The reason people assume investment risk in the first place is the potential for a higher “realized” rate of return than would be achieved in a risk-free environment… eg an FDIC insured bank account featuring compound interest.
- Over the past ten years, such risk-free savings has not been able to compete with riskier mediums due to artificially low interest rates, forcing traditional “savers” into the mutual fund and ETF market.
- (Funds and ETFs have become the “new” stock market, a place where individual stock prices become invisible, questions about company fundamentals meet blank stares, and talking heads in the media tell us that individuals are no longer in the stock market.)
Risk comes in many different forms, but the primary concerns of the average income investor are “financial” and, when investing for income without proper thought, are “market” risks.
- Financial risks involve the ability of companies, government agencies, and even individuals to meet their financial obligations.
- Market risk refers to the absolute certainty that all tradable securities will experience fluctuations in market value…sometimes more than others, but this “reality” needs to be planned for and dealt with, never to be feared.
- Question: Is the demand for individual stocks driving money and ETF prices higher, or vice versa?
We can reduce financial risks by choosing only high-quality (investment grade) securities, through appropriate diversification, and understanding that a change in market value is actually “harmless to income”. By having a business plan to deal with “market risk”, we can actually turn it into an investment opportunity.
- What do banks do to obtain the amount of interest they guarantee to depositors? They invest in securities that pay a fixed rate of income regardless of changes in market value.
You don’t have to be a professional investment manager to manage your investment portfolio professionally. But you need to have a long term plan and know something about asset allocation… An often misused and misunderstood portfolio planning/organizing tool.
- For example, the annual portfolio “rebalance” is a symptom of an asset imbalance. Asset allocation needs to control every investment decision throughout the year, every year, regardless of changes in market value.
It’s also important to realize that you don’t need high-tech computer programs, economic scenario simulators, inflation estimates, or stock market projections to properly align with your retirement income goal.
What you need is common sense, reasonable expectations, patience, discipline, soft hands and an oversized driver. The “KISS Principle” should be the foundation of your investment plan; Winning epoxy compound keeps the structure safe and secure during the development period.
In addition, focusing on “working capital” (as opposed to market capitalization) will help you with all four core portfolio management processes. (Business majors, remember PLOC?) Finally, a chance to use something you learned in college!
Retirement planning
A retirement income portfolio (almost all investment portfolios eventually become retirement portfolios) is the financial hero that appears on the scene just in time to fill the income gap between what you need for retirement and the guaranteed payments you’ll get from uncle and/or past employers.
However, how strong a superhero’s power is does not depend on the size of the market capitalization figure; From a retirement perspective, it is the income generated within the outfit that protects us from the financial bad guys. Which of these heroes would you like to refuel your wallet with?
- Million dollars Vtinx Wallet That yields about $19,200 in annual spending money.
- CEF’s million-dollar income, well-diversified portfolio that generates over $70,000 annually…even with the same equity allocation as the Vanguard Fund (just under 30%).
- A million dollar portfolio of GOOG, NFLX, and FB produces absolutely no money to spend.
You’ve heard that drawing 4% out of a retirement income portfolio is normal, but what if that isn’t enough to fill the “income gap” and/or more than the amount the portfolio produces. If both of those “what ifs” prove true… well, it’s not a pretty picture.
And it gets uglier quickly when you look inside your 401k portfolio, IRA, TIAA CREF, ROTH, etc. and realize they don’t even produce nearly 4% of your actual spendable income. Total return, yes. Earned disposable income,” no.
- Ensure that your portfolio has been “growing” in market value over the past 10 years, but it is likely that no effort has been made to increase the annual income it produces. Financial markets live on market value analytics, and as long as the market goes up every year, we are told that all is well.
- So what if your “income gap” is more than 4% of your portfolio; What if your portfolio yields less than 2% like the Vanguard Retirement Income Fund; Or what if the market stops growing by more than 4% annually.. while you are still depleting your capital by 5%, 6%, or even 7%???
The lesser-known (only available in individual portfolios) closed-end income fund approach has been around for decades, and included all the “what ifs”. They, along with Investment Grade Value Stocks (IGVS), have the unique ability to take advantage of market value fluctuations in either direction, increasing portfolio income production with each monthly reinvestment action.
- Monthly reinvestment should not become a DRIP (dividend reinvestment plan) approach, please. Monthly income should be pooled for selective reinvestment where the greatest benefit can be achieved. The goal is to reduce the underlying cost per share and increase the return of the position…with just a click of the mouse.
A retirement income program focused solely on market capitalization growth is doomed from getgo, even at IGVS. All portfolio plans need an income-focused asset allocation of at least 30%, often more, but never less. All individual security buying decisions need to be supported by a “growth purpose versus income purpose” asset allocation plan.
- The “Working Capital Model” is an automated beta asset allocation system that has been around for over 40 years and pretty much guarantees annual income growth when used properly with a minimum of 40% earmarked for income purpose.
The following points apply to an asset allocation plan that manages individual taxable and tax-deferred portfolios…not 401k plans because they usually can’t produce enough income. Such plans should be set aside as securely as possible within six years of retirement, and transferred to a personally directed IRA as soon as physically possible.
- Asset allocation “for income purpose” starts at 30% of working capital, regardless of portfolio size, investor age, or amount of liquid assets available for investment.
- Beginning portfolios (less than $30,000) must not contain an equity component, and no more than 50% until six figures are reached. From $100,000 (up to age 45), up to 30% of income is acceptable, but not particularly productive income.
- At age 45, or $250,000, go to 40% for income purpose; 50% by age 50; 60% at age 55, and 70% from income purpose bonds at age 65 or retirement, whichever comes first.
- The income purpose side of the portfolio should remain as fully invested as possible, and all asset allocation decisions should be based on working capital (ie the cost basis of the portfolio); Cash is considered part of the equity, or “growth purpose” allocation.
- Equity investments are limited to seven years of CEFs and/or “investment grade value shares” (as defined in brainwashing book ).
Even if you are young, you need to quit heavy smoking and cultivate a growing income stream. If you keep increasing income, market value growth (which you are expected to worship) will take care of itself. Remember, a higher market cap may add to the hat, but it doesn’t pay the bills.
So here’s the plan. determine your retirement income needs; Start your investment program with an income focus; Add stocks as you get older and your portfolio becomes more important; When retirement approaches, or portfolio size gets serious, make your income purpose allocation serious, too.
Don’t worry about inflation, the markets or the economy… Your asset allocation will keep you moving in the right direction while focusing on increasing your income each year.
- This is the key point of the entire “ready for retirement income” scenario. Every dollar added to the portfolio (or acquired by the portfolio) is reallocated according to the “working capital” asset allocation. When the income distribution is above 40%, you will see income magically rise every quarter… no matter what happens in the financial markets.
- Note that all IGVS pay dividends which are also divided according to the distribution of assets.
If you’re within ten years of your retirement age, an increased income stream is exactly what you want to see. Applying the same approach to IRAs (including 401k rollovers) will produce enough income to pay an RMD (Required Mandatory Distribution) and put you in a position to say, without reservation:
Neither a stock market correction nor higher interest rates will have a negative impact on my retirement income; In fact, I would be better able to raise income in either environment.