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Managing The Retirement Income Portfolio: The Plan
The reason people consider investing risky in the first place is the prospect of earning a higher “made” rate of return than is available in a risk-free environment… ie, an FDIC-insured bank account with compound interest.
Over the past decade, such free savings have not been able to compete with risky individuals due to artificially low interest rates, forcing traditional “savers” into the mutual fund and ETF marketplace.
(Funds and ETFs have become the “new” stock market, a place where individual equity prices are invisible, questions about the company’s fundamentals are met with blank stares, and headlines tell us that people are no longer in the stock market).
Risk comes in different forms, but the investor’s main concern is “financial” income and, when investing for income without a proper mindset, “market” risk.
Financial risk involves the ability of companies, government entities, and individuals to honor their financial obligations.
Market risk refers to the absolute certainty that all the securities sold will have fluctuations in the market price … sometimes more than others, but this “truth” must be planned and monitored, never to be afraid.
Question: Does demand for individual stocks drive up funds and ETF prices, or vice versa?
We can reduce financial risk by choosing only high-quality (investment grade) securities, by diversifying properly, and by understanding that market price changes are truly “harmless”. By having an action plan to deal with “market risk”, we can 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 return regardless of changes in market value.
You don’t have to be a professional investment manager to manage your investment portfolio wisely. But, you need to have a long-term plan and know something about asset allocation… an often misused and misunderstood tool for portfolio planning.
For example, annual portfolio “rebalancing” is a sign of poor asset allocation. Asset allocation should govern every investment decision throughout the year, every year, regardless of changes in market value.
It’s important to note, too, that you don’t need hi tech computer programs, economic simulators, inflation forecasts, or stock market forecasts to properly align yourself with your retirement income target.
What you need is common sense, reasonable expectations, patience, discipline, soft hands, and a great driver. The “KISS Rule” should be the foundation of your investment strategy; An epoxy compound that keeps the structure safe and secure during development.
Additionally, a focus on “working capital” (as opposed to market value) will help you in all four basic portfolio management processes. (Business heads, remember PLOC?) Finally, a chance to apply what you learned in college!
A retirement income portfolio (almost all investment portfolios are ultimately retirement portfolios) is a financial hero that appears on the scene just in time to bridge the income gap between your retirement needs and the guaranteed payments you will receive from Uncle and/or the past. employers.
How strong a super hero’s power is, however, does not depend on the size of the market value; from a pension perspective, it is the income generated within the vesting that protects us from financial shocks. Which of these heroes do you want in your wallet?
A million dollar VTINX portfolio generates approximately $19,200 in annual revenue.
A million dollar, well-allocated, CEF portfolio income generating over $70,000 per year… and with Vanguard’s equity allocation (just under 30%).
A million dollar portfolio of GOOG, NFLX, and FB that doesn’t generate spending at all.
I’ve heard that a 4% withdrawal from a retirement income portfolio is about the norm, but what if that’s not enough to fill the “income gap” and/or more than the value the portfolio has produced. If both of these “what ifs” turn out to be true… well, it’s not a pretty picture.
And it gets even worse when you look inside your actual 401k, IRA, TIAA CREF, ROTH, etc. Total compensation, yes. Earned disposable income, ‘fear not.
Your portfolio has certainly “grown” in market value over the last ten years, but it is likely that no effort has been made to increase the annual income it generates. Financial markets are based on market value analysis, and as long as the market goes up every year, we are told that everything is fine.
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 more than 4% per year… while removing the capital at a 5%, 6% or 7% clip???
The lesser known (only found in individual portfolios) Closed End Income Fund approach has been around for decades, and all the “what ifs” have been covered. They, in combination with Investment Grade Value Stocks (IGVS), have the unique ability to take advantage of market price declines in any direction, increasing the portfolio’s income generation with each monthly reinvestment process.
Monthly reinvestment should not be a DRIP (equity investment plan), please. The monthly income should be combined with selected investments where the best “bang for the buck” can be found. The goal is to reduce the cost base per share and increase the yield of the area … with one click of the mouse.
A pension income system that focuses solely on market value growth has been condemned from the getgo, even by the IGVS. All portfolio plans require an asset income focused allocation of at least 30%, often more, but not less. All security purchase decisions should support a functional “growth objective vs. income objective” asset allocation strategy.
The “Working Capital Model” is a 40+ year proven vehicle asset allocation system that highly guarantees annual income growth when used properly with a minimum 40% income target allocation.
The following points apply to asset allocation plans that operate taxable and tax-deferred portfolios…not 401k plans because they can’t generate enough income. Those plans must be allocated for potential security within six years of retirement, and transferred to a personally directed IRA as soon as physically possible.
The “income objective” asset allocation starts at 30% of working capital, regardless of the size of the portfolio, the age of the investor, or the amount of assets available for investment.
Starting portfolios (less than $30,000) should have no equity component, and no more than 50% until six figures. From $100k (up to age 45), as little as 30% to income is acceptable, but not income generation.
At age 45, or $250k, go for a 40% income goal; 50% in 50 years; 60% at age 55, and 70% of securities for income from age 65 or retirement, whichever comes first.
The income objective side of the portfolio should be kept 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 allocation, or “growth objective”.
Equity investments are limited to seven-year equity CEFs and/or “investment grade value stocks” (as described in the book “Brainwashing”).
Even at a young age, you need to stop smoking heavily and generate a growing income. If you keep the income growing, the growth in the market value (which is expected to fall) will take care of itself. Remember, a higher market price may increase the cap size, but it doesn’t pay the bills.
So this plan. Determine your retirement income needs; start your investment process with a focus on income; add equities as you grow and your portfolio becomes more important; as retirement deepens, or portfolio size becomes more difficult, make your share of income goals more important as well.
Don’t worry about inflation, the markets, or the economy… asset allocation will keep you moving in the right direction while focusing on growing your income every year.
This is at the heart of the whole “retirement income readiness” scenario. Every dollar added to the portfolio (or earned by the portfolio) is re-allocated according to the “working capital” of the asset allocation. When the income distribution is above 40%, you will see the income increase dramatically every quarter… regardless of what happens in the financial markets.
Note that all IGVS pay dividends which are divided according to asset allocation.
If you are within ten years of retirement age, a growing income is exactly what you want to see. Using the same method for your IRAs (including a 401k rollover), will generate enough income to pay the RMD (required minimum distribution) and put you in a position to talk, without putting:
No stock market correction or rising interest rates will have a negative impact on my retirement income; in fact, I will be able to maximize my income better in any case.
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