Investing for early retirement

I recently had a chance to meet with Derek Foster, author of Stop Working: Here's How You Can (2005). It was an opportunity to delve more deeply into how Canada's "youngest retiree" was enjoying retirement and the investment approach that gave him financial independence.

First off, the section on Derek in an earlier column, Retire before 40, requires updating. He and his wife have sold the Wasaga Beach home and now live in the Ottawa area. They also have upgraded to a 2005 Toyota Sienna, had a third child, and no longer receive income from part-time work or real-estate rentals.

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Their current residence isn't luxurious, but that was not the goal: it was to be free of "wage slavery" and to have more time for family and activities of their own choosing. So how is Derek doing with his "list of things to do" during retirement (on page 12 of his book)?

He is spending a lot of time seeing his kids grow up, doing things with them like going swimming and taking a trip to Disneyland. His self-published book is also claiming some of his time (responding to orders, arranging reprints, etc.).

The book has been more successful than anticipated, selling about 14,500 copies so far (5,000 considered a bestseller in Canada) through Chapters and his Web site. For more details on Derek's self-publishing adventure, see my Sept 25 blog.

Derek's portfolio

What enabled Derek to take the risk and time to self publish a book? It was the achievement of early retirement through regular savings and investing in a portfolio of non-cyclical stocks and income trusts paying steady and rising dividends and distributions. Income stocks and trusts are obviously Derek's passion: it can be seen in the conviction with which he espouses his investment approach and his intimate knowledge of the investments he owns.

Since he is buying stocks and trusts not for their anticipated price gains but stream of dividends and distributions, he is relieved of the worry of declines in stock market prices. In fact, he looks forward to market crashes because he can then buy more cheaply shares in his favorite companies - like those on Mergent's Dividend Achievers list.

The risk of dividend cuts and suspensions is spread over a portfolio of about 20 stocks and trusts. Also, Derek likes to focus on companies that are mostly immune from business downturns, such as regulated utilities and suppliers of products that people keep on buying regardless of economic conditions (like food, beverages, tobacco, and health care). Derek's approach seems to take a lot of the anxiety out of investing in the stock market.

The highlight of our meeting was seeing his portfolio. It has no bonds and very little cash:

•  Canadian stocks and trusts: Algonquin Power, Canadian Oil Sands, Corby Distillers, Enbridge, Encana, IAT Air Cargo, Livingston International, Manulife Financial, Pembina Pipeline, Pengrowth Energy, RioCan REIT, Royal Bank, Sun Gro Horticulture, George Weston and Epcor Power.
•  U.S. stocks: Anheuser Busch, Johnson & Johnson, Pfizer and Wal-Mart.

The income stream is about $26,000 a year. Because of low tax rates and few deductions, Derek says it is equivalent to a gross salary of $70,000. Then there is the supplementary income from book sales. He also has no mortgage.

Derek went over the analyses behind the selection of each of his stocks and trusts (his Bachelor of Commerce courses and accounting knowledge have come in handy). One thing that stands out is the timing of his purchases. He usually doesn't buy until one of his "dividend achievers" has been battered by bad news.

For example, Foster bought Canadian Oil Sands when it encountered cost overruns, Corby Distillers after it was booted out of the index, Pfizer during a drug scare, and Royal Bank during the underperforming period in its U.S. operations. He bought RioCan at the height of the dot-com boom when it seemed online shopping would make shopping centers extinct.

Relatedly, he'll take a position in a company when he thinks the market is misjudging value. Algonquin Power and Enbridge had earnings strength masked by the method of accounting for depreciation expense. IAT Air Cargo's location at the Vancouver airport minimizes competitive risk because of land scarcity (plus exposure to Chinese trade).

The lesson? If you want to retire early, set up a regular saving program and build a portfolio of non-cyclical stocks and income trusts with histories of uninterrupted and rising dividends and distributions - like some of those in his portfolio, especially if any go on sale after a spot of bad weather.