Let’s talk about the Metronome Portfolio.
You probably know what a metronome is, right?
It’s a musical device that keeps tempo when playing an instrument. The Metronome Portfolio is divided into three major parts and has four foundational legs.
By the end of this video, you’ll learn how to build the ultimate dividend portfolio that can genuinely improve your life. It may sound like an exaggeration, but you’ll see what I mean. We’ll start with the foundation or the legs of the metronome, and you should too if you’re interested in building this type of portfolio.
The Four Legs
The foundation consists of four legs, and it’s crucial to have all four of them securely in place. Without them, the whole structure will be unstable and could potentially collapse. So, before you start investing and building the Metronome Portfolio, make sure you have these four legs sorted and securely established:
- Income
- Emergency fund
- Knowledge
- Emotional balance
Let’s go through each point individually so I can stress why each one is important and how they are interconnected.
Income
It may seem obvious, but you need income to start investing using this model. The amount you can invest is proportional to the income you receive and the percentage of that income that you can save. Increasing your income should be your first priority, as it will have a significant impact on how much you can save and ultimately invest.
For example, a 10% return on $10,000 is $1,000, but if you can only save $5,000 in a year, you would need a 20% return to achieve the same outcome.
Increasing your income and the percentage of money saved should outweigh the focus on optimizing investment returns, especially in the beginning stages.
Emergency Fund
Before moving on to the next step, it’s essential to have an emergency fund.
This fund provides a safety net and ensures that you have money readily available in case of unexpected events. It prevents the need to withdraw from your investments and helps maintain the compounding and growth of your portfolio.
Additionally, having a significant amount in your bank account gives you the confidence to take bigger risks in life, career choices, and investing.
Whether you want to relocate, switch careers, or start a business, having savings provides a cushion and support during transitional periods.
Determining the size of your emergency fund depends on how long you think it would take to find a comparable job or overcome a financial setback. Typically, it’s recommended to have three to six months’ worth of expenses, but you should consider your specific circumstances. If you’re confident in finding another job quickly, keeping two months’ worth of expenses might be sufficient. However, if job opportunities are scarce or your salary is high, you may want a larger emergency fund to sustain you during challenging times.
By prioritizing income and building an emergency fund, you’ll be in a better position to contribute more of your income to investments.
The emergency fund provides peace of mind and acts as a buffer before tapping into your investment portfolio.
Knowledge
One of the most cliché pieces of advice on financial YouTube is the importance of knowledge before you start investing.
While it’s true that knowledge is necessary, depending on who you’ve been listening to, you might need to unlearn some things. So, why is knowledge important? Well, no matter how much effort you put into something, if you’re heading in the wrong direction, it won’t matter.
Let’s illustrate this with a silly example.
Tim’s friend tells him that they will play tennis over the weekend, and he’s confident he will win because Tim has never played tennis before and probably doesn’t even know the rules. Tim decides to do some research and turns to TikTok, the modern database of experts on every topic.
The first tennis video he watches demonstrates a guy hitting a between-the-legs shot at a target. Tim goes outside and starts practising these between-the-legs shots, even looking into the equipment he needs for the game.
On Instagram, he sees a guy promoting special trainers with three levels, where the first level doesn’t have any soles, forcing you to walk barefoot. The higher levels require a monthly payment, even if you don’t play tennis that month, but you do get a free tennis ball if you sign up.
When the weekend comes, Tim’s friend annihilates him embarrassingly. Tim’s friend has been playing tennis for years, had a coach, and read books on tennis. He started off on the right track and put in the time and effort to become the best. Tim could train for another 10 years, but if he continues with his current strategy and direction, he will only get further from his goal rather than towards it.
So why did Tim perform so poorly? He was following information that didn’t apply to his specific goal. He wanted to play competitively with his friend, not show off fancy between-the-legs shots.
This is why it’s crucial to have a solid understanding of your strategy, comprehend how investing works at a fundamental level, and grasp what it means to be a shareholder before you start investing your money.
Many people were confident in 2020 and 2021 but are now facing a 70% loss and re-evaluating their desired direction.
And this brings us to the final leg.
Emotional Balance
The last leg for the base of the metronome is emotional balance.
You need to be mentally prepared for your portfolio to experience a 50% downturn at some point.
It’s as simple as that.
However, it’s not easy to see months or years of progress vanish due to market fluctuations.
But you must be prepared for it.
People often say “buy the dip” or “buy when there’s blood in the streets” during good times, thinking they will act accordingly when the market turns.
However, when the time comes to implement this strategy, many get scared and start making anonymous posts on Reddit, asking if they should sell before it gets worse.
Achieving emotional balance is simple in concept but certainly not easy in practice. Nevertheless, it is a crucial step before you start building your metronome portfolio. While we won’t delve into the details here, remember that emotional balance is an important aspect to consider.
With the foundational legs of the structure in place, we can now move on to the more exciting part of the base.
The Base
This section of the overarching portfolio is represented by the base part of the metronome.
It is the thickest part of the portfolio, providing support for the rest, and narrows as it goes higher. It is accompanied by a ticker that moves from side to side, producing a ticking sound. This part represents the dividend component of your portfolio.
- The base consists of investments that form the foundation and support the higher levels of your portfolio.
- The ticker symbolizes the dividends you receive, with each tick representing money being deposited into your bank account.
- The speed at which the metronome moves, as well as the dividend frequency, can vary depending on your settings.
Monthly-paying stocks or portfolios focused on almost daily dividends will result in more frequent dividend payments, making the metronome move faster. On the other hand, quarterly-paying stocks or dividend experiments with an average speed, while investments in private or certain European companies that pay annual dividends will set the metronome to a slower pace.
To work with this section effectively, the first step is to calculate your minimum viable lifestyle.
Minimum Viable Lifestyle
This concept is similar to the minimum viable product used by startups when entering a new market or starting a new business.
In this case, you need to determine the absolute minimum quality of lifestyle that you would reasonably accept without negatively impacting your mental health. It should be a level of living that you could tolerate if you were put in that position.
The minimum viable lifestyle calculation varies depending on your life circumstances.
For example, as a student, your figure would be lower as you are used to living cheaply. If you’re already working with a high salary, your minimum viable lifestyle target would likely be higher.
Factors such as living with parents, moving abroad, or having dependents can also influence this figure.
The calculation is personal and should reflect the lowest lifestyle you are willing to accept.
For instance, if your minimum viable lifestyle figure is £500 per month, your annual requirement would be £6,000. If it’s £1,000 per month, your annual requirement would be £12,000. And if it’s £2,000 per month, your annual requirement would be £24,000. Remember, this represents the minimum viable lifestyle, not your desired retirement lifestyle.
Next, you need to consider dividend calculations based on your desired level of safety or conservatism. The most conservative approach is aiming for a 4% yield, which aligns with the Trinity Study’s safe withdrawal rate often discussed in the financial independence/retire early (FIRE) community. However, you can choose a more aggressive approach.
In the example, if the target average portfolio yield is 5.5%. To determine the total amount required for this segment, divide your annual requirement by the yield percentage. For a £12,000 annual requirement at a 5.5% yield, the target would be approximately £220,000. The same calculation applies to the £6,000 and £24,000 annual requirements.
These figures may change in the future based on personal circumstances, but it’s essential to have a current target. The base part of the portfolio can utilize strategies such as The Dividend Experiment portfolio and the 10 Dividend Investing Commandments. It could also accommodate the almost daily dividends, potentially used to cover your minimum viable lifestyle.
If you’re in the UK or a similar location that offers an ISA (Individual Savings Account), it’s ideal to allocate this part of the portfolio to your ISA. Since you’ll be receiving frequent dividend payments, it simplifies tax reporting.
There are three points at which it makes sense to move on to the next part of the portfolio.
- When you reach your minimum viable lifestyle target level.
- When you reach the ISA limit threshold and want to invest more in a tax-optimized way within the current tax year.
- When you want to invest immediately but find that no dividend stocks meet your criteria or appear appealing enough.
Understanding and effectively managing the base part of your portfolio is crucial, although it may seem complex at first.
The Middle
The middle section of the portfolio can be seen as the overflow area. This is where any extra money you have after diligently working towards your minimum viable lifestyle target in the base section should be allocated. If you’ve already filled your ISA (Individual Savings Account), the excess money goes into the middle.
However, it works the other way as well. If, in year one, you filled your ISA and started putting money into the middle, some of it can be moved back out in year two and allocated to your next year’s ISA allowance.
The middle section is also where you’ll be allocating money for retirement once you’ve achieved your minimum viable lifestyle target. Therefore, it should be stress-free and tax-optimized, serving as a place to store medium to long-term funds without excessive monitoring.
To achieve this, it is recommended that the middle section consists of 100% accumulating ETFs (Exchange-Traded Funds), preferably broad-based index funds. ETFs provide an easy way to diversify your investments by offering a basket of different stocks within a single stock. For example, an ETF like VUA G represents a basket of the top 500 stocks in the USA, all packaged as one stock that can be easily bought and sold.
Managing 500 individual stocks would be cumbersome, but condensing them into one ETF makes it much simpler. ETFs are the epitome of a set-and-forget approach. For those seeking the easiest option for this section, an ETF like VWRL (which contains the world’s biggest companies across continents) can be a suitable choice. By investing in ETFs, you have exposure to the global economy, benefiting from its growth over time.
One advantage of buying ETFs in this section is that you can essentially buy them at any time since they represent the entire market. It becomes difficult to find specific bargains, but by consistently averaging and buying regularly, you can take advantage of the market’s long-term upward trend.
In contrast to the base section focused on dividend portfolios where value hunting is emphasized, the middle section is more about buying and not overthinking.
This section is also a suitable place to include your pension investments. While it won’t provide income immediately since early access is restricted, pension investments typically involve these types of funds and ETFs. If you have a SIP (Self-Invested Personal) or Lifetime ISA, they would also contribute to this section of the portfolio.
Once you achieve your minimum viable lifestyle target, the period between then and your retirement goal should be dedicated to accumulating as much as possible in the middle section. Eventually, you will transition these funds into the base section without triggering capital gains tax, effectively increasing your income from the minimum viable lifestyle level to a retirement income level.
At the beginning of your journey towards accumulating a metronome portfolio, this segment may not be substantial unless you have a high income or a relatively low minimum viable lifestyle target. So, if you’re not filling up this section yet, there’s no need to worry.
When filling up the middle section, you have the flexibility to customize the ETFs according to your preferences. However, it’s advisable to establish a general weighting that is mostly set once and then rebalanced periodically, instead of constantly tweaking it. The middle section is primarily about setting and forgetting, allowing you to maintain your sanity on the path to financial freedom and, ultimately, retirement.
This approach stands in contrast to the final segment, which represents the tip of the metronome.
Tip of The Metronome
The final part of the metronome portfolio is the tip, which serves as a contrast to the other sections. It acknowledges the human nature of wanting to take higher risks for potentially higher rewards. This section includes high-risk, high-reward plays that may tempt you, such as hyper-growth stocks, penny stocks, moonshot-type plays, and even cryptocurrencies. However, it’s important to keep the tip to a minimum percentage of your overall portfolio.
It is recommended that the tip section should not exceed 5% of your total portfolio, preferably less than 3%. If you prefer to skip this section entirely, that is entirely up to you and can be a wise decision. However, many individuals enjoy taking bigger risks or exploring moonshot opportunities with significant potential rewards. The key is to manage these risks in a way that won’t jeopardize your entire portfolio or hinder your overall progress.
The reason the tip section is not extensively covered in the Dividend Experiment YouTube channel is that it can be irresponsible to showcase the tip content without explaining the rest of the portfolio. Additionally, the creator of the channel is currently not actively engaged in activities related to the tip section, with their current portfolio allocation being zero per cent in the tip.
The Purpose of the Metronome Portfolio
The metronome portfolio may seem more complicated than a pure dividend portfolio or a simple buy-and-hold index fund approach until retirement. However, it offers several benefits:
Preparation for Early Retirement
The metronome portfolio allows you to prepare for early retirement without suddenly transitioning from buying to selling investments. By achieving your minimum viable lifestyle target and targeting a higher retirement income, you can either increase the base section with dividend payments and compound them or funnel money from the middle section towards the base.
This gradual transition into retirement income eliminates the need for a sudden change and ensures that your living quality remains unaffected during economic downturns.
Unrestricted Potential
Unlike targeting specific dividend-paying companies or higher-yield dividend payers, the metronome portfolio removes the need to beat the market. By buying the market through ETFs, you can benefit from market downturns rather than being taken advantage of. This approach provides a low-stress addition to your primary goal of generating income.
Fun and Enjoyment
The metronome portfolio offers a more engaging and exciting journey compared to the perceived “boring middle” phase of financial independence and retirement planning. You can experience the dopamine hit of tangible progress as your dividends increase year by year. Additionally, when dividends are received, you have the flexibility to decide how to spend and invest them based on the prevailing market conditions.
The tip of the metronome allows thrill-seekers to explore more exciting investment opportunities with a small portion of their portfolio, providing an extra level of enjoyment and motivation to stay on track.