Is Dividend Investing Dead? The Derek Foster Story

by Mike Holman

Last week the Toronto Star broke the shocking news that Derek Foster had sold all his equity positions and was sitting in cash as of Feb, 2009. Currently he is selling put options on various stocks to make some money – a strategy he proposed in his third book Money for Nothing.

For those who don’t know who Derek Foster is – he is the self-proclaimed “Canada’s youngest retiree”, leaving the workforce at age 34 after accumulating a good-sized portfolio of dividend stocks.
His first book “Stop Working” was a pretty good read – although his math is suspect, he espoused a somewhat conservative dividend investing strategy and is also a big proponent of frugal living.  One of the keys to his strategy was to buy and hold stocks “forever”.

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To answer the title of the post – I don’t think dividend investing is dead – it’s not even “sleeping”.  Here are some thoughts:

Derek Foster wasn’t solely a dividend investor

Although Derek owned a number of traditional “dividend aristocrat” type stocks – he also owned a lot of income trusts which are far from dividend stocks.  Most of them are mid-cap (or smaller) companies that pay out a lot of return of capital.  He also got into a lot of option trading as well – which is clearly not dividend investing.  I think if he had stayed with more traditional dividend stocks, he might have had more luck staying in the market.

Diversification is good

I wrote a post a while back called “Ignore the last 10 years” which contained probably the best advice I’ve ever given on this blog.  I didn’t listen to my own advice and I doubt anyone else did either. :)  The problem with relying on a single investment strategy is that if it doesn’t work then you are screwed.

The last 10 years or so (ie 1997 to 2007) have been fantastic for dividend investors – especially in Canada.  Over the last year or two – a lot of investors piled into dividend stocks because they had done so well in the recent past.  This was in part because of Derek’s first book which another blogger has named the Foster effect.  This is a recipe for disaster as anyone who has invested in the Canadian banks knows.

Yes, their dividends haven’t been cut but it is no fun watching your investment sitting at 30-40% of your purchase price – dividend or no dividend, that is a bad investment.  We Canadian bank owners have been very lucky compared to the US bank owners though – I’m not sure if there is a single US bank remaining that hasn’t gone out of business or is owned by the government.  It is amazing how socialist America is becoming.

Derek didn’t follow the 4% rule.

The 4% rule is a basic guideline for how much money you can safely take out of your investment portfolio.  I don’t have the exact details but from what I understand – he was taking more than 4% which increases the risk that he will run out of money (or more likely – will have to change his strategy at some point).

Derek didn’t have much of a buffer

It was clear from reading his first book and several interviews that Derek knew how to live cheaply.  The problem with living cheaply however is that you don’t have anything to cut if times get tough.  Derek’s situation is hard to analyze because he made some money from his books.  Another big factor is that he is still quite young (late 30’s) so it’s not hard to imagine that he could easily get a job of some sort to help pay the bills which might mean that a big safety buffer is unnecessary.

Conclusion

Derek is doing fine – his strategy might have had a big downturn but he is a pretty smart guy and will do ok.

Dividend investing is still a perfectly valid strategy – but like any strategy you shouldn’t rely on it 100%.

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