June 1, 2021
Updated: June 2021. Original post: February 2020.
Peter Thornhill is well-known for his dividend investing strategy and his book Motivated Money, but there’s no official step-by-step guide to implement his method.
So, with Peter’s approval, I decided to create this ‘how-to’ article, for those who want to get started and put the strategy into practice.
By the way, if you haven’t already, check out my earlier interview with Peter Thornhill.
Before we begin, a caring disclaimer: Nothing here is personal advice. This strategy may not suit you for a variety of reasons. Please do your own research before making investment decisions.
For those unaware, here’s a few quick facts for context.
To boil the strategy down to a simple core concept, it’s this: Investing for a growing income stream.
Sounds simple, I know. But somehow people manage to butcher it and have all sorts of pre-conceived notions about how to do it.
The strategy is implemented by investing in a diversified portfolio of dividend-paying shares. The basic premise is that over the long term, a broad group of Australian businesses will earn higher profits, and will pay higher dividends to shareholders over time.
As the investor buys more shares, and the dividends increase over time, this income will grow to the point where the investor can live off the dividends which the portfolio spits out each year.
While his strategy may not be for everyone, it’s certainly an effective long term method for building wealth and a nice income stream.
Okay, enough intro. I’ve boiled Peter’s philosophy down to 10 simple steps.
You’ve heard this before, it’s called saving money. And it’s a huge fundamental pillar in building wealth over time.
Saving is like eating your vegetables. It’s easy to shrug off saving as boring and uninspiring. But it’s very important. No matter our income level, we need to focus on saving at least some of our income.
So, suck it up and eat your damn vegetables. Saving is the most important factor.
This sounds simple, but almost nobody does it! In Australia, we seem to love housing so much that we borrow to our limit to buy the best place we can possibly afford.
If we really get to the core of this message though, it means buying a moderately priced home to live in. Or rent. This keeps your total cost of living down and enables you to save and invest more.
And if you’re renting and using debt to buy shares, it means use that debt sparingly.
The goal is to own a portfolio of productive businesses which earn plenty of cash and send some of it our way each year in the form of dividend payments.
Luckily, there are ready-made baskets of companies we can buy in one hit. One way is to buy all of them, via a low-cost index fund ETF that tracks, say, the top 300 stocks.
He strongly prefers to invest in low fee LICs over ETFs – especially those which have been around a long time.
These LICs invest in a broad group of Australian companies (often 50-100+), which they expect to do well over time and pay increasing dividends.
They’re low cost, long term focused and have low turnover. This means they’re tax efficient as they don’t buy and sell often.
At this point, all investors need to do is open a brokerage account, choose a fund (or a couple) to invest in, and get started.
If you’re not sure how to buy shares, read my Beginners Step-by-Step Guide on How to Buy Shares (with Screenshots).
Once you’ve bought some shares, something fantastic will happen. Every 6 months or so, you’ll get a lovely cash dividend deposited into your bank account.
This dividend is a portion of the profits from all the companies in the fund you’ve invested in. As an owner, naturally some of the money is sent to you, while the companies use the rest to further grow their businesses and future profits.
At this point, you can spend it at the pub or your local cafe. But the best option is to simply put this cash towards buying more shares.
This increases your piece of the pie and means your future dividends will now be larger! This is compound interest at it’s finest.
Peter Thornhill is also a fan of debt recycling.
Basically, if you’re investing and also paying off your home, it’s possible to slowly convert your mortgage into an investment loan. And being an investment loan, the interest is then tax deductible.
But many people get different parts of this concept confused, so a strong understanding is needed before going down this path. Read more about it here.
If it suits you and your personal situation, then debt recycling can be very tax efficient. But keeping things simple is pretty cool too.
Use your monthly savings and your increasing dividends to continue growing the portfolio. Because dividends naturally increase over time (due to rising company profits) and you’re constantly adding more money, your annual passive income will increase at a healthy rate.
Sure, the markets and dividend payments will take a few steps back once in a while. But the long term trajectory is overwhelmingly likely to be up, as it has been throughout history.
While it takes time, eventually this income will grow to be larger than your annual spending. It mostly depends on how much cash you’re putting in – your savings rate!
You’ll also want to keep some cash, to top up your income in retirement when times aren’t so good. Peter recommends a couple of year’s worth of expenses. So if you spend $50k per year, perhaps $100k is a good starting point.
It’s also prudent to maintain flexible spending and spend less during scary times (which is a natural reaction for most people anyway). This means you won’t have to dig into your cash buffer as much and makes your financial position more resilient.
Hooray! You’re officially retired! If you make it this far, a hearty congratulations are in order!
At this point, you’ve got a healthy-sized portfolio and a decent cash buffer. You can now live off your passive income. Your only job is to manage your income and expenses, which you’ve been doing for a long time already.
If dividends fall due to lower company profits from an economic shock of some kind, you can use your cash and spending flexibility to plug the gap comfortably for many years until dividends steadily recover.
Fortunately, LIC dividends also tend to be more resilient than the market as a whole, which is likely to be a good source of comfort during any scary periods.
You’re now free to live your life as you see fit. Use your unlimited free time to spend on the things most important to you.
Whether it’s quality time with your family, improving your health, enjoying your hobbies, learning new things, starting a part-time job or volunteering, spending time outdoors in nature, or just kicking back and reading articles on your favourite site *cough* Strong Money Australia.
Anyway, you get the idea. It’s your retirement, so do whatever you like! Now, that’s typically where the story ends for Peter’s strategy. But there are two other things that both Peter Thornhill and myself think are extremely important to add.
With any luck, your portfolio will continue to grow over time as you simply live off the income stream. It’s important to consider that, on average, company profits and therefore dividends increase faster than inflation over the long term.
And if you’re even half-good with your money, your portfolio’s income may be growing a bit faster than your overall spending. This is fantastic news!
Because if you manage this extra wealth and income well, it allows you to give back to causes that are important to you.
You might’ve seen in one of my portfolio updates that I’m trying to increase charitable donations each year at a slow and steady pace. I got this idea from Peter, who not only gifts during his and his wife’s lifetimes, but has planned to put half of their estate into a charitable trust which will donate the increasing dividend income each year to causes important to Peter & his wife.
With your experience, free time and ‘proof’ that the sharemarket is not a crazy gambling machine, you’re then in a perfect position to help others see the benefits of long term share investing.
If you can help one person see that their future doesn’t have to be solely dictated by their workplace and whatever pension is being handed out in 20 year’s time, you can consider that a success!
It’s human nature to want to help others. But we’ve got to help ourselves first. Once people can see the progress in your own life, they’ll be more willing to listen (no guarantees though!).
Now that we’ve got the basic steps covered, there may be some questions, especially from any newbies.
Some people often get Peter Thornhill’s strategy confused. So, I want to discuss what to avoid. As strange as it sounds, this is likely to provide answers to some common questions.
By approaching things from the opposite side, it can often help us see more clearly how to make better decisions. This is by no means an exhaustive list, but are what I feel is worth mentioning.
Rather than focus on high yield today, focus on getting the highest income over time. This means you can’t just own a bunch of high yield stocks or funds.
You need to own companies that are growing, because that’s what will drive your growing income in the long run.
Luckily, the LICs mentioned own a diverse portfolio of companies with different levels of growth and yield. The result is, a decent dividend stream which grows steadily over time. More on this topic: Everything You Need To Know About High Yield Investments.
You don’t know what’s going to happen to the markets tomorrow, next month, or next year. I certainly don’t. And neither does anybody else.
So don’t bother trying to guess what’s coming next. Focus on what you can control – saving money and increasing your ownership of a large group of companies. That’s where results come from.
Of course, this doesn’t stop you from trying to invest more, if you notice the market is down -20% or more, for example. But playing the waiting game and hoping for better prices to come around is rarely a good approach.
Further reading: Timing the Market: Silly or Sensible?
Special comment from Peter Thornhill: A personal experience of mine. Following the GFC, CBA’s share price fell from around $65 to a low of around $25. At $50 I thought, “what a bargain” and bought more. They fell to $40 and I swallowed hard and bought more. At $26 they offered us new shares. I gritted my teeth and bought more.
Whenever I related that story the reaction from most people was, “why didn’t you wait and buy them all at $26?” My response was, “well, I didn’t have you nearby to tell me the right time!” Do any of those purchases look silly with the share price now at $84 and 12 years of increased dividends?
Avoid competing with your peers, or other speculators you see touting their recent performance.
This will lure you into straying from your strategy, or chasing whatever hot stocks have done well recently – a disaster waiting to happen. Be satisfied with steady progress and focus on your long term investment strategy.
Your investments should be simple, so you can spend time on more important things, like family, friends, work and hobbies.
A few diversified funds will likely get the job done just as well as any fancier approach. Creating a complex portfolio may give you something to do, but it typically won’t make you wealthier.
The best part is, by following a simple long term investment strategy, work will eventually become optional and you can then devote time however you please.
And it’ll be because you made money work for you… not the other way round!
As Peter Thornhill is fond of saying “Do not become a slave to your money. Make money your slave.”
Yes, it’s exciting to see money coming in and your portfolio growing. But don’t be sucked into watching every single movement, up and down.
This delivers no value to your life and typically causes more pain than joy, since unless shares are at an all-time high on the day you’re looking, you’ll be disappointed.
So log into your brokerage account, buy your shares, and go do something else! Remember, each dollar is an employee working for you. But they don’t work harder just because you’re watching them!
This may seem like a strange tip, but for a long term investor, the news does more harm than good.
The media has no interest in helping you achieve your long term goals. Their only interest is eyeballs and clicks.
Besides, even if the stories were accurate, they are very short-term in nature. This means they’re largely irrelevant for people like us who should be thinking in terms of many, many decades.
Well, now you know all about Peter Thornhill’s investment strategy and how to follow it in practice.
It’s all pretty simple. But if you have other questions, they’ve likely been answered in my full interview with Peter Thornhill.
In my view, many of the points mentioned here are important, whether you decide to follow Peter’s investment strategy or not.
Save and invest in a low cost, low turnover, diversified basket of shares. Focus on the growing income stream, instead of the daily prices. And think in terms of decades and generations, not months or even a few years.
By the way, if you’re interested in the spreadsheet I use to keep track of my annual dividend income, you can get a copy of it below…