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Managing The Retirement Income Portfolio: The Plan

Guest Article By Steve Selengut 

The reason people assume the risks of investing in the first place is the prospect of achieving a higher “realized” rate of return than is attainable in a risk free environment… i.e., an FDIC insured bank account featuring compound interest.

Risk comes in various forms, but the average income investor’s primary concerns are “financial” and, when investing for income without the proper mindset, “market” risk.

  • Financial risk involves the ability of corporations, government entities, and even individuals, to honor their financial commitments.
  • Market risk refers to the absolute certainty that all marketable securities will experience fluctuation in market value… sometimes more so than others, but this “reality” needs to be planned for and dealt with, never feared.
  • Question: Is it the demand for individual stocks that push up funds and ETF prices, or vice versa?

We can minimize financial risk by selecting only high quality (investment grade) securities, by diversifying properly, and by understanding that market value change is actually “income harmless”. By having a plan of action for dealing with “market risk”, we can actually turn it into 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 do need to have a long term plan and know something about asset allocation… an often misused and misunderstood portfolio planning/organization tool.

  • For example, annual portfolio “rebalancing” is a symptom of dysfunctional asset allocation. Asset allocation needs to control every investment decision throughout the year, every year, regardless of changes in market value.

It is important to recognize, as well, that you do not need hi tech computer programs, economic scenario simulators, inflation estimators, or stock market projections to get yourself lined up properly with your retirement income target.

What you do 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; compound earnings the epoxy that keeps the structure safe and secure over the developmental period.

  • Over the past ten years, such risk free saving has been unable to compete with riskier mediums because of artificially low interest rates, forcing traditional “savers” into the mutual fund and ETF market place.
  • (Funds and ETFs have become the “new” stock market, a place where individual equity prices have become invisible, questions about company fundamentals meet with blank stares, and media talking heads tell us that individuals are no longer in the stock market).

Additionally, an emphasis on “working capital” (as opposed to market value) will help you through all four basic portfolio management processes. (Business majors, remember PLOC?) Finally, a chance to use something you learned in college!

Planning for Retirement

The retirement income portfolio (nearly all investment portfolios become retirement portfolios eventually) 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 will receive from Uncle and/or past employers.

How potent the force of the super hero, however, does not depend on the size of the market value number; from a retirement perspective, it’s the income produced inside the costume that shields us from financial villains. Which of these heroes do you want fueling your wallet?

  • A million dollar VTINX portfolio that produces about $19,200 in annual spending money.
  • A million dollar, well diversified, income CEF portfolio that generates more than $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 that produces no spending money at all.

I’ve heard said that a 4% draw from a retirement income portfolio is about normal, but what if that’s not enough to fill your “income gap” and/or more than the amount produced by the portfolio. If both of these “what ifs” prove true… well, it’s not a pretty picture.

And it becomes uglier rather quickly when you look inside your actual 401k, IRA, TIAA CREF, ROTH, etc. portfolio and realize that it is not producing even close to 4% in actual spendable income. Total return, yes. Realized spendable income, ‘fraid not.

  • Sure your portfolio has been “growing” in market value over the past ten years, but it is likely that no effort has been made to increase the annual income it produces. The financial markets live on market value analytics, and so long as the market goes up every year, we’re told that everything is fine.
  • So what if your “income gap” is more than 4% of your portfolio; what if your portfolio is producing less than 2% like the Vanguard Retirement Income Fund; or what if the market stops growing by more than 4% per year… while you are still depleting capital at a 5%, 6% or even a 7% clip???

The less popular (available only in individual portfolios) Closed End Income Fund approach has been around for decades, and has all of the “what ifs” covered. They, in combination 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 every monthly reinvestment procedure.

  • Monthly reinvestment must never become a DRIP (dividend reinvestment plan) approach, please. Monthly income must be pooled for selective reinvestment where the most “bang for the buck” can be achieved. The objective is to reduce cost basis per share and increase position yield… with one click of the mouse.

A retirement income program that is focused only on market value growth is doomed from the getgo, even in IGVS. All portfolio plans need an income focused asset allocation of at least 30%, oftentimes more, but never less. All individual security purchase decision-making needs to support the operative “growth purpose vs. income purpose” asset allocation plan.

  • The “Working Capital Model” is a 40+ years tested auto pilot asset allocation system that pretty much guarantees annual income growth when used properly with a minimum 40% income purpose allocation.

The following bullet points apply to the asset allocation plan running individual taxable and tax deferred portfolios… not 401k plans because they typically can’t produce adequate income. Such plans should be allocated to maximum possible safety within six years of retirement, and rolled over to a personally directed IRA as soon as physically possible.

  • The “income purpose” asset allocation begins at 30% of working capital, regardless of portfolio size, investor age, or amount of liquid assets available for investment.
  • Start up portfolios (under $30,000) should have no equity component, and no more than 50% until six figures are reached. From $100k (until age 45), as little as 30% to income is acceptable, but not particularly income productive.
  • At age 45, or $250k, move to 40% income purpose; 50% at age 50; 60% at age 55, and 70% income purpose securities from age 65 or retirement, whichever comes first.
  • The income purpose side of the portfolio should be kept as fully invested 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 experienced equity CEFs and/or “investment grade value stocks” (as defined in the “Brainwashing” book ).

Even if you are young, you need to stop smoking heavily and to develop a growing stream of income. If you keep the income growing, the market value growth (that you are expected to worship) will take care of itself. Remember, higher market value may increase hat size, but it doesn’t pay the bills.

So this is the plan. Determine your retirement income needs; start your investment program with an income focus; add equities as you age and your portfolio becomes more significant; when retirement looms, or portfolio size becomes serious, make your income purpose allocation serious as well.

Don’t worry about inflation, the markets, or the economy… your asset allocation will keep you moving in the right direction while it focuses on growing your income every year.

  • This is the key point of the whole “retirement income readiness” scenario. Every dollar added to the portfolio (or earned by the portfolio) is reallocated according to “working capital” asset allocation. When the income allocation is above 40%, you will see the income rising magically every quarter… regardless of what’s going on in the financial markets.
  • Note that all IGVS pay dividends that are also divvied up according to the asset allocation.

If you are within ten years of retirement age, a growing income stream is precisely what you want to see. Applying the same approach to your IRAs (including the 401k rollover), will produce enough income to pay the RMD (required mandatory distribution) and put you in a position to say, without reservation:

Neither a stock market correction nor rising interest rates will have a negative impact on my retirement income; in fact, I’ll be able to grow my income even better in either environment.

My articles always describe aspects of an investment process I have been using since the 1970’s, as described in my book, The Brainwashing of the American Investor. All the disciplines, concepts, and processes described therein work together to produce (in my experience) a safer, more income productive, investment experience. No implementation should be undertaken without a complete understanding of all aspects of the program.

Article Source: https://EzineArticles.com/expert/Steve_Selengut/12786

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The Best of Intentions May Not Be Enough

On Friday I posted about being careful about following advice that you are given about investing. Well, today I ran into another person who had advice for me about investing. There was nothing malicious or devious about his advice. He probably had good intentions. However, he never answered the question that I originally posted to the group. His whole posture in answering my question, which really had nothing to do with my question. His advice had more to do with trying to become my unofficial financial advisor that I didn’t ask for. This person was touting value investing with dividends being secondary, I made it clear in my responses that my focus was on dividends and not share prices because I want to avoid risk whenever I can. Which I why I prefer funds over individual stocks.

So, if I follow this gentleman’s advice I would now be following HIS strategy and not MINE. Be especially careful when you post a general query in investment group forums because you will get all of the so-called experts that will respond to you like a real financial consultant who has spent a considerable amount of time with you and has a detailed knowledge of your financial situation. Be extremely careful. This not to say that investment groups and forums should be avoided. No, you can gleam some useful information from these sources. Just be very cautious with the information you get.

As for me, I’ll remain a member of the group but I’ll no longer actively participate by asking questions. I’ll try to figure things out on my own or seek information from a professional or wait and see if anyone posts a similar question to the group I have no time for unsolicited advice where the full detail of the financial situation isn’t known. You will always encounter those that want to flaunt their “expertise” and look for opportunities to do so without being asked. They tend to read more into a question than what was intended. It’s called The Dunning-Kruger Effect.