Derek Foster Interview – Part 2

Derek Foster

Part-2

Continued from Part-1. If you haven’t already, be sure to read the fist half of the interview…

Derek Foster needs no introduction! He quit the rat race at 34 and became a millionaire using simple investment strategies.  He shared his unique approach in his five National Bestselling Books, including STOP WORKING: Here’s How You Can, and The Idiot Millionaire.

Derek also offers regular financial tips in Canadian MoneySaver Magazine and he has been featured in various media across Canada. Love him or leave him, Derek Foster is an inspiration to many investors using a dividend focused strategy to fund their (hopefully early) retirement.

Dividend Ninja:
Derek in the previous half of the interview, I asked you about index investing. Don’t you think with a 100% dividend portfolio, which is really a 100% equity portfolio, you’re taking risk with that?

Derek:
No, it depends on how you define risk. Volatility risk, absolutely!  Sure if I’m going to look at my statements every day, this is up and that is down, then yes in that sense there is a degree of risk.  But in my opinion, the biggest risk an investor faces longer term is inflation. And bonds just don’t protect you from that either, especially now with yields being as low as they are going to go.  I would rather be a 100% in equities without a doubt, and good quality equities at that.

And there are reams of empirical data. I mean I understand the whole asset allocation model, but look at all the data – stocks have outperformed over the long term. And I think good quality stocks outperform even more.

Dividend Ninja:
And 2008 and 2009 was certainly an exceptional time period for any investor, no matter what you invested in. Bonds did save my hide in 2009. The 4% or 5% return I was making was not huge, but it certainly gave me a cushion.

Derek:
Yah I absolutely agree with you. But let’s address that for a minute, because I think that’s a really good point. A lot of people who said they were in bonds at that time did outperform, and that’s absolutely true. I just don’t think you can take a snapshot of 6 months, or a one year period, and say that proves the theory. If you look at it over the last decade, or the last twenty years, or the 20th century – stocks have still done better.

Dividend Ninja:
Derek, I know a lot of dividend investors don’t worry about falling share prices in market downturns, mainly because they will still earn their dividend income. However in the 2008 and 2009 financial crisis it didn’t work out that way for U.S. investors.

Many U.S. companies cut their dividends while their share prices collapsed. Take GE, Pfizer, and the U.S. Banks for example, all of which slashed their dividends (after raising them for years). Granted 2008 and 2009 was an exceptional time period. But if you are relying on dividend income from your stocks, then dividend cuts can really impact your bottom line. We were lucky in Canada, but that might not always be the case. Your thoughts?

Derek:
Yes, you’re absolutely right. That’s one of the bigger lessons I learned from the financial crisis. I’m now a little more hesitant on financial companies than I was before the crash. But essentially I’m more hesitant on these financial companies, because they do use this incredible amount of leverage. With the exception of Pfizer which fell off the patent cliff, if you trace GE back the trouble they ran into was their financial arm. Even the Canadian banks use leverage and the U.S. Banks of course.

In my own personal situation, I do have other sources of income. So if I was 100% reliant on dividend income portfolio, I’m not sure, but I’d still probably be 100% in dividend stocks. I think if you ignore the banks with their leverage, the chances of a Coca-Cola cutting its dividend, or a JNJ, or a Colgate or whatever is much lower, as all of them actually raised their dividends in 2008-2009.

I highlighted financial company risks (and also risks to companies which rely on patents) on pages 35-38 of my most recent book, The Idiot Millionaire.  The examples you give are either financial companies or in the case of Pfizer (they fell off a patent cliff). During the same time, many excellent companies actually increased their dividends.

Dividend Ninja:
Derek, for me the Dividend Payout Ratio is one of my most important key criteria for a stock. What ratio or screening criteria do you think are the most important for dividend investors to consider?

Derek:
First of all I look for high quality stocks that have a competitive advantage, or an economic moat. So my first screen:  Is this a quality company that is recession proof? Is it a product that people have brand loyalty to? Is it a product where somebody can’t come in and take away their business?

After that screen is cleared I’m then looking at the dividend history. Have the dividends gone up regularly? Have the earnings gone up regularly? To me that is an absolute key, that consistent increase.

From there, is it trading somewhat historically cheaply? You’re not going to get these super quality companies at super-cheap, but I mean reasonably cheap.

Dividend Ninja:
Derek, back in February 2009 as almost everyone knows you sold all your stocks. I know you mentioned you were implementing a put-option strategy to pick up the stocks back at a lower price. Many writers and investors felt that you simply sold in a panic. I know you received an enormous amount of flack for that. Can you comment on that?

Derek:
I sold partly because I wanted to buy back more cheaply via put options, then the markets soared faster than anyone expected. The interesting thing is that I was able to buy back many stocks at prices cheaper than I sold, in many cases due to currency swings with the Loonie soaring as well – but that was pure luck for me!

In hindsight, I made some mistakes. I’ve made lots of mistakes in the past, and I can guarantee that I will make more in the future. This is the reason I chose the title of “The Idiot Millionaire” in my latest book. The reality is that if you choose to invest, you will make mistakes at times. Even Warren Buffett, who’s 1000 times smarter than me, makes mistakes at times. But over time, if you stick to quality stocks and keep you r expenses low – the whole thing is rigged in you’re favour. So I admit I am a complete idiot at times, but I also have a new worth comfortably over $1 million. So investing has been pretty good to me!

Dividend Ninja:
Looking back on that whole experience, how do you think that changed your investment strategy?

Derek:
What I’ve realized and I alluded to it earlier, is its very hard to know what’s on the balance sheet of financial companies. You know this number of mortgages outstanding, and all rated Triple AAA, but how trustworthy is that? So I’m gravitating even more towards the certainty.

I mean I had some extra money to invest recently, and I noticed even Warren Buffet was backing up the truck on Wells Fargo. You know I looked at it, and I said I don’t want it. It’s kinda like the forest fire after there’s been a forest fire, pretty safe to bet there isn’t going to be another one. But I just don’t want to buy another black box. You know that’s the biggest lesson I learned.

Dividend Ninja:
You know I could have bought Manulife Financial for $12 last year, but for the same reasons you mentioned I just didn’t go there, even though it looked cheap.

So looking back on 2008 and 2009, what advice would you now give to investors if we have another market downturn?

Derek:
I think you have to go with the quality companies. I have become even more stringent on quality than I used to be. So barring the Earth colliding with the Moon or something, I mean people are still going to brush their teeth, drink Coca-Cola, or shop at Wal-Mart. So I think if you build the portfolio with those super high quality firms, it can whether the downturns reasonably well. In fact, if stock prices plummet, most of these companies are continually buying back their own shares. So it’s like a positive for them as well.

Dividend Ninja:
So Derek, more importantly, can we expect another book from you in the near future?

Derek:
I am working on one right now, but with Summer coming and we’re off camping for a month or so. Perhaps it will be completed this fall.

Dividend Ninja:
Good and prudent advice in the interviews Derek! Thanks so much for taking the time for this. It’s been a real pleasure on my part! :)

Derek:
Thanks for the interview – take care!

. . .

Continued from Part-1. If you haven’t already, be sure to read the fist half of the interview…


Derek Foster’s Books

Derek Foster is the author of five National Bestselling Books:

  • STOP WORKING:Here’s How You Can!
  • The Lazy Investor: Start with $50 and no Investment Knowledge
  • Money for Nothing: And You Stocks for FREE
  • STOP WORKING Too: You Still Can!
  • The Idiot Millionaire

buy now

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10 Responses to “Derek Foster Interview – Part 2”

  1. Dividend Mantra

    May 18. 2011

    Good stuff Ninja!

    I’m glad to hear that I’m not the only one a little shy around the financial stocks. He mentioned Buffett backing up the truck on Wells Fargo, and he also has a position with US Bancorp. I think both are cheap stocks, valuation-wise, but how do we really know? The valuations are according to what figures? It’s kind of smoke and mirrors with the financial companies. I may end up purchasing very small positions with some banks, but only with the caveat that I’ll know it’s all speculation.

    His point really hit home for me, stick with quality companies and you’ll get quality returns. I’m also glad to know that I’m not the only crazy one out there that’s a fan of 100% equities!

    Take care and thanks for the interviews Ninja and Derek!

    Reply to this comment
  2. Michel

    May 19. 2011

    What cdn companies does he like? Is his portfolio in the book?

    Reply to this comment
  3. Good part 2! I like the questions and answers.

    Derek, if you are reading, what ratio of invested capital do you have in your investment. For example, do you have 10 stocks with 10% each or do you have 20 stocks with 5%? Did you figure out some logic to it :)

    By the way, The Lazy Investor got me going with the full drip with computershare and CIBC mellon. Unfortunately, I found out when I was 35 … So I won’t be retired by 34. :)

    Cheers!

    Reply to this comment
  4. Derek Foster

    May 20. 2011

    Michel,

    In “The Idiot Millionaire” book, half the companies I listed are Canadian with the other half being American…

    Passive Income Earner

    My portfolio consists of around 20 stocks (amounting to 4-7% of my portfolio)…

    Cheers,
    Derek

    Reply to this comment
  5. Ed

    May 28. 2011

    Great interview. I am personally looking for about 40 stocks to be well diversified, that would put me at about 2.5% per company.

    I would also want to be earning about 10% above what I can comfortably live on. That would give me a good cushion if up to 4 companies at the same time dropped their dividend to zero, to still earn what I could comfortably live on.

    If more dropped further, then I could tighten the belt a little.

    Reply to this comment
  6. The Dividend Ninja

    May 28. 2011

    Ed,thanx for dropping by :)

    WOW 40 stocks, that would be great diversification! You would also want to make sure your diversified among sectors as well, but with that many holdings you should be by default. Global diversification as well?

    Yes everything is overpriced right now. Best to build up cash, collect dividends, and wait for a market correction – it will happen.

    Cheers
    The Dividend Ninja

    Reply to this comment
  7. jana

    Jun 12. 2011

    Derek is a guy, I wouldn’t take ANY advice from anymore. I bought his first two books and model (kind of) my portfolio after his. When the year 2008 came along, it was struggle for sure, but I stayed put, did not do any major changes and survived. He (Derek) sold his portfolio, just about when things started to turn up again. Ever since, I do my own thing and supplement my pension with dividend income. Don’t need Derek or anybody else, do my own research and read a lot.

    P.S. When I read your interview in G & M, and you mentioned buying George Weston shares for their special dividend, I smiled. Did the same, stupid thing, thought that I would get away with that, alas didn’t. Lost some money on that. Oh well, one of those life experiences, I guess.

    Reply to this comment
  8. The Dividend Ninja

    Jun 12. 2011

    Hey Jana,

    Thanks for dropping by :) I admire your fortitude in staying through the hard times in 2008 and 2009!

    Cheers

    Reply to this comment

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