I am super happy to welcome back Lars Kroijer for another investing Q&A. This is a collaboration between Monevator and Lars’ own YouTube channel.

All the questions below come from Monevator readers. As before, Lars’ answers in both video and edited transcripts.

Note: embedded videos are not always displayed by email browsers. If you’re a Monevator email subscriber and you can’t see three videos below, please head to our website to view this Q&A with Lars Kroijer.

What’s the case against dividend stocks?

We start this time with a question from Ray. He is in the de-accumulation phase, but he’s still looking for a return on his investments.

Ray notes that Lars tends to recommend global equity market trackers. However, Ray continues, “this year, the ACWI – the All Country World Index – is only paying a 1.7% dividend, whereas my dividend-focused ETFs seem to be doing better than that. So is my strategy wrong?”

Lars replies:

So here we’re in the world of equities. I have explained elsewhere why most people should not have just equities in their portfolio. It is typically far too risky. Please see my other work for more on that.

It’s also worth noting that I argue you can’t outperform the markets. You should simply buy equities in proportion to their market value and diversify across the total world market as much as you possibly can, and as cheaply as you can. We do that is because we don’t think we can allocate value between equities in a superior way to the market. We accept that we cannot beat the market.

On to this question about dividends.

The first thing to ask: is there any reason to think that dividend paying stocks overall will outperform non-dividend paying stocks? And the answer to that is, no – unless you think you can beat the markets.

With dividend-paying stocks, you get a change in the share price – capital appreciation – plus the dividend. Whereas with non-dividend paying stocks, you just get that change in the share price.

Now I think what Ray is alluding to – and practically speaking, I can see an argument for – is automatically receiving dividends into your bank account. You need the cash, perhaps for your living expenses. If you have non-dividend paying stocks, you have to sell securities to realize your capital to get that cash. That can be a headache for some people.

I think the overriding issue is one of tax.

Suppose we have two groups of stocks. One pays a 5% annual dividend and the other does not pay a dividend.

Let us say the first group is flat for the year. But you received your 5% dividend, so your $100 became $100 plus $5 as a dividend.

With the second group you do not receive any dividend. However those shares went up by $5. So they are now worth $105.

This could be a similar group of stocks. It could even be index trackers with different payout policies, which may be what Ray is alluding to.

Anyway, with the second group, to obtain the cash you would have gotten from your dividends with the first group, you can sell 5% of your portfolio. You should – ignoring tax – be equally well-off.

For most people, in one case you would be paying a dividend tax and in the other a capital gains tax. That choice is what should drive your decision. It’s not that we think we can predict which group of stocks will do better. It’s more that your individual tax situation should drive it.

Also note some trackers pay out the dividends they receive from the underlying companies. Others reinvest it. Again, which type you own should depend on your current and expected future tax situation.

That should be the driver, not the dividend policies of the underlying businesses.

Beyond a global tracker for equities

Next up is ‘MBA’, who asks: “Does your case for using a global tracker fund mean one should not invest in a global smaller company tracker? At the moment, my split is 60% global all caps, 20% global smaller companies, and 20% emerging markets.”

Over to Lars:

Let me start by emphasizing that I believe you should really try – with the equity portion of your portfolio – to own equities in proportion to their market values.

Of course most people should not only own equities. There are other videos I’ve done on how you should think about your split between different asset classes. Equities-only would be too risky for most people.

Ideally, you should invest in equities according to their market value. You are essentially saying each dollar invested in equities is equally clever and well-informed. You don’t think you can do better by allocating the proportions of your stocks in a different way from what the market has already done.

You say this because you accept you cannot outperform the markets. You’re simply trying to capture the global equity risk premium. What this is is anyone’s guess! But historically, equities have outperformed the risk-free rate by about 4-5% above inflation.

I am saying you should invest in all equities to capture this premium.

But in reality, as MBA suggests, a lot of the indices do not really include small caps. Small caps may be too expensive or illiquid to trade. It’s therefore hard to represent them perfectly, all over the world. So very often they’re excluded – certainly in the larger indices.

Likewise, a lot of indices have a heavier weighting to the US market compared to its share of GDP, or to global equity values. There are various reasons for this. One is there is a disproportionate number of huge global companies quoted in the US. Think Google, Facebook, Apple, and so on. These are all large global firms, with a lot of business outside the US. The stocks are bought on the US market. But that does not mean you’re only exposed to the US economy with them.

In any case I don’t really have a problem as to what MBA suggests with people that say “I kind of want to correct this lack of exposure to small caps” or “I kind of want to get a little bit away from what some perceive as an overexposure to the US stock markets”. You might do that by buying small cap index funds. Just be sure you do it in a globally diversified way.

Make sure you do not end up with a portfolio where you essentially become a collector of indices. You can have so many indices tracked that you don’t quite know what is there or why.

A lot of global indices are highly-correlated. I think you get 95% of the way there by owning a global tracker.

Holding cash instead of government bonds

Our last question comes from ‘Haphazard’, who asks, “Do you still believe the lowest-risk part of a portfolio should be in a government bond fund? Even with today’s very low negative yields – as opposed to cash, for example?”

Lars replies:

First, a reminder. I believe that for a large majority of investors, you can create a very robust portfolio with two products. You select the lowest risk government bond in your currency and at the appropriate maturity, and you combine that with a global equity index tracker. You choose the proportion to suit your individual risk preferences.

Check out my previous video series on Monevator for more on that.

Coming back to Haphazard’s question, I don’t have a problem with cash. I would just encourage you to think of the risk of the bank where you have your cash, versus the risk of a local government bond.

For most developed economies, there is a deposit insurance. The government guarantees deposits and banks up to a certain amount.

That means for up to that amount you’re effectively taking government risk.

As a side note, this means if you have your money with one of the larger banks in your country, there is a high correlation between the failure of that bank and the failure of your government. I know that in a lot of the economies around the world that may seem remote in early 2021, but it is something to think about.

I would also say be careful about going yield hunting among other country’s government bonds. You would be taking FX risk in a lot of cases. Also, if you’re getting a higher yield you’ll typically be taking some credit risk. The higher yield alone does not tell the whole story.

Most people would intuitively understand the very high interest rates you’re getting from governments like that of Venezuela do not make much sense. You’re taking massive FX risk and credit risk. People would therefore stay away. But even in less extreme samples, you’re taking FX risk and credit risk if you are getting a higher yield.

Coming back to cash – and maybe cash alternatives – with your local bank. As long as it is within the insurance limits, then absolutely take it if you’re getting higher yields.

However if you’re buying your local bank’s fixed income products and they’re giving you a far higher return than your local government bond – and you aren’t within the deposit insurance – I’d encourage you to understand what kind of risk you are taking.

Are you well-equipped to take that risk?

For example, you might make higher returns with corporate bonds than your government’s bonds. But you’re also taking a different and in some cases a far higher risk that you may not be very well-equipped to take.

I also worry a bit when people say interest rates are so low they cannot possibly go any lower. Predicting interest rates is like predicting stock markets. It’s very hard for individual investors to do better than the market.

I’d encourage you to really think about what it is you believe you know that enables you to do that.

If you feel the minimal-risk asset’s interest rate does not give you enough return in your simple two-product portfolio – and you’re willing to take more risk – I’d say maybe take that risk in the equity markets. At least that keeps things simple.

The lowest risk part of your portfolio is not a return generator. It is the part where you say you’re not going to lose this money, come what may. So perhaps try not to be greedy!

Until next time

Please do follow-up Lars’ answers in the comments below. You can also ask us questions for next time, although we’ll only be able to pick three of them.

Watch more videos in this series. You can also check out Lars’ previous Monevator pieces and his book, Investing Demystified.

I achieved financial independence in seven years and retired early six months after that. Documented the journey, too. From initial plan, through battling FIRE1 demons, to finally ending my career and starting a new life.

I learned a lot along the way – but I appreciate you haven’t got seven years to relive it with me.

So let’s distill down that knowledge into a single capsule post that you can swallow and digest to smooth your own path to FIRE.

To begin at the beginning

Managing my mind was probably more important than managing my finances. So I’ll cover the psychological aspect of FIRE first, and in more detail than the money side.

If you think FIRE is only for the rich or young, know that my salary flattened out at mid-five figures and my partner’s at low-five.

We didn’t have kids. But we were facing other headwinds:

• I was past 41 before I resolved to attempt FIRE.
• At age 35 I didn’t have a pension nor a single penny of the mortgage paid off.
• We didn’t scoop an inheritance nor did I have a lucrative side-hustle.

The point is you can achieve financial independence and have the option to retire early without a six-figure salary.

You don’t need to make any big investment bets, either. A low-cost, diversified passive investing strategy can do the trick.

I didn’t do anything special bar stick to the plan.

One final warm-up point: you’ll find plenty of great insight in the reader comments if you follow the links to the original posts.

Many in the Monevator community are financially independent or heading for FIRE. You’ll discover interesting voices, answers to questions, and encouragement from readers along the way.

FIRE psychology

The financial side of FIRE is well-documented. The difficult part is staying the course once things cut up rough, as they inevitably will.

Origin story

Something sets you off on the FIRE track. Perhaps a horrendous work situation, or the realisation that life on the hamster wheel isn’t for you.

My financial origin story is rooted in one of the biggest economic shocks of the past century:

Plugs were pulled. Projects terminated… We stopped hiring. We let people go. My inbox started to fill up with CVs from ridiculously overqualified people looking for refuge.

I wasn’t getting any younger and digital disruption was spreading through my industry like ash dieback. It was adapt or die time.

If I moved hard and fast enough then I could afford to be unlucky, ill, or old – the kind of hand that gets dealt to ‘other people’.

The 2008 recession made me realise that my own departure was inevitable. I decided I’d rather be in control of the timing. 

FIRE plan: the first cut

Your initial plan probably won’t be your final plan. It just needs to get you off the launch pad.

For me:

The plan is to be financially independent in a decade. I can see now that it can be done. And I can see how it will be done.

The thought of it is making me tingle. This will be the biggest and most rewarding challenge of my life.

My first-cut FI plan did change, but the direction of travel remained true:

• High savings rate: I consistently hit 70%.
• Moderate income goal: this was super-lean at the start. I’ve had to fatten it up somewhat.
• Utilising the UK’s tax breaks, and especially making the right call on ISAs vs SIPPs.
• Modest expected investment returns.
• Realistic Sustainable Withdrawal Rate (SWR): I started with a cautious 3% SWR. Further research told me that a higher dynamic SWR was possible, but not the naive 4% rule popularised on the Net.

(See the FIRE investment planning section below for more.)

You don’t need to know everything to begin. Just enough to get yourself on the front foot.

Everyone makes mistakes along the way, but the biggest mistake is to listen to eejits who warn:

• You’ll be knocked over by a bus tomorrow.
• Communists will take over the day after that.
• The financial system is a giant Ponzi scheme.

Or insert suspiciously dramatic neurosis de jour here. Or world weary fatalism there. 

For all the ‘end of the world as we know it’ millenarian paranoia I’ve heard, it’s my own financial situation that’s been transformed.

Early doubts: quarter of the way there

Okay, fast-forward to two years down the road. All the initial excitement has gone. With a long journey still to go, this leg felt like a horrible grind:

It feels like I’m rowing solo across the Atlantic. The planning is done, the course is set and all I gotta do is row.

Behind me are hundreds of miles of flat, grey ocean. There’s nothing on the horizon. In front of me, are thousands of miles of flat, grey ocean. There’s nothing on the horizon.

It’s hard to tell I’m moving at all.

That post focused on the mind games I used to keep hope burning. It also included links to others in the community who inspired me.

Later on, I wrote a stronger post on the mind hacks that kept me motivated. This was boosted by some suggestions from the Monevator massive.

Doubts dispelled: three-quarters of the way there

More than five years in, and things look very different. I didn’t realise I’d be on the brink of FI in one more year. But the scent of freedom was in my nostrils:

The FI dream feels real. The way ahead looks like a downward glide. Is it me, or are those milestones spaced a little closer together now?

With so much achieved, many of my financial worries had disappeared. My brain is moving on to think about how I need to reinvent myself for a new post-work life.

The upside of FI is that I’m less worried about a financial deluge sweeping us away. We can’t defend against every risk. But at least these days we live in a house on stilts.

The downside is that now I’ve freed up that brainspace, it’s as if I’ve nipped down to the anxiety exchange to see what other troubles are available.

Psychologically, I needed to think about what my FIRE life would look like.

Some high-profile members of the community had crashed and burned on quitting work. The FIRE movement no longer glowed with naive enthusiasm.

Typically, the British answered the relentless beat of the US optimism-drum with sombre notes. But it was still useful to learn that FIRE doesn’t automatically lead to a land of rainbows and unicorns.

The Investor, The Details Man, and I raked over some of the burning FIRE issues in a debate. It helped clarify my thinking.

Financially, I rapidly rebalanced my portfolio from a risky equity skew by adding more government bonds. I wanted to try to avoid everything I’d gained being smoked in one big crash.

One year later that move helped me keep my mind during the frightening coronavirus crash.

Financial independence was postponed by the losses of March 2020.

Few of us predicted what happened next.

Financial independence day

Just 18-months after my previous post I declared FI.

I hit my number. I hit my number. Sweet Holy Jesus, I hit my number! [Falls to the floor and sobs with joy].

It wasn’t time to hit the work eject button yet. I felt like I’d climbed a mighty peak and needed to admire the view, while watching out for altitude sickness:

I’ve watched too many others in the FIRE community quit their jobs, move to an exotic new location, and apply for gender reassignment all at once.

I’ve been sleeping well. KPIs don’t disturb my dreams. I’m not weighed down by that fat-suit of dread that I wore during the Global Financial Crisis.

My work stress has fallen away, now that I have the option to walk.

Being able to walk away makes walking away much less urgent.

So now I have enough to live on, how am I actually going to live?

A post on FIRE fears was my answer to that question. It lays out some of the reasons why FIRE can fail, followed by my personal prescription for making the most of the opportunity.

Leaving work

This was the moment of truth. Six months after I’d hit my number, and I was champing at the bit to start a new life. I resigned and left my old world.

Just don’t mention the ‘R-word’!

In my mind’s eye, my last day was an Apocalypse Now of burning bridges as I dropped truth-bombs from my Stratofortress of freedom.

Financial independence demons

Many people fall by the wayside on the road to FIRE. They burn out, lose faith, or mistime the market, among other calamities.

Make no mistake, FIRE is a long and lonely path. I’ve previously tried to head off some of the demons:

Some corners of the internet make financial independence sound like a short sprint to the finish line, blowing kisses to well-wishers along the way.

In reality, it’s a slog. The danger of a breakdown cannot be discounted.

FIRE investment planning

Monevator is primarily about investing. Let’s have some quick links to posts that will help you hit your FI number.

Passive investing guidance

Simple, effective, manageable, and proven – why passive investing took over the world, if not the headlines.

How to create an FI investment plan

How to put together an FI plan that fires you off the starting blocks.

Building your asset allocation

The how and why of asset allocation construction.

Portfolio protection in a crisis

UK market history shows what works during depressions, World Wars, stagflation, and runs on banks. Ignore these lessons at your peril.

Risk tolerance

Half of YouTube is demanding you leverage up these days. Here’s some guidance to help you estimate how much risk you can stomach.

Ideas for funds

Picking cheap tracker funds – why you should keep it simple and how.

Choosing your SWR

What you really need to know to choose your SWR. Also, how you can improve this lynchpin metric.

SWR: FIRE special

A deep dive on choosing a global portfolio SWR that takes low yields into account. Plus FIRE time-horizons that last from ten to 50-plus years.

Maximising your ISAs and SIPPs

A UK-centric series on exploiting your tax shelters to hit FI.

The ultimate FIRE calculation

This piece shows you how to hook everything up. Plug in your target FI number and income, together with tax, ISAs, SIPPs, investment contributions, expected returns, investment fees, State Pension, SWR, and time horizon.

Personal inflation

This is hardly ever discussed but your personal inflation experience will have a big bearing on your FI fate.

Saving to increase quality of life

There’s no money to invest without savings. But rather than make painful sacrifices, save in line with your values instead.

Living a meaningful life on less

One of the founding fathers of the modern FIRE movement – Jacob Lund Fisker of Early Retirement Extreme – wrote a guest post for Monevator on living a frugal lifestyle.

Jacob is inspiring. He’s still the most innovative voice in the FIRE community, in my opinion. I hope this reference will help more people find his work.

Decumulation

Accumulation is a tried-and-tested recipe. But living off your portfolio for decades is a whole other ball game. It’s still relatively new.

Did the pioneers of FIRE get their sums right? That story is unfolding every day and now I’m part of it, too.

Here’s my real-life decumulation strategy and back-up plans. 

(Also, we’ve kicked off a model decumulation portfolio.)

I’ll let you know how I get on.

Take it steady,

The Accumulator

FIRE updates

FIRE: at three months

FIRE life vs old life

Six months in

Nine months in

One year anniversary 

FIRE: cost of living crisis

Mrs Accumulator has her say

Second year anniversary

Third year anniversary

1. Financial Independence Retire Early. [↩]

What caught my eye this week.

A year or so has passed since global stock markets began to recover, resuming their age-old tradition of making smart people look like idiots.

• Tech stocks rallied first, which was blamed on 20-something traders and lockdown mania.

• Later in the year, small cap stocks joined the party. Just more retail madness, we were assured.

• Finally, cyclical and value stocks and the share prices of companies smashed-up by the pandemic began to soar. The Fed had euthanized the market, screamed the talking heads.

Well, not so much.

What really happened was tech stocks rallied as it became clear that economic life would go on, mediated by the Internet.

As the extent of government support was revealed, riskier companies that had been hit hardest in the crash began to bounce back.

Lastly, confirmation of the (always-predictable) vaccine success suggested a boom was around the corner.

All this was aided and abetted by lower for longer interest rates, no doubt.

You hate to see it

All this is clear enough in retrospect. It wasn’t at the time.

Nevertheless, the level of nonsense going around last March was off-the-scale.

Some savvy bloggers I like earnestly discussed how start-ups were dead for a generation.

When Robin Hood suffered a couple of outages (due to the sheer volume of trades it was handling) others bizarrely concluded the platform was done.

We weren’t in a recession, apparently. It was a once-in-a-generation depression.

People might never fly again! It had been revealed as forever unsafe. Would you ever go into a cinema again? Not even if vaccinated.

Oh, FIRE1 was finished – how often did we hear that one?

Most perplexing of all: how could the stock market go up when people were losing their jobs, and everyone was shopping on Amazon?

I got a lot wrong in 2020. Suffice to say I haven’t missed my calling as an epidemiologist. It was a truly strange situation, even if it wasn’t your first rodeo.

Still, I’m glad I kept my head where investing was concerned.

As I wrote around the bottom on 22 March 2020:

There’s too much panic and gloom out there. This is very bad, but it’s not the end of the world. It’s not even the end of the equity market […]

I have been increasing equities and risk all last week. Nobody knows. But there’s a lot in the price already.

I say this 100% partly to blow my own trumpet. (I’m fed up of US bloggers writing “nobody thought it was good time to buy in March 2020”).

But more as a reminder that it really is possible not to run with the herd.

You have to assess what has changed and what has not.

I was pleased to notice one person listening in amid the market scrum:

Look forward, not down

You should always try to remember two things in times like early 2020.

Firstly, the market in the short-term reflects people’s emotions and best guesses. It does not reflect reality, as such.

When everyone is scared and their guesses are made in the dark, expect that to show up in prices.

Secondly, in the longer-term the market is a discounting mechanism. This means it looks forward.

Every time people met rising share price last year with incredulity, it was because they were comparing where the market said we were going with what they were seeing in the day’s news.

That’s the same as getting hysterical on a flight over the middle of the Atlantic because you’d bought a ticket to New York, but all you see out of the window is the ocean.

Things can only get better

Everyone is happier now, of course. Things are looking brighter by the day.

From the Financial Times:

“It’s remarkable how quickly the consensus has shifted in only six months,” said Neil Shearing, chief economist of Capital Economics, a consultancy.

It is now becoming clear that the pessimism last autumn about the longer term outlook for advanced economies was an “intellectual failure”, he said, because most economists “reached back to the financial crisis and applied the lessons from that period, but this crisis is different”.

This change in mood is very evident to somebody like me who eats and drinks this stuff all day long.

Some of those previously panicking pundits now opine that the market “will never be allowed to crash again – the Fed won’t allow it.”

Even if it does, they believe index investors will always buy-in and so shares will always quickly bounce back.

These propositions may well have some truth to them. But it’s easy to see they’re made on the back of all-time highs. We’ll see how fast they hold the next time there’s a dip.

The truth is it’s often better to buy when investors are gloomy, rather than when they are whacked-out on happy juice.

I wrote in February 2020 – just before Covid properly hit us – that:

Every year the global bull market in equities and bonds continues, it gets harder to convince people that investing isn’t always so breezy.

Nobody paid me much mind, except to say they didn’t want to own government bonds.

A couple of months later some were writing obituaries for capitalism.

Now the global economic output is bouncing back and with it optimism about investing.

Yet as Sentiment Trader pointed out this week, buying when manufacturing has been in a slump has actually been the better guide to stronger market returns:

Human nature tells us that we should be happiest when this index is at a high level – thereby indicating that manufacturing and by extension, the economy is strong.

One might intuitively assume that this is when the stock market performs the best.

And one would be wrong. Very wrong as it turns out.

The full article has some persuasive charts and tables.

Charlie Bilello made a similar point on the back of the same strong growth figures. But he sensibly cautions against reading too much into this:

Does that mean manufacturing activity is unimportant to the economy?

No, just that using it to time your exposure to stocks does not appear to be an effective strategy.

The fact that the best performance from stocks has actually come after the worst manufacturing readings tells us as much.

And it provides another instructive reminder that the stock market is not the economy.

Any way you cut it, most stock markets look expensive right now. Even the junky stuff has rallied.

That is rational, but it isn’t a cue to go crazy.

Stay slow and steady and sleep at night

Indeed, rather than charging in and out of shares, it would be hard to think of a better 12-month advert for a passive investing strategy.

Or, in short, do not sell.

That’s because this stuff is hard. You can be battle-tested and alert to people panicking and still be too cautious (as even I was in March 2020) or sell your fast-growth stocks picked up in the slump after they’d doubled in a few months, only to watch them go on to double again. (Yep, I did that, too).

Investing only looks easy in hindsight. But it’s not quite so difficult as emotionally flighty pundits make it sound in the midst of the highs and lows.

p.s. We had several dozen substantive responses – far more than I expected – to our call for new writers. At least ten could be a good fit for Monevator. I need to set aside a day to consider everyone properly. Will be in touch soon!

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1. Financial Indepedence Retire Early [↩]