income investing

Sooner or Later…

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When I was a young man, my father told me that the mortality rate is 100 percent. I apologize for speaking so plainly, but sooner or later there is a funeral in store for every one of us.

This sad fact weighs on many of the financial decisions we make later in our lives. The issue is that we never get to know ahead of time when our funeral is going to be. A new retiree might live another forty years, or they might not live to see their next birthday. Plans that make sense for one scenario may not make sense for the other, and we do not get to know which scenario we will face.

When possible, we prefer to invest for retirement on a sustainable endowment-style basis, aiming to generate portfolio income to live on rather than spending down principal: “owning the orchard for the fruit crop.” The longer you can maintain your principal, the less likely it is that you will outlive your money. This approach also has the advantage of leaving a legacy intact to pass down to your heirs, if that is a priority for you.

But not all of us are fortunate enough to be able to comfortably retire on portfolio income alone. And not everyone is content to lock away a lifetime of earnings without getting the enjoyment of spending it themselves. Spending your principal is also an option if you want to live more luxuriously, although this increases the risk of outliving your money—you may wind up merely trading future comfort for present pleasures. The decision you make at 65 may haunt you at 85.

None of us knows the future, life has a way of getting in the way of our best laid plans. Our preference is to plan for a long, healthy life: we believe it is better to have money and not get to spend it than it is to need money and no longer have it. But ultimately, the choices you make about retirement are a matter of which risks you’re comfortable with. Figuring out your priorities is your job. Once you know what you want to do, talk to us and we’ll see if we can help you try to do it.

New Balance for Your Portfolio

Our recent article about finding your strategy provoked interesting conversations. We quickly saw a new framework for investors to reconcile competing needs and desires. This article puts context around the three central tradeoffs investors face.

Current Income or Long Term Growth?

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Fortunately, there are investments and strategies that offer the opportunity for long term growth while providing current income. Dividend-paying blue chip stocks are the best example. While suitable as part of an appropriate portfolio for many people, growth with income investments do not provide stability of market value, part of the next tradeoff.

Stable Value or Long Term Growth?

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While most people might prefer stability AND growth, it isn’t possible to have all of both. The best we can do is some of each. We ceaselessly seek to inoculate clients against fear of downturns, which are an inherent part of long-term investing. Behavioral Economics suggests that the price of stability is too high And yet most people need some ‘money in the bank’ or stable value holdings. They serve as emergency funds and also build confidence in your investments.

Stable Income or Stable Value?

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This may be the most under-utilized concept in the financial world. Investments that provide reliable recurring income fluctuate in value. And investments that deliver stable value do not provide reliable recurring income. Those now planning to retire have seen a vivid example in their lifetimes. Bank deposit interest rates have ranged from more than 1% per month at times to less than 1% per year at other times. In other words, the value was stable but the income was not.

The key concept here is that people living on their capital do not spend statement value to buy groceries or pay the electric bill. Portfolio income is the key to the monthly budget. Therefore, reliability of income could be more vital than stability of value.

Putting it All Together

We can do a better job of managing our goals when we understand that reliable income and long term growth provide opportunities that stable value holdings do not. Think about these ways to build a portfolio that you can live with:

  • Set aside an emergency fund so you are prepared for the unexpected.
  • Know where your income is coming from for the months and years ahead.
  • Plan for rising cost of living with a certain amount of growth potential.

These are major issues, requiring some thought and discussion. We are available; write or call to set an appointment when we can discuss your situation.


The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results.

Stock investing involves risk including loss of principal. The payment of dividends is not guaranteed. Companies may reduce or eliminate the payment of dividends at any given time.

Inflated Expectations

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Back in 1970, gas was 25 cents a gallon and you could buy a liter of Coca-Cola for 15 cents. We all know that money is not what it used to be. When planning for the future, we need to remember that our money is not always going to be what it is now, either.

Conventional monetary policy aims for “normal” levels of inflation in the low 2-3% range per year. That may not sound like much, but it adds up. At this level of inflation, prices double approximately every 30 years. If you bury a dollar in the ground and dig it back up in 30 years, you can expect it to only buy half of what it could buy today.

For some people, this is fantastic news. If you take out a mortgage to buy a house, it gradually becomes easier for you to pay it off over the lifetime of the loan. At the end of a 30 year mortgage you’ll still be paying off the same amount, but the prices of everything else (including your wages) will have doubled. A small amount of inflation gives people incentives to invest and take risks with their money, helping make the economy more productive.

If you’re planning to retire on fixed assets, however, inflation poses a serious threat to you. With advances in healthcare it’s not unreasonable to expect new retirees to live another 30 years. After thirty years of inflation your retirement assets will only buy half as much in groceries and rent. Retirement funds that seem generous when you’re 65 may leave you in dire straits when you’re 95.

The simplest way to fix this is just to have more money than you’ll ever need—it doesn’t matter if your money loses spending power if you have even more money to spend. Of course, this is easier said than done! Saving diligently and spending wisely will only take you so far. If your retirement bucket isn’t big enough to weather inflation, you need to be able to grow your bucket. A balanced growth and income portfolio can potentially give you retirement income while still having some growth possibilities.

There are no guarantees; the future is full of uncertainty. Growth-oriented holdings can be volatile, and it takes steady nerves to watch the value of your retirement holdings going up and down. If you can tolerate it, though, including growth holdings as part of your retirement portfolio can give you a chance to stay ahead of inflation.


The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.

There is no guarantee that a diversified portfolio will enhance overall returns or outperform a non-diversified portfolio. Diversification does not protect against market risk.

Annual Market Forecast

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It is that time of year. Prognosticators and pundits issue their forecasts for the year ahead. Wouldn’t it be nice to know what the future holds! Some forecasts are hedged, and don’t really say much. Our prediction is quite specific.

Many of those who have visited our offices know that we actually do have a crystal ball. It forecasts the direction of the stock market for the coming year. It does not say how far the market will go, but it always predicts the direction.

If you knew which way the stock market was going to go, could you make money investing?

Here’s the catch: our crystal ball has only been 76% accurate. So perhaps the question should be, if you knew which way the stock market was going to go 76% of the time, could you make money investing?

Without further ado, here is what my crystal ball says about the direction of the stock market for the year beginning January 1: it will go up.

Long-time observers will not be surprised. The crystal ball always says the market is going up. It has never predicted a down year. And checking back over the past hundred years, according to Standard & Poor’s, it has been right 76% of the time.

We don’t know how well its track record will hold up, but we believe this presents a favorable backdrop to buy bargains, avoid stampedes in the markets, and seek to own the orchard for the fruit crop. In other words, to keep on keeping on, following our plans and strategies.

It is tempting to include a discussion of the economy, the strengths we perceive, and the faint possibility of recession. We’ll leave that to people with more time on their hands. If your plans or planning will be evolving in the new year and require our attention, please call.


The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.

Investing involves risk including loss of principal. No strategy assures success or protects against loss.

Our Three Principles, or Postmodern Portfolio Theory

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We recently wrote about the conventional investment wisdom, as embodied in Modern Portfolio Theory. No surprise here: we don’t like it. The pie charts, talk of asset classes and correlation…it is all wonderful until it isn’t. Our alternative approach relies on three fundamental principles. We believe they apply in every season.

Our first principle, avoid stampedes in the markets, is based on our understanding that the stampede is usually going the wrong way. There was a stampede into tech stocks in 1999, which ended badly. There was a stampede into real estate in the early 2000’s, which ended badly. There was a stampede into commodities after that, which ended badly. In short, major peaks are usually accompanied by a stampede of money that drives prices to extremes.

Our second principle, seek the best bargains, lets us sort “the market” into its pieces. The three major asset classes are stocks, bonds, and cash alternatives. Cash and its alternatives currently earn practically zero-point-nothing interest rates; bonds are barely better. Diving one level deeper into stocks, we find that some sectors and industries are expensive and others appear to be bargains.

Our third principle is to seek to own the orchard for the fruit crop. Portfolio income is an important component of total returns, and those among us who rely on our portfolios to buy groceries surely understand the importance of cash income. As noted above, interest rates remain very close to zero—we do not believe that bonds or cash alternatives are a good way to generate income these days. But we are currently enjoying generous dividends from many companies in the bargain sectors, including the oil and natural resource companies. Other holdings purchased in past years continue to pay regular dividends, from pipelines to telecom to auto stocks.

We must note that, in actual practice, these principles require patience. One should always know where needed cash and necessary income will come from. Please see our post ‘The Fruits of Investment (link)’ for a fuller treatment of the three principles in action.


The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. We suggest that you discuss your specific situation with your financial advisor prior to investing. All performance referenced is historical and is no guarantee of future results.

There is no guarantee that a diversified portfolio will enhance overall returns or outperform a non-diversified portfolio. Diversification does not protect against market risk.

Investing involves risk including loss of principal. No strategy assures success or protects against loss.

Can Investment Arithmetic Buy Your Groceries?

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One of the enduring concepts used by successful retirees and endowment funds alike is the idea that portfolio income is what pays the bills, not portfolio market value. Market values change from day to day and minute to minute. As we’ve written before, “Own the orchard for the fruit crop.” It helps one’s sanity to focus on the fruit crop (portfolio income), not the value of the orchard (market value.)

Imagine a company, XYZ Widgets, whose shares trade for $100 per share and pay annual dividends of $3 (a yield of 3% annually on the stock price.) The price of XYZ stock can go up or down in the short term, but historically there is little correlation between changes in the market price and changes in the dividend.

Let’s imagine that XYZ stock falls to $50. While companies may sometimes cut dividends they are often reluctant to do so, so XYZ may continue paying $3 per share. Despite the drop in stock price, shareholders would still get the same $3 with which to pay their bills. In fact, XYZ may then be an even better prospect for income investors: at $50 a share, that $3 dividend now gives them a 6% annual yield on their cost.

The same applies to bonds and other income-generating investments. A 5% bond issued at full price may be sold off down the road for cheaper if bondholders are worried about the company’s prospects for making good on their debts. If you bought that 5% bond for 50 cents on the dollar you would receive the same amount of interest, but now it would be equivalent to a 10% return on your investment each year. If the company recovered and was able to pay full price at maturity, you would receive 100 cents for every 50 cents worth of bonds you bought at a discount.

This arithmetic is one reason why investors who “buy low” often have an edge. A market downturn can have alarming effects on your retirement savings. But while the purchasing power of your retirement funds may go down, falling prices also allow you to buy income investments at higher yields.

There is no guarantee that you will be able to find high quality investments at such steep discounts, or that discount investments will turn out to be high quality. These examples are intended to illustrate the arithmetic of portfolio income, not as advice to any individual to buy a specific investment.


The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. We suggest that you discuss your specific situation with your financial advisor prior to investing.

The payment of dividends is not guaranteed. Companies may reduce or eliminate the payment of dividends at any given time.

Bonds are subject to market and interest rate risk if sold prior to maturity. Bond values will decline as interest rates rise and bonds are subject to availability and change in price.

Investing involves risk including loss of principal. No strategy assures success or protects against loss.

Can You Afford Retirement? Part 2

© www.canstockphoto.com / Kenishirotie

In the prior installment, we wrote about determining how much income you’ll need in retirement.

The challenge we face in trying to understand retirement planning is that so many of our resources are in lump sum form. IRA balances, profit-sharing plans, and 401(k)s show one big number, the account value. But in the real world, we need recurring income with which to pay our bills.

So how do you take a lump sum and figure out the recurring income it will produce? Or, if you know the income you will need to fund our retirement lifestyle, how do you figure out the lump sum you need?

(If you would like us to do the arithmetic, or if you are actually getting ready to figure out your own retirement scenario, feel free to call for an appointment in the office or a telephone conference. If you are more the ‘do-it-yourself’ type, read on.)

Our baseline assumption is that a diversified, well-invested portfolio can stand withdrawal rates of 5% annually on a perpetual basis. So if your hypothetical retirement income target says you need $24,000 per year ($2,000 per month) from your portfolio after Social Security benefits and pensions, you can figure the size of the portfolio needed simply by multiplying $24,000 by 20 (or equivalently by dividing $24,000 by 5%.) Either way, this formula says you will need $480,000 in order to produce $24,000 of portfolio income per year.

Some commentators say that 4% is the right number, not 5%. A lower withdrawal rate will produce greater financial security, all other things equal. Our experience says 5% is workable, but this is not guaranteed. It is a rule of thumb. We would expect that the lump sum would go up and down in value with a generally rising long term trend, and that income withdrawals may increase from time to time.

Some people prefer to plan for a certain number of years, or use annuities, to boost planned spending for a given amount of retirement resources. Our preferred methodology, when possible, is to rely on generating sustainable levels of income on a continuous basis.


The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.

Annuities are long-term, tax-deferred investment vehicles designed for retirement purposes. Gains from tax-deferred investments are taxable as ordinary income upon withdrawal. Withdrawals made prior to age 59 ½ are subject to 10% IRS penalty tax. Surrender charges apply.

All examples are hypothetical and are not representative of any specific investment. Your results may vary.

Investing involves risk including loss of principal. No strategy assures success or protects against loss.

The Fruits of Investment

© www.canstockphoto.com / Kurhan

Imagine for a moment that you are a simple farmer cultivating a modest but lush orchard of apple trees. Every year you reap a bountiful harvest of fruit to feed your family, with some surplus to sell for other foods and necessities you can’t grow yourself.

Every once in a while your neighbor comes by and offers to buy all your trees for firewood. Even if he offers you a generous price, accepting it would be foolish: the money you could sell it for would sustain you for a while, but it would not produce new crops for you year in and year out. It would run out where a well-tended orchard could keep providing for you long after.

One day your neighbor comes up to you in a bad mood, still wanting to buy your trees. The timber market has been flooded with cheap wood, cutting into his profits, so now he can only offer a much lower price for your trees.

If you wouldn’t sell your orchard when the price is high, why on Earth would you want to sell it when the price is low? As long as you plan to keep your orchard and live on your fruit crop, it shouldn’t matter to you what price someone may quote for it.

For those of us planning to retire on our investments, we would do well to heed the parable of the orchard and the fruit crop. Many retirees plan to live on a portfolio of income-bearing investments. We know that investments are subject to volatility, and at some point in your retirement you will probably see price swings in your investments—even government bonds and other conservative investments are not immune. But your ability to pay bills and buy groceries doesn’t depend on the market value of your holdings, it depends on the dividends and interest payments they generate. As long as your “fruit crop” is secure, you have no reason to sell your orchard. Therefore it doesn’t matter what someone wants to buy it for.

Investors, like farmers, sometimes suffer crop failures—there are no guarantees. But it is the stability of your income that should concern you first and foremost, not the stability of your price.


The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.

Government bonds are guaranteed by the US government as to the timely payment of principal and interest and, if held to maturity, offer a fixed rate of return and fixed principal value.

The payment of dividends is not guaranteed. Companies may reduce or eliminate the payment of dividends at any given time.

Investing involves risk including loss of principal. No strategy assures success or protects against loss.