How do you actually make a living from stocks?
What are the specific steps? Do you sell the shares?
This is a question many people ask me.
The underlying question here is also: what comprises a return on a stock? Is it just the rise in the stock price?
In this blog post, I will explain the three things that can make up your return.
I’ll also explain how I generate an income so I can pay the bills.
What Makes up a Financial Return from the Stock Market?
Let’s begin with a definition.
According to Investopedia, a financial return is “the money made or lost on an investment over some period of time.”
Let’s break that down. How can you make money on a stock?
Here are the three factors:
1. Increase in The Stock Price
A financial return on a stock can be an increase in the stock’s market price.
This is probably what most people associate with the word “return” when it comes to stocks.
To make a living this way, you will have to sell, and this will of course reduce your remaining number of shares.
Hopefully, the remaining shares are worth so much more than when you first invested that your total wealth grows even if you sell a small portion of that portfolio.
When a company makes a profit, they can choose to pay part of the profit to the owners.
As a shareholder, you are one of the owners.
When companies pay out a portion of the profits, that is called a dividend.
The dividend goes into your investment account without you having to sell the paper.
Sounds cool, doesn’t it? You don’t have to sell. You can just lean back and enjoy the ride.
Then why not just focus on companies that pay a lot in dividends?
There are, in fact, major disadvantages to actively pursuing the so-called dividend kings.
Companies that are growing and have a large market potential ahead of them are too busy reinvesting the profits in new markets, new employees, innovation, and acquisitions. They don’t pay dividends, because that would mean missing out on great growth opportunities in the market.
The major dividend stocks typically consist of very mature companies like the Coca-Colas and Johnson & Johnsons of the world.
If you only invest in the dividend kings, you’ll miss out on great growth opportunities, and your overall return will falter.
The other disadvantage of dividends is that you have to pay tax on them. This handicaps the effect of compounding.
You can read more about the advantages and disadvantages to dividend stocks in this blog post.
3. Share Buybacks
Share buybacks are an alternative to paying dividends.
Instead of giving the money directly to the shareholders, the company may choose to use some of the profit on buying back some of their own shares.
This will cause the price of the stock to rise in the long run, because the cake (the company) will be divided into fewer slices (shares). When the cake is cut into fewer slices, each slice is worth more.
Your piece of the cake, your shares, will therefore be worth more over time if the company makes regular share buybacks.
Warren Buffett loves stock buybacks, and his company Berkshire Hathaway regularly buys back shares.
So what are the benefits of buying shares back in terms of dividends? Why is Warren Buffett so happy about it?
When you receive dividends, you must pay tax on that amount. You don’t have to pay taxes when the company repurchases stocks (provided, of course, that you don’t sell the share).
This means that share buybacks don’t cripple the effect of compounding. The money can continue to grow exponentially.
But to take advantage of this, you will of course have to sell the stock at some point, and then we’re back to square 1.
You can read more about share buybacks in my blog post here.
How Do I Make a Living From Stocks?
A lot of people ask me how I do it.
Do I sell shares in order to pay the rent? Or do I pick dividend stocks?
The answer is that I do something completely different.
I do a particular kind of options trade that creates an income flow.
I follow the principles of value investing when doing these trades. I look for undervalued companies and analyze them.
The great advantage of my method is that I can live off my shares without having to sell them.
It doesn’t hurt my portfolio and doesn’t set up barriers for compound interest rates.
This is the secret method that I don’t usually talk about in my blog posts because people can get it horribly wrong if they do it uninformed.
Where did I get the inspiration for this method? From Warren Buffett himself.
It’s a public secret that Warren Buffett is one of the biggest stock options traders in the world.
Why is it a secret?
Because he doesn’t talk about options.
One thing is what Warren Buffett does and another is what he recommends his followers do.
He tells his followers to invest in an index fund. But that is pretty far from his own value investing and stock picking style.
Why does Warren Buffett never talk about his options trades?
I believe it’s for the same reason I avoid it.
I’m afraid people will google “options” and do it wrong and lose a lot of money on it. You have to know what you’re doing if you move into options – or you might put a lot of money at risk.
There is only one place where I talk about options, and that is in my courses.
I’ve been teaching this stuff for years in Danish, and more than 150 people have attended my 8-12 week long courses.
This fall I will launch my first course in English.
Make sure you’re on my email list if you want to be invited to my next webinar where I tell you about my upcoming online value investing courses. If you download my e-book, you can say yes to receiving emails.