If it’s not quite a central investing rule, it is at least one of the most common approaches to portfolio management: You invest aggressively when you are young and more conservatively as you get older. This age-based approach to investing, which has led to the proliferation and increasing popularity of target-date funds in 401(k) accounts, essentially dictates that a stock-heavy investment approach eventually give way to a healthy diet of bonds throughout your investment lifecycle.
But Catherine Avery Investment Management, an advisory firm in Connecticut, challenges this common investment approach in a new survey assessing best-practice investment strategies for baby boomers. The firm recently completed its first ever recommended “mock portfolio taste test” that examined different investment parameters and long-term return characteristics for boomers. The results show that a value-oriented portfolio loaded with dividend paying stocks is cheaper and less risky than a traditional growth portfolio. The firm also says its value portfolio is trading more cheaply than the S&P 500.
According to CAIM’s analysis: A $1,000 principal investment in a dividend paying stock, with a 3% annual dividend yield growing at 5% a year, and modest 5% annual stock appreciation, will grow to more than $4,000 (342%) at the end of 20 years. By comparison, Treasuries will grow to just over 200%, while the S&P 500 has a 20-year historical return of 191%.
CAIM recommends that boomers purchase “a portfolio of less expensive, fundamentally attractive, large cap companies that are under leveraged and pay dividends.” Besides the 3% dividend yield, it has less than half the leverage of a growth portfolio, is generating more free cash flow per share and is significantly cheaper than the indices. Although the growth portfolio has generated more than three-times the stock price performance versus that of its value portfolio year-to-date, over the last five years the growth portfolio has only slightly outperformed the value (10% versus 8%). The firm argues that this suggests “significantly greater potential upside” for the value portfolio.
“Stocks in general help preserve purchasing power and are the best defense against inflation,” says Catherine Avery, founder of CAIM. “Bonds won’t protect them. The first inclination is to retire and to load up on bonds but with baby boomers living longer that’s not going to work. A 10-year treasury yields 3%.”
According to Avery, value stocks that pay dividends will help boomers protect themselves against some of the main risks as they age: Health care costs, outliving assets, forced retirement or locking in poor returns with low-yielding, safer investments.
But that learned investing practice that so many of us carry—load up on bonds and get conservative a we grow older—has in many ways been reinforced by the recent financial crisis. Investors are more risk-averse. Older investors are more concerned with value preservation. So this begs the question: How difficult will it be to convince aging baby boomers to think like younger, long-term investors?
“I think at this point in time considering what happened with the financial crisis people are frightened and paralyzed,” Avery concedes. “Mutual fund flow data shows the bulk of money is going into bonds. But I also think people are finally becoming at ease with what’s happening the market right now.”
And the point of this survey, Avery continues, is to help baby boomer re-learn their investment approach. The biggest risk when money is shifted into bonds is that investors become complacent, she says. When the interest rates begin to rise, the value of the bond investments begin to filter off.
“We are tying to shift the thinking and focus of these investors going forward,” Avery says. “A lot of baby boomers might think, ‘I don’t have 10 or 20 years’ [to wait on returns]. But you don’t have 10 years to sit with a bond that collects 3% either. Think about what you’re leaving for your heirs.”
