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Building a Better Retirement Income Portfolio
By Don Schreiber
April 20, 2011
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Advisors are struggling to come up with a better retirement income portfolio solution, which we believe we have found.
This is not just about dividends. Inflation is a major concern long term that advisors not only need to be aware of when building retirement portfolios but must have an effective portfolio management solution.
Bonds, savings accounts and CD's all generate income, but fail the inflation test. Many advisors and investors are not aware of the dramatic inflation fighting benefits that dividend paying stocks offer. Investors cannot depend on or seem to capture the return benefits from growth stock appreciation. Volatility causes risk adverse investors to abandon their investment plan. Instead of building capital, they destroy capital by buying high and then selling lowor as we say, they practice dollar lost averaging. Instead what is needed is stop loses when investing, and being able to buy low for clients and sell at higher target prices – a disciplined risk management approach. Systematic withdrawal plans don't work because volatility and bear market trends cause compound liquidation as investors need to sell an increasing number of shares at lower prices to meet income needs. Over the past five years or longer, advisors have tried to deal with the negative effects of systematic withdrawal plans by adjusting allocation strategies to include a cash bucket (bucket strategy) to allow investors to withdraw income from a money market account obviating the monthly need to sell shares. Often advisors recommend a 3 year cash reserve, which commits a significant portion of the portfolio (15-20% depending on income withdrawal rate) to money market accounts generating a negative return net of fee. A second benefit of the cash bucket is supposed to help investors from bailing on their investment portfolio as the balance of their portfolio loses value, but this is a dubious assumption at best.
In practice, investors still react to the majority of their capital losing 20-50% in value during a bear market decline. The sad fact is that severe market declines cause a bucket portfolio strategy to fail retired investors, even if they don't bail, as secular declines in prices cause shares to be liquidated at low prices to refill the cash bucket. Over the past 10 years (2000-2010) a $100k portfolio allocated in a bucket strategy invested 15% in cash, 43% to S&P 500, 28% to NASDAQ, 14% to DJ Corp. Bond Index fell to less than $47k in value, while generating 5% income adjusted annually for inflation. It would be highly doubtful the depleted capital balance would be able to continue to support the investors primary income objective over any long period of time. With Baby Boomers swelling the ranks of retired investors, advisors need rational retirement portfolio investment strategies that can actually work in both bull and bear market cycles, so retired investors can actually achieve their retirement goals.As indicated in a recent white paper we have published, dividend paying stocks have historically increased dividend income at a faster rate than inflation, as measured by increases in the CPI, whichhas reduced purchasing power. By focusing on the income received quarterly, investors may be able to stay invested during declining market cycles. When reinvested dividends can unleash the powerful benefits of compounding and dollar cost averaging, helping to grow investment capital. The combination of increasing dividends and increasing capital can help investors keep pace with inflation over time. Since dividend yields can fall short of an investors income withdrawal need, we recommend pairing dividend stock allocations with bonds to increase portfolio cash flow. This can help prevent negative systematic withdrawal effects. Risk management is important to reduce volatility, especially in down market cycles, to reduce the catastrophic loss of capital that bear markets often cause. This can also help keep investors more comfortably invested, preventing them from selling low. We suggest advisors use goals and stops to help protect capital and harvest gains. With higher interest rates and inflation looming, advisors should also consider adjusting bond duration to help protect principal invested in bonds. By using a more stringent and active portfolio management system that manages for risk, and seeks to protect the engine of growth – capital - advisors and their investor clients can have a better retirement income portfolio, and sleep better at night. Don Schreiber Jr., CFP , CEO & Founder of WBI Investments, is also co-author of the new edition of All About Dividend Investing (2011, McGraw-Hill), and has just launched two mutual funds for investment professionals. He manages around $650 million (half of which is for other advisors). He can be reached at dschreiber@wbiinvestments.com.
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