There is nothing fundamentally wrong with a strategy of assembling a diversified portfolio of dividend paying stocks purchased at reasonable valuations and holding it for the long-term. Such a portfolio is likely to (more or less) provide the benefits that come with long-term stock ownership. This old strategy has been (and continues to be) profitably employed by countless investors and went awry for Derek Foster for a variety of reasons, almost all of which can be traced back to one cardinal error — too much focus on rewards and not enough on the risks:

No allocation to fixed income. Bonds may be boring but in periods of market stress, they can be counted on to provide income. Dividends or distributions provide no such guarantee and it is risky for retirees to solely rely on dividends to pay the bills. Even long-term investors can add some stability to their portfolio by allocating a small portion to bonds and rebalancing occasionally. A 100% allocation to stocks should be made only after careful deliberation.

Making concentrated bets. In an interview with James Daw (“Happily Retired at 34”, Toronto Star, Sept. 26, 2006), Derek Foster said that he had 20 percent in Canadian Oil Sands Trust (COS.UN) and 37 percent in oil and gas producers. Initially, it turned out brilliantly — oil prices kept going higher and higher and then crashed taking the portfolio down with it. From a cash flow perspective, distributions from just two energy holdings contributed more than half of the portfolio’s income in 2008. When those contributions were cut, the income from the portfolio dropped precipitously.

Aggressive withdrawal rates. Conventional wisdom suggests that investors retiring at the traditional age can safely withdraw 4% of their portfolio in the first year. But even a 4% withdrawal rate is probably too aggressive for young retirees whose portfolio needs to last lot longer. Derek’s withdrawal rate was even more aggressive and would have depleted the portfolio in short order but for the income from book sales.

Extrapolating recent trends. The 2000 to 2008 stretch was a glorious time – many blue-chip companies boosted their dividends at a torrid pace and it was easy to believe that the happy trend will last forever. But dividend growth has a speed limit – in the long-term, dividends cannot increase at a faster rate than earnings and earnings do not grow in double digits in mature economies. Incredibly, Derek is at it again, arguing that his profits from selling puts is proof that the new strategy of “money for nothing” is working.

Investors following the dividend strategy while paying attention to the risks outlined here are likely to experience financial success. Investing is always about managing risks — the returns are up to the market gods. [Note: Four Pillars alluded to some of these points in yesterday’s post but I wasn’t in the mood to rework mine.]

This article has 31 comments

  1. RIght on the money CC. Not being diversified, withdrawing too much, chasing yields, concentrating in highest current yields without regards for dividend growth – Derek was simply asking for it 🙂

    His idea of cash secured puts is interesting however, and could be used for certain scenarios where one implements waiting limit orders in order to buy a stock at lower levels.

  2. Just out of curiousity, can someone tell me what this big bet was that Foster made a few years back and in turn made him his small fortune?
    thanks.

    • Canadian Capitalist

      Matt: If I recall correctly, Derek has said in media interviews that he bet his entire portfolio, which included a margin loan on Philip Morris in the late nineties when it was sued by the State Governments. He reported made a bundle on that bet.

  3. Not being diversified and investing as if the stock market only goes up can kill your portfolio. You’re right CC about the strength of the Canadian market pre-2008. Most investors came to believe that anything less than 15% per year was a poor return. Buying on the dips worked until it didn’t!

  4. I dont understand why everyone gave him so much credit for his book in the first place. Nurse 911 had a great post on the foster effect http://www.nurseb911.com/2008/04/foster-effect.html

    He has no financial background
    Not long experience in the investment world
    Most of the good things he says come from Benjamin Grahams teachings and Warren Buffet

    20% of your holding in just one income trust, is just not investing to me.

    No bond or fixed income allocation, every investor understands (or should) that majority of your return depends on your asset allocation and NOT your individual holdings.

    No diversification not a proper asset allocation these are just the basics of investing

    And clearly he does not believe in the buy and hold strategy that he sold to others.

    Is options strategy I can only hope that his readers will do a lot more research than just jumping in blindly into his “money for nothing” strategy.

  5. Love your DF rants….DF got scared and changed course at the wrong time. He got lucky once with PM, he got lucky again by investing in Blue Chips at a good time. Then as we all experience when investing in equities he started to loose money got scared and ran away.

    I would understand the average Joe acting this way, but not a guy who writes and sells books telling everyone to buy and hold forever than when the going gets stuff he heads for the hills…..I have no respect for this guy….

  6. I don’t understand why so many people are getting so emotional about Derek Foster and his books. It’s not like Foster was *lying* or trying to *fleece* people for heaven’s sake, yet that is what’s implied. If readers didn’t put all their eggs in the Foster basket to begin with, it seems they wouldn’t feel so betrayed.

    (1) Lots of authors change their mind, theories, strategies
    (2) Radical situations dictate radical measures: I’m sure you know others, too, who pulled their money out of this market
    (3) Besides, Foster’s option strategy was already working for him before the 2008 – it’s not like he pulled it out of a hat just in time for his third book.

    If there’s one thing the “Foster story” teaches, as CC has said in his article, it’s to not put all your eggs in one basket – I think it’s safe to say that in retrospect Foster wasn’t diversified enough.

  7. Maybe people get so emotional because he’s a “success” (however you want to define that) story. The way I look at it, he got lucky on a stock pick, rode the bull market, and punched out of the work force only. Yeah, I would love to quit my job but I’m not willing to force my family to live like a pauper to do it (I think he said that him, his wife, and 4 kids live on $36K a year).

    One thing that always struck me (I read two of his books) is that he doesn’t talk about insurance. Insurance is very important, especially with small children. Even though he doesn’t need to insure his ability to “earn income”, a CI policy might come in handy if he and his wife were ever struck with, say, cancer.

  8. MoneyEnergy – Wow, you set the bar pretty low. Anyone who writes a non-fiction book is purporting to have above average knowledge or expertise, and that is what the public pays for. When they are subsequently revealed to have none, criticism is acceptable. Your blog says we should encourage excellence (I agree), but can you point me to the ‘excellence’ of DF?

    CC – perhaps you can do a post on the quality of the average investment/business book on the shelves today. I find it pretty disappointing.

  9. strategy wrong/right is irrelevant the reality is Derek Foster is a salesman period.

    its convienent that he “sold” his equity portolio right around the time he realeases a book about writing put options

    he’s looking for publicity , he’s getting it and it sucks.

  10. …hmmm, I am sensing a theme this week CC!

    I do agree with PI though- however you feel about him he is successfully getting attention to his books- which, if his business model is to sell knowledge, he’s taking all the right steps getting there. His books are published by a small publisher so he should be getting more than standard royalty.

  11. NN, point taken: my bar-setting might appear a bit lower than usual just as a reaction to the Foster backlash we’re getting.

    But realistically, what’s an “expert” nowadays anyway? Foster self-published. It’s easy for anyone to do that. He used the words “lazy” in his titles – of course that’s going to sell. I don’t think we should be trying to chop down “the experts” perhaps because they aren’t. I guess I see Foster’s books as sharing knowledge at a moment in time when they were working for him. We all know that “past returns are no guarantee of future performance,” and the same goes at a more general level.

    Some people seem to be perceiving some lack of character or integrity-breach in Foster, and I would argue that’s not true. He was involved in his options strategies long before writing his third book and now cashing out of the market. If anything, he’s just staying honest to his best judgments.

    His excellence was being able to stick to a disciplined strategy and make it work for him, and then being able to share it with others so they might perceive new possibilities for themselves re: what they could do. If his books motivated people to wake up to their financial lives, that’s a good thing. Just waking up, of course, isn’t enough – you need to do the research and study, too.

    So perhaps, in some sense, his books are closer to the self-help/inspirational genre than serious investment “knowledge.” I think that’s the sense in which I would recommend them, in order to say, “get off your butt, get motivated, you can do this too eventually”.

  12. I have to agree with CC some fixed income is essentail to a portfolio. Most people can not handle the risks of 100% equities so don’t bother trying.

    Ray – Ah, yes that is true of a lot of non-fiction books. In the end it’s all about selling the product (the book). Foster had a good story so he sold his books well. I don’t blame the man, he wrote an entertaining book.

    Thicken My Wallet,

    Actually he should have made a lot of money as a self publisher. Usually author cut is around 7 to 10% of book cover price is my memory is correct. Yet if you self publish you get likely about 75% for direct sales (depends on his print run size and costs), 35% book store sales and 15% to distributors. Since the first book was a national best seller (ie: 5000+ books in one year) that would mean he made at least anywhere from $15,000 to $75,000 on just the first book in the first year. Now he is on book #3. Trust me if he can keep selling books he will be fine regardless of his portfolio.

    Tim

  13. Indeed there is alot of DF criticisms going on here, some of it deserved, and some not.

    NN: in his book, in the very first section. DF clearly states that he is no financial expert, and his “advice” should not be taken blindly. Those that did take his advice blindly did so under their own fault.

    • Canadian Capitalist

      I’ll readily admit his salesmanship is brilliant. I also agree that any ideas (even Buffett’s or Graham’s) should only be adopted only after careful consideration and due diligence. And for the record, I’m an indexed investor, not a dividend investor. In fact, I borrowed the first two DF books from the library, so I can’t even complain that I spend $20 or $40.

      Actually, I find it pretty amusing to find out that he sold out and is now giving market timing tips in media appearances. If there is one thing that makes you appear as a fool, it is expressing an opinion on the stock market’s short-term direction. It would be ironic if last month did indeed turn out to be the bottom of the bear market.

      But what bugs me is the put writing strategies in his third book. It is, quite frankly, dangerous for the financial health of Joe Retail Investor. DF deserves the criticism he gets for trying to sell half-baked ideas.

  14. For all who are interested here is a recent video interview with Mr. Foster….

    http://www.cbc.ca/thehour/videos.html?id=1063578735

  15. I think diversification is so accepted that most people don’t question it. I think people should. Warren Buffett is a focus investor, making big bets when the odds are in his favour. Why wouldn’t Foster preach concentration? It certainly worked for him, or he’d be still working at a job he hated with a fraction of his current wealth. Yes, it’s riskier, but the rewards can be outsized. To beat the market, you have to pick better than average companies at fair prices.

    I don’t think everyone should concentrate their investments, and if you do want diversification, I completely agree with CC’s strategy of using index ETFs, since they are low cost. It’s a great strategy if you want to come very close to matching the market.

    One thing that bugs me about Derek Foster is he claims to be Canada’s youngest retiree. I know someone who hasn’t worked since he was 30 and intends never to go back to work.

  16. gene! I didn’t know that DF claimed that he’s Canada’s youngest retiree… What a joke! The kid brother of a friend of mine retired at the ripe old age of 28 with $1.5 million that he made from stocks of his employer at the time – a junior mining company. Also, Canadian business magazine several months ago profiled a kid who (while still a teenager), sold off an internet business that he started for about $250 million, I think? And I think his portion of that transaction was about half of it, which is still some serious coin. Of course, DF can probably claim that this kid isn’t retired, which is true – he’s off starting another internet venture…

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  18. I take all these books with a grain of salt. This reminds me of the Rich Dad Poor Dad scenario. Kiyosaki (spelling?) basically identifies the cash flow quadrant which I think is a valid point for the layman. Then the remainder of the book is just filler, then the guy goes and makes a fortune basically rehashing the same thing over and over. So I take the cash flow quadrant from him. From Foster it kind of sunk in that dividends etc. are taxed favorably, though the glaring ommisiion in my mind was always his choice not to mention his gamble on Philip Morris. Each of these books and people have a little something but my best strategy was always taking a little of everything and coming up with my own. Pay myself first, debt reduction, reduce management fees and so on. I would never throw myself solely on the philosophy of just one person, well maybe Buffett but he’s been at it longer than Foster or Kiyosaki. Each person’s goals are different. I only read Foster’s first book, I bought it after seeing him profiled in Money Sense magazine. There were a few other well off people in that same issue, but they never wrote books! Maybe if his latest strategy works out he can bill himself as the King of the Market Timers! I see another book on the horizon.

  19. I would not consider Derek Foster to even be retired, let alone “Canada’s youngest retiree.” He is currently working as an writer. While he may have stopped working before writing any books, his “retirement” was only temporary, and thus more like a sabbatical. Many people could stop working temporarily for a short period of time and live off savings and investing, but I would only consider it retirement if it were permanant.

  20. CC and many of the posts here are making my ealier points – too much time is being spent bashing of DF is going on here. It is time to let this one alone. I think there has been enough posting about DF and his invesgtment style. While we all have the right to question his ideas these postings seem more like a peronal vendeta and attacks. I think this topic has been discussed too much. I don’t find I am leanring anything valuable anyomre from these rants. So, folks, let’s get back to personal finance not DF. I hope you will see points where you read the above postings.
    CC, Buffett is the world’s best investor alive today so your agruments against DF will not work agaist Buffett’s ideas. What is indexed investor anyway? I have heard of value investor but not indexed.
    Cheers, Ed

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  22. CC: what’s with your mention of “aggressive withdrawal rates”?
    Derek isn’t making “withdrawals” of out his capital (like occurs in an rrsp/rrif). He is getting paid with distribution income! So what gives? Why do you criticize him on that?

    ps. great blog btw!

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  26. Mark in Nepean

    Excellent post CC!

  27. I think what people should take from DF is that the markets should not be treated
    Like a casino, buy great companies at decent price that pay out a decent portion of
    Their ongoing profits as dividend and sit back and watch. Even if stock levels
    Drop yield is based on the number of shares you own not on share value.
    In addition when we talk about retirement we should think about what that
    Really means, doesn’t it mean sitting on the beach every day or being able to
    Do the type of work you like best and work for yourself rather than to the greater
    Benefit of some large corporation or CEO.
    Sitting on a beach gets boring just add Kevn Oleary