I recently got a call out of the blue from someone that I went to Washington & Lee with back in the day. We were good friends during our Freshman year, but we joined separate fraternities, and for whatever reason, we didn’t hang out a whole lot after that.
Anyway, his grandmother just passed away, and he found himself in the verge of clearing almost $32,000 in an inheritance once the estimates fees and whatnot are taken into account.
He decided he wanted to invest the money. That decision alone put him ahead of most 24 year-old men out there.
But, of course, it leads to another far more important question: Invest in what?
That’s what prompted his call to me to discuss possible opportunities. He has a job, but no specific retirement accounts. That prompted me to suggest the following: Create a five-year plan and scale that money into a Roth IRA over time (the current tax code allows for $5,500 annually provided you make at least that much). He could get $11,000 invested fairly quickly, by making a 2013 contribution anytime between now and April 15th, 2014, and he would be eligible to sock another $5,500 away coming this January 1st. That would get a third of his inheritance into productive assets quite within the next 45 days.
Ideally, each of those $5,500 investments would be split up into two pieces of $2,750 each, so that the inheritance could be split up into 11-12 productive businesses. My suggested plan would have him invested in blocks of Coca-Cola, Pepsi, Clorox, Chevron, Exxon, Nestle, Colgate-Palmolive, Disney, Visa, Procter & Gamble, Johnson & Johnson, and Kraft. You give those suckers three or so decades to grow, and you would have basically created your own little pension to take care of you.
Think of it like this: If you have $30,000 in a tax-free account with dividends reinvested, you can put yourself in the position to have 8.5% annual growth plus 1.5% returns coming from dividend reinvestment, so you could realistically compound your money at 10% annually over that time frame, due to the nature of high-quality cash generating businesses mixed with long periods of time and tax-favored holding structures. That $30,000 could realistically turn into $979,000 by the time he is 65 (assuming 10% annual returns for a thirty-five year stretch).
Although that was my suggestion, he decided he didn’t want to wait until he was 65 to enjoy the money (fair enough), and he didn’t want to practice such widespread diversification—he wanted “silver bullet” style investments that give money now.
Instead, based on his goals, he decided to put roughly $10,000 each into BP, Royal Dutch Shell, and Conoco Phillips, and take the dividends as cash to spend now. That’s not a stupid way to behave.
In terms of current income, he gets $495 in immediate income from BP (and that amount should go up I most years).
From Royal Dutch Shell, he should get a little over $500 in immediate income.
And in the case of Conoco, he should get $378 in immediate income.
Tax-rate wise, he’ll have to pay 15% annually. So, on that $1,373 in dividend income, he’ll get to keep $1,167. Once a month on average (namely, twelve times per year), he will see “Santa Claus” come and drop off $97 in his checking account. I don’t know what he drives, but that is roughly what I spend on gas per month. This inheritance basically got him free gas for the rest of his life, should he treat the money that way. Or, he could treat the dividend income as a rent subsidy that will effectively pay for 2-3 months of his rent each year. That’s not a bad place to be.
And the best part is that he is doing something that is not exhaustive. Normally, I write about income investing in a delayed gratification sense—you’re socking away money today for something in the future. But money is only useful if you take the money and do something useful with it. That sounds like a tautology, and maybe it is—but money is useless if you just pile it up and scrooge it away until you die. But an extra ~$1,200 or so in the pockets of a 24 year-old is great, and the cool thing is that those companies will likely grow their dividends at a rate greater than 4% over the long term, so he will actually be growing richer as he spends money.
Is this how I would do it? No. But that doesn’t mean it’s not a great decision. For the rest of his life, he stands a good chance of seeing money deposited into his account month. He gets to spend that. He gets to see the money grow each. He will get to spend that. And, the best thing is that, the price of the shares should continue to increase over the coming decades, so he could likely sell the Conoco, BP, and Shell stock for a good chunk of change a couple decades from now, if he should so decide. In fact, even though he is spending the money now—it could still theoretically act as a retirement, using his grandmother’s gift to give him spending money in his 20s, 30s, 40s, 50s, 60s, and beyond. That’s a gift that keeps on giving.