Why I Don’t Invest in VTSAX … But My Kids Will
We may earn money or products from the companies mentioned in this post.
My wife and I have been building a portfolio of dividend stocks for almost 10 years now. In that time, we have built up positions in almost 40 different companies in both our taxable (Robinhood, Fidelity, etc.) and tax-deferred (IRA’s) accounts.
Between all of our different accounts, we except to earn about $8,000 next year in dividend income. Based on using the Rule of 72, we can estimate that our total annual dividend income will reach $16,000 after 8 additional years and $32,000 after 16 years!
While this income will not fully fund our retirement or allow us to reach Financial Independence (FI) … it will certainly go a very long way in helping out.
And while investing in dividend stocks has been great … the only regret I have is not starting sooner as we started building our income stream while I was in my mid-30’s. If I were to have started in my early to mid-20’s, then we could have been much further along towards FI.
Since we can’t go back in time and start again, my wife and I are doing the next best thing … teaching our kids (ages 14, 10, and 6) about the value of investing early on. In fact, we are in the process of setting up custodial accounts for each of them now.
But instead of sending them down the path of dividend investing, we are switching gears a little and having them invest in low cost index funds.
Investing in Low Cost Vanguard Index Funds
Anyone who has spent anytime around the FI community has probably heard of someone praising VTSAX (Vanguard Total Stock Market Index Fund Admiral Shares) as the best tool for investing in the stock market.
To be honest, if I hadn’t spent years learning about dividend stocks and building our portfolio … I probably would have went the simple route and invested everything into VTSAX or an equivalent.
The Vanguard Total Stock Market Index Fund (VTSAX) basically buys you a piece of the entire U.S. stock market. It offers diversification across thousands of companies and has an extremely low expense ratio of 0.04% for admiral shares.
For new investors (like my 3 kids), you need a minimum of $10,000 to get started which may be a bit high. Fortunately there is an alternative fund called (VTSMX) which are for market shares. This fund still has a low expense ratio of 0.15% and requires a minimum investment of $3,000 to get started.
This still doesn’t help my kids out too much … which is why we will be investing in the Vanguard equivalent ETF called Vanguard Total Stock Market ETF (VTI). As our kids get older and start earning income and their portfolios increase, we will likely switch over to VTSMX and eventually VTSAX overtime.
Reasons to Invest in VTSAX
So you may be wondering why someone who strongly believes in investing in dividend stocks (as opposed to index funds) would recommend index funds instead? Well, here are several reasons why our kids will be investing in VTSAX (or the equivalent) … for now –
1. Investing in VTSAX Makes Everything Simple
Teaching my children … specifically my 14 year old son … about dividend investing has been a little more difficult than I thought it would be. He doesn’t really care too much about individual stocks, dividend yields, P/E ratios, etc. All he really wants to know is how much money he could make from his investments after 30 years … and will he be a millionaire?
So instead of worrying and stressing about how to teach him about investing … for now we are just sticking with what is easy – VTSAX … or for him the VTI ETF equivalent.
Investing in low cost index funds that track the entire market (or the ETF equivalent) just makes everything simpler.
2. Still Earning Dividends
I know most people in the FI Community generally don’t like earning dividend income because of the tax implications. Personally, I don’t hold that same point of view and don’t worry too much about how much dividend income we are earning each year. Most of the dividends we earn are “qualified dividends” anyway.
And despite any tax concerns, I strongly believe in building some income from dividends. The good news is that VTSAX (or the equivalent) still pays dividends … although not as much as some dividend stocks. So our kids will still learn about earning dividend income by investing in the VTI ETF, which I feel is important.
3. Lower Fee’s
As a dividend income investor, I am a big fan of zero cost brokers like Robinhood. My wife and I have built up sizeable positions in our taxable brokerage accounts by leveraging Robinhood, LOYAL3, and Stockpile to get zero or very cheap trades.
But for our children, there are not as many options for low cost trades. Since they are under 18 and don’t have any earned income, we need to setup custodial accounts for them. Stockpile offers custodial accounts but charges $.99 per trade. So for my daughter who may have $100 to invest in birthday money … that is almost 1% fee to buy anything.
Opening up Vanguard custodial accounts for them and investing in VTSAX, VTSMX, or VTI comes at a very low cost … compared to the amount of funds they will be investing.
If you are just starting out … it is very difficult to build a diversified portfolio … which is especially important when you are buying dividend stocks. Personally, I like to have a minimum of 10 stocks in a dividend portfolio … but preferably 20 to 30 or even more.
So when my kids are starting with just a couple hundred dollars each to invest … it is impossible to diversify by investing in stocks alone.
But putting their money into VTI gives them that diversification and more (see #5).
5. Less Volatility and Fewer Emotions
This is part of what diversification can get you in the stock market … lower volatility. Investing in the entire stock market in one of the Vanguard tools drastically reduces volatility compared to individual stocks. I don’t want my 14 year old son to get discouraged after buying a stock and watching it drop by 5% (or more) in a week.
These index funds can certainly drop and will follow the overall stock market. But the dips and peaks will be much smoother along the way.
Basically, it takes all the emotions out of investing … which I think is great for young investors who are learning the ropes for the first time.
I Am Still Not Buying VTSAX (at least for now)
So based on the reasons I listed out above, you would think my wife and I would move all our money into VTSAX or a close equivalent … but that just isn’t going to happen right now.
A good amount of our portfolio is held in taxable accounts, with almost every stock we own more valuable then when we made our first purchase. So moving our funds would create taxable events which we want to avoid.
Second … we are investing for income … not necessarily portfolio value. We use a screening process to identify which stocks to buy based on several criteria … one of which is rising dividends. If a company were to make a dividend cut … then we would immediately sell the stock.
In almost 10 years, we have only sold 2 stocks because of a dividend cut. Some have frozen dividends from time to time while many have given us raise after raise each year. The point is that on average, we get a 6% raise each year just in dividend income.
I believe there is no right or wrong way to reach financial independence. Investing in VTSAX has a ton of advantages and has been a very successfully strategy for many people reaching FI.
On the other hand, there are plenty of successful investors who are reaching FI and living off the dividend income they are earning every year. These investors (myself included) are not trying to “outpick” index funds as that would be impossible.
For our children, I think the best approach for now is to invest in low cost index funds for the simplicity. And my wife and I will continue building our dividend portfolio.
Which strategy do you follow? Low Cost Index funds versus Dividend Stocks?