Being just 5 years out from reaching Financial Independence (FI) I have started to fine tune everything as the acquisition phase of my investing journey is coming to an end. Losing the safety net of my steady weekly earned paycheck means I have to do more to avoid investing mistakes or unplanned events.
Recently I posted my my first fine tuning with target emergency funds I plan on having during FI as well as eliminating a rainy-day fund and instead amortizing replacement costs and adding that to my monthly budget. A quick summary of that is as follows:
- The Market Crash Emergency Fund – equal to 9 months of expenses
- The Healthcare Emergency Fund – equal to 3 months of nursing home care
- Additional $583 added to my monthly expenses – amortization of replacement costs for home, transportation, and appliances.
The final piece of fine tuning my plan revolves around achieving my income goal of passive income equal to 115% of my annual expenses while mitigating the risk of inflation, which for this exercise I will use the long term inflation average (since 1913) of 3.24%.
Jumping straight to the final solution, I determined the best mix to maximize income and reduce risk would be an allocation of 70% Dividend Growth Equities, 20% Real Estate (REITs), 5% Business Development Companies (BDCs) and 5% in Leveraged ETFs.
Fidelity Cash Management
The Fidelity Cash Management Account is one item I have not spoken about in the past. To consolidate my financial sources, I have chosen to use Fidelity as a replacement for my bank checking account as most of my investments are already with Fidelity and this just simplifies things.
The other aspect of the cash management account is the reference to 6 months of expenses. No this is not another emergency fund. The intent of this balance is to smooth out my dividend income into a steady monthly cash flow amount. As many investors are aware, dividend income is not the same month to month so again this is another simplification step.
Finally, achieving this is quite simple actually as 6 months before I hit my FI target I simply turn off all my DRIP and reinvestment activities and allow the dividends to pool.
Growth Rates & Inflation
Starting with my Dividend Growth bucket, my annual growth rate fluctuates between 4% to 5%. This came down quite a bit as I leaned heavily into buying utility stocks in 2020 when they were on sale. While this provided stability it came at a price of muting my growth rate.
The REIT bucket can vary wildly. Some years my REITs saw a 6% rise while other years its was less than 1%. For this analysis I will stay conservative assuming an annual growth rate of 1% on the low end to 2% on the upper end.
Regarding the BDCs bucket, this is an ebb & flow with dividend raises. Some years are 0% while others I have seen 5%. For this analysis I will stay conservative assuming an annual growth rate of 0%.
The Leveraged ETF bucket is a fairly new aspect to my portfolio and something I have been researching. Leveraged funds such as QYLD and JEPI have become quite popular as of late in the investing world due to their high yield and monthly payouts. Some seek the high yields while others look at total return, however, my take on them is slightly different. One factor I have noticed amongst these funds is their monthly payout varies immensely depending on the option activity so it is understandable. For my portfolio I prefer more consistency and predictability, as such I have narrowed my list down to just three funds that currently have the least variability in their monthly payouts:
- NUSI (Nationwide Risk Managed Income Fund) – The average monthly payout for NUSI is $0.17 per share. Its payout variation ranges from -10% to +10.59%. Of all the funds I reviewed NUSI by far had the most consistent month to month payout. The only downside to NUSI is in a slow declining market it increases the costs of theirs puts & calls strategy and I do have some concerns if they can stay consistent with their payouts.
- XYLD (Global X S&P 500 Covered Call ETF) – The average monthly payout for XYLD is $0.40 per share. Its payout variation ranges from -16.75% to +25.25%. XYLD surprised me being the runner-up to NUSI when it comes to a low variable payout, I thought its sister fund XRMI which uses a collar strategy to limit risk would have performed better but that varied from -23.5% to +26.5%.
- DIVO (Amplify CWP Enhanced Dividend Income ETF) – The average monthly payout for DIVO is $0.14 per share. Its payout variation ranges from -22.14% to +12.14% however the instances of negative months are dramatically lower than other funds. Of all the funds DIVO has the smallest dividend at just 4.82% however (this is the best part) it has annual dividend growth! Excluding a single long term capital gain event in 2019, DIVO has increased their dividend over the last 3 years at an average rate 6.28% and makes DIVO my favorite out of the three.
Because of DIVOs growth rate, my Leveraged ETF bucket will have a projected annual growth rate of 2% that I will use for both the low and high end.
Combining all the growth grates and adjusting for weighting, my overall portfolio will see growth on the low end of 3.45% and 4.4% on the upper end. Using the long term average annual inflation rate of 3.24% my portfolio will achieve a positive real growth rate.
|Low End CAGR||Upper End CAGR|
|LT Inflation Rate||-3.24%||-3.24%|
As you can see in the table above, a 0.21% real CAGR does not leave much left on the table but it is positive none the less. Considering the amount of money I will be investing over the next 5 years, this was the best combination I could use that would allow me to achieve FI. If I reduce the allocation to dividend growth stocks I would, in the short term, exceed my income need but after inflation is factored in I would have a negative CAGR and longer term that benefit would quickly erode.
Now my entire FI plan for next 5 years has been laid out, my only task left is working towards the final solutions. Of course no one is perfect, I have tried to account for as many scenarios as possible that could occur during my FI years but I may have missed something and I am always open to any input or a glaring omission I might have missed.