-flow to buy back shares as well as regularly increase their dividends. One specific thing to look for is the dividend payout ratio.  Companies that have a lower dividend payout ratio, say below 60% of earnings, will have more money to invest back into the company and grow the stock price.  These can be some of the best long term investments because the company finds multiple ways to increase shareholder value.