Charlie Munger, the renowned investor synonymous with much of Berkshire Hathaway Inc.’s (BRK.A, BRK.B) enduring triumph, deemed reaching a savings milestone of $100,000 pivotal in the pursuit of financial freedom. As he once emphasized:

The first $100,000 is a *****, but you gotta do it. I don’t care what you have to do – if it means walking everywhere and not eating anything that wasn’t purchased with a coupon, find a way to get your hands on $100,000.

In this article, we will explore why Mr. Munger’s $100,000 passive income snowball holds such significance, the types of stocks to seek in making this a reality, and then present a straightforward 5-stock portfolio that can significantly contribute to this realization.

The Potent Force of Charlie Munger’s $100,000 Passive Income Snowball

The rationale for why $100,000 signifies a crucial milestone is that at this juncture, the investment portfolio begins to yield substantial returns that, when reinvested, commence generating significant returns of their own. Thereby, diminishing the need for additional investment from actively earned income to sustain the portfolio’s growth. For instance, when an investor garners a 10% annualized total return – a reasonably realistic expectation for well-diversified indexes like the S&P 500 (SP500) over the long term – the reinvested earnings on a $100,000 portfolio could deliver over $1,000 per year in additional income. This underscores the formidable power of compounding and how, once an investment portfolio attains critical mass, it evolves into a potent wealth creation engine that necessitates minimal external investment.

The omnipotence of compounding through reinvested investment profits is particularly conspicuous with high-yielding dividend stocks as they offer a dual benefit: a steady income stream via dividends and the potential for capital appreciation. Unlike strategies reliant on asset liquidation (e.g., the 4% Rule), investing in dividend stocks furnishes income without depleting the principal. Furthermore, these stocks often engender intrinsic value growth and dividend payouts, allowing investors to retain some of their dividend payments and reinvest them in procuring additional shares of high-yielding dividend stocks. This approach helps mitigate the risk of income shortfall due to market volatility that plagues many retirees, ensuring the longevity and sustainability of one’s retirement portfolio.

However, not all dividend stocks are created equal. To optimize the effectiveness of a strategy centered on constructing a portfolio of high-yielding dividend stocks, it is advantageous to adhere to specific criteria when selecting dividend stocks. These encompass opting for stocks with robust and resilient business models, sound balance sheets, secure and burgeoning dividend disbursements, and substantial current dividend yields.

Stocks in sectors such as utilities (XLU), midstream energy (AMLP), real estate (VNQ, RQI), and business development companies (BIZD) often furnish stable cash flows and relatively robust resilience against economic downturns, while also bestowing high dividend yields, rendering them ideal for nurturing a passive income snowball.

Furthermore, companies with minimal debt levels, strong liquidity, and conservative payout ratios are less inclined to slash dividends during economic downturns, ensuring a dependable income stream for retirees. Another essential metric is an extensive track record of consistent and escalating dividends, indicative of a company’s capability to not only sustain but also augment its dividend disbursements through thick and thin, thus, making it a dependable passive income generator that can counteract the incessant erosion of purchasing power from inflation. Ultimately, a higher initial yield diminishes the necessity for aggressive future dividend growth, thereby expediting the timeline to retirement.

Strategies for Constructing a Powerful Passive Income Snowball with $100,000

To foster a formidable passive income snowball, all that is requisite is a quintet of stocks: a real estate investment trust (“REIT”), a business development company (“BDC”), a midstream company, a dividend growth ETF, and a high-yield ETF. The ETFs confer substantial diversification to the portfolio, the dividend growth ETF endows it with appealing long-term dividend growth, the high-yield ETF furnishes it with ample current yield, and the REIT, BDC, and midstream company dispense an enticing amalgamation of the two while further extending its diversification (given that the dividend growth and high-yield ETFs under scrutiny lack meaningful exposure to these sectors). Without further ado, here are our selections:

With ENB, FSK, and O, investors acquire among the largest investment-grade high-yield companies in their respective sectors, each boasting strong fundamentals, well-covered quarterly dividends, relatively resilient and durable business models, and ample diversification, rendering them fairly stable investments across various business environments. O stands out as the most durable and defensive, followed by ENB, with FSK being the riskiest, hence the allocation of one-third the amount to FSK compared to O and ENB.

For investors desiring additional risk mitigation, further diversification is easily achievable by either investing in the aforementioned ETFs for each sector or including a few more blue-chip stocks in each sector, such as Enterprise Products Partners L.P. (EPD) and Energy Transfer LP (ET) for midstream businesses, Main Street Capital (MAIN) and Ares Capital (ARCC) for BDCs, and W. P. Carey Inc. (WPC) and Agree Realty Corporation (ADC) for triple net lease REITs.

JEPI represents our high-yield ETF, combining exposure to mega-cap tech stocks and other holdings in SPY with a covered call strategy yielding lucrative monthly payouts. Investors can further diversify high-yield ETF exposure by investing in preferred ETFs (PFFA).

Ultimately, we selected SCHD as the core of our passive income snowball because, as we recently elucidated in detail, it merges broad diversification, quality, and dividend growth, with attractive long-term total returns, while still yielding sufficiently high current yield to seamlessly integrate with a high-yield portfolio.

We appreciate that this portfolio amalgamates an attractive current yield (6.3%) affording investors a robust head start on retirement, while remaining poised to generate 4% annualized dividend growth that outpaces inflation.

Insights for Investors

Mr. Munger promulgated invaluable wisdom when he urged individuals to toil diligently to establish a foundational nest egg, thereby setting the stage for the magic of compounding to operate in their favor as expeditiously as possible. Once one attains a six-figure investment portfolio judiciously invested in dividend growth stocks, the landscape shifts, contingent more on time than personal effort from that point onward. By seamlessly fusing hard work and disciplined saving with a prudently diversified portfolio of REITs, MLPs, BDCs, high-yield and dividend growth ETFs, and other high-yield/dividend growth stocks, anyone can realize long-term financial freedom and a prosperous retirement.