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Managing The Retirement Income Portfolio: The Plan
The reason people take on the risks of investing in the first place is the prospect of a higher “realized” rate of return than is achievable in a risk-free environment… i.e. an FDIC insured bank account with compound interest.
Over the past decade, such risk-free savings have been unable to compete with riskier media due to artificially low interest rates, forcing traditional “savers” into mutual funds and the ETF market.
(Funds and ETFs have become the “new” stock market, a place where individual stock prices have become invisible, questions about company fundamentals are met with blank stares, and media talking heads tell us that individuals are no longer in the stock market).
Risk comes in many forms, but the primary interests of the average income investor are “financial” and “market” risk when investing for income without proper thinking.
Financial risk involves the ability of corporations, government entities, 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 feared.
Q: Is it demand for individual stocks that pushes up funds and ETF prices, or the other way around?
We can minimize financial risk by choosing only high quality (investment grade) securities, proper diversification and understanding that a change in market value is actually “harmless to income”. By having an action plan to deal with “market risk”, we can actually turn it into an investment opportunity.
What do banks do to get 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 tool for portfolio planning/organization.
For example, annual portfolio “rebalancing” is a symptom of dysfunctional asset allocation. Asset allocation must control every investment decision throughout the year, every year, regardless of changes in market value.
It’s also important to remember that you don’t need hi-tech computer programs, economic scenario simulators, inflation estimates, or stock market projections to get you on track 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; The mixture receives an epoxy that keeps the structure safe and secure during development.
Additionally, the emphasis on “working capital” (as opposed to market value) will help you navigate all four basic portfolio management processes. (Business majors, remember PLOC?) Finally, you get a chance to use something you learned in college!
Planning for retirement
A retirement income portfolio (almost all investment portfolios eventually become retirement portfolios) is a financial hero that arrives on the scene just in time to fill the income gap between what you need to retire and the guaranteed payments you get from uncle and/or the past. employers.
However, how powerful a superhero’s power is does not depend on the size of the market value number; in terms of retirement, the income produced inside the costume protects us from financial villains. Which of these heroes do you want to replenish your wallet?
A million dollar VTINX portfolio that produces approximately $19,200 in expenses annually.
A well-diversified million-dollar income CEF portfolio that generates over $70,000 annually… even with the same stock allocation as Vanguard (just under 30%).
Million GOOG, NFLX and FB portfolio that produces no spend at all.
I’ve heard that 4% withdrawals from a retirement income portfolio is about normal, but what if it’s not enough to fill your “income gap” and/or more than the amount the portfolio will produce. If both of these “what ifs” turn out to be true… well, it’s not a pretty picture.
And it gets uglier rather quickly when you look into your actual 401k, IRA, TIAA CREF, ROTH, etc. portfolio and realize it’s not generating even close to 4% of actual spending income. Total return, yes. Realized income spent, don’t worry.
The market value of your portfolio has certainly “grown” over the past ten years, but chances are no effort has been made to increase the annual income it produces. Financial markets live on market value analysis and as long as the market goes up every year we are told everything is fine.
So what if your “income gap” is more than 4% of your portfolio; what if your portfolio produces less than 2% like the Vanguard Retirement Income Fund; or what if the market stops growing at more than 4% a year… while you are still draining capital at a 5%, 6% or even 7% clip???
The less popular (only available in individual portfolios) closed-end closed-end fund has been around for decades and covers all the “what ifs”. Combined with Investment Grade Stocks (IGVS), they have the unique ability to take advantage of market value swings in either direction and increase portfolio income production with each monthly reinvestment procedure.
Please, monthly reinvestment must never become a DRIP (Dividend Reinvestment Plan) approach. Monthly income must be compounded for selective reinvestment where the biggest “bang for the buck” can be achieved. The goal is to reduce the cost basis per share and increase the return on the position… with one click of the mouse.
A retirement income program that focuses only on market value growth is doomed, even in IGVS. All portfolio plans need an income oriented asset allocation of at least 30%, often more but never less. All individual stock purchase decisions must support an operational asset allocation plan of “growth vs. purpose of income”.
The “Working Capital Model” is a 40+ year proven autopilot asset allocation system that pretty much guarantees annual income growth when used correctly with a minimum allocation for income purpose of 40%.
The following bullet points apply to an asset allocation plan that operates individual taxable and tax-deferred portfolios…not 401k plans because they typically cannot produce adequate income. Such plans should be vested to the maximum possible safety within six years of retirement and rolled over to a personally directed IRA as soon as physically possible.
Asset allocation for “income purposes” starts at 30% of working capital, regardless of portfolio size, investor age or amount of liquid assets available for investment.
Starter portfolios (under $30,000) should have no equity component and no more than 50% until six figures are reached. From $100,000 (under age 45), just 30% is acceptable for income, but it’s not a particularly productive income.
At age 45 or $250,000 switch to 40% income purpose; 50% by age 50; 60% at age 55 and 70% income securities from age 65 or retirement, whichever occurs first.
The income earmarked side of the portfolio should be invested as much as possible and all asset allocation determinations must be based on working capital (i.e. portfolio cost basis); cash is considered part of the equity or “growth purpose” allocation.
Equity investments are limited to seven-year trailing equity CEFs and/or “investment grade value stocks” (as defined in the book “Brainwashing”).
Even if you are young, you need to quit heavy smoking and create a growing income stream. If you keep your earnings growing, the market value growth (which you are expected to worship) will take care of itself. Remember, a higher market value may increase the size of the hat, but it won’t pay the bills.
So this is the plan. Determine your retirement income needs; start your investment program with a focus on income; add stocks as you get older and your portfolio becomes more substantial; as retirement looms or portfolio size becomes serious, focus on targeted income distribution as well.
Don’t worry about inflation, the markets or the economy… your asset allocation will keep you moving in the right direction while focusing on growing your income each year.
That’s the crux of the whole “retirement income readiness” scenario. Every dollar added to the portfolio (or earned by the portfolio) is reallocated according to the “working capital” asset allocation. When the income allocation is above 40%, you will see income magically grow every quarter… no matter what happens in the financial markets.
Note that all IGVS pay dividends, which are also distributed according to asset allocation.
If you are within ten years of retirement age, a growing income stream is exactly what you want to see. By applying the same approach to your IRA (including a 401k rollover), you’ll create enough income to pay RMDs (required mandatory distributions) and put yourself in a position to say without reservation:
Neither the stock market correction nor the increase in interest rates will have a negative impact on my retirement income; in fact, I will be able to increase my income even better in both environments.
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