Tuesday, May 27, 2014

#37 "Hedge" against price inflation by investing in staples you use.

From Investopedia: Definition of 'Hedge'

"Making an investment to reduce the risk of adverse price movements in an asset..."

People like to complain about gasoline prices. They also like to complain about bank fees.  And how about cell phone fees?  Yep, people keep complaining about phone fees.  Energy costs such as electricity generation and delivery, natural gas costs etcetera are generally going up over time... and yep, people sure do complain about them.  Every year all of these products and services increase their cost to consumers like clockwork, sometimes around the rate of inflation and sometimes higher such as in the case of finite resources such as oil and gas.  If the cost of these items is expected to go up over time, and its reasonable to expect that businesses will pass on the cost of these items to customers so that companies can preserve profits, is there a way to either hedge against their price increase or to participate in the increasing value of these consumables?  There sure is!  Buying good companies that produce products or services that people use everyday is a good way to participate in the market.  It is also a way to hedge against rising prices of the products and services they sell.  A good example of this is participating in increasing gasoline prices by investing in Oil and Gas stocks.  We like to focus on companies that pay and increase their dividends over time.  This way when the price of gasoline goes up, we are able to participate in the increase through the accompanying dividend increases.  As the price of gasoline goes up, it costs me more money to fill up the tank of my car... but I also profit from the rising price of the oil and gas stocks that I own.  This is my hedge against price inflation.



The everyday costs/staples that we consume are gasoline, mortgage payments, insurance, phone plan, internet plan, electricity, heating fuel etc... so to hedge these costs we own shares in Oil and Gas companies, Banks, Insurance companies, A Phone and Internet company, Electricity Generation and Delivery companies.  All of the companies pay me a dividend and they all have raised them at or above the rate that they increase prices on their products or services that I buy.

So while some people have a tendency to do nothing but complain about higher prices year after year, we've taken a different approach.  We participate in the higher prices and higher profits through stock ownership.  Since we've been doing this for nearly 15 years now - and the dividend increases have outpaced inflation - many of our bills are now paid for by the cash-flow of the stocks we hold in their specific sectors.... such as our oil stocks now actually pay for our gasoline purchases, our phone company stock pays for our monthly cell phone costs and so on.

Monday, May 26, 2014

#36 Owning a good company is better than working for one.

"Investors should be rewarded for actually owning companies and gaining returns on their investments." - Mark Cuban

My father and I were discussing wealth creation the other day and he asked whether I knew any multi-millionaires.  Having studied and worked in the Oil Patch in Calgary, I've come to know personally a number of wealthy people with very high net worths, some well into the 10's of millions.  Calgary is a vibrant city with lots of opportunity, and a lot of money moving around within it.  If there is anywhere that rewards calculated risk-taking, it is Calgary.  The overwhelming majority of folks I know who are wealthy did not become wealthy from earning a paycheque.  They became wealthy from either starting and operating businesses or by investing in, or acquiring shares of, companies that go on to be very successful.  I asked one of my high net-worth friends what they their best piece of advice was to generate wealth.  He said it was simple: "Owning a good company is better than working for one"...  i.e. Their key to wealth creation was owning businesses, not working for them.  This flies in the face in what the majority of the school system teaches... to become an employee and rely on a government pension.

The rationale for business (or stock) ownership is this: A paycheque is temporary and you are compensated only in exchange for your labour.  You get paid for the work you do once, but if you stop you get nothing in perpetuity.  Owning a well-run business, or shares of a one, can result in passive cash-flow in the form of dividends and tax-deferred capital appreciation as the business grows for as long as you own your share of the business.  This is one of the reasons I don't understand why people don't take advantage of work-sponsored share matching programs.  Getting shares in a successful company at a discount sounds like a great thing to me....then to benefit from that company ownership for a long time, perhaps long after you've left the company, just seems like a solid way to build wealth to me.  Buying shares privately in an RRSP, TFSA or Taxable account also make sense if you take a long term approach and pick solid companies that will still be around in 10-20 years.  Its not as hard as it sounds.. really.



Taking on the risk of business or company share ownership can lead to sizeable rates of both capital and cash-flow growth.  Growth rates of good companies tend to outpace inflation, and dividends can grow well above the rates of paycheque raises.  Rather than start a business, we chose to invest in companies that had a track record of growing their earnings and increasing their dividends AND ones we think will continue to deliver raises above the rate of inflation.  We regularly get dividend income raises far greater percentage-wise than employment income raises these days.. which means our investments are now bringing us closer to Financial Independence than our paycheques.   Since the rate of growth of our portfolio's dividends alone outpaces our employee paycheques growth, we have put as much as we can into them as early as we can.  This allows the compounding to work in our favour early.