How to Generate Retirement Income from Stocks
By Gregory Claude Fetters, CPA/PFS CFP®
Retirees are struggling to generate enough retirement income with bonds and high dividend stocks yielding less than 5%. At the same time inflation continues to eat away at this retirement income cutting its buying power in half every 15 to 20 years. If a retiree wanted to generate $10,000 a year increased each year for 3% inflation for 30 years they would need to start with a $219,200 portfolio yielding 5%. Adirondack Asset Management did this same calculation to see what would have happened using actual annual rates for the last 50 years. The least amount a retiree could have started out with to achieve a 30 year $10,000 annual inflation adjusted income was $216,000 for the period 1967 to 1997 and worst case $267,200 starting amount to survive the period 1954 to 1984.
If instead, a retiree invested in a broadly diversified stock portfolio or simply bought a total stock market index fund they could expect only a 2% dividend. However, in addition to dividends, this portfolio could be expected to grow at its historical rate of 8% to 10%. The retiree could tap into this capital gain by selling a little of their holdings each year to make up the rest of their increasing annual required income.
Again, Adirondack Asset Management went back to the actual data for the last 50 years and found that the least amount a retiree could have started out with in a broadly diversified stock portfolio to achieve a 30 year $10,000 annual inflation increased income was $163,400 for the period 1974 to 2004. That is 24% less than of the “Income Retiree’s” least case amount. Worst case for stocks was a $180,500 starting amount to survive the period 1960 to 1990. Even this worst case starting amount for a stock portfolio is 16% less than the best case income portfolio.
Past performance is no guarantee of future returns, and a 100% allocation to stock funds is probably not the optimum retirement portfolio allocation. But, those who insist that the bulk of their retirement portfolio should be in income producing securities should think twice. Consider the significant improvement in probability of funding inflation adjusted retirement cash flow targets with most of a portfolio in diversified stock funds combined with planned annual sales to supplement dividend and interest income.
Inflation Never Sleeps
By Gregory Claude Fetters, CPA/PFS CFP®
Advertisements for the new Dodge Charger and the movie remake of the Dukes of Hazzard got me thinking of 1973 when our family went to the local Dodge dealer and bought a new yellow Charger with the 318 cubic inch V8 for $3,200. A little over 30 years latter the V8 Dodge Charger costs $29,500, over 9 times more than 1973. I did a little research and found that a movie ticket then cost $1.50 and gas for the Charger cost 40 cents a gallon both about five times less than today. I also found prices for a couple other common items from 1973 and then went to the food store and bought the same thing. A 1.55 oz Hershey bar 12 cents then up over five times to 65 cents now, loaf of bread 33 cents then up three times to 99 cents now, 18oz box of Total cereal 90 cents then up more than four times to $4.29 now, first class postage stamp 10 cents then up almost four times to 37 cents now.
These price increases on average are about in line with the overall Consumer Price Index which grew four and a half times since 1973. Did people in 1973 believe they would be walking out of the food store in 2005 paying five times more for the same stuff in their shopping cart? Is there any reason to believe we will not be paying five times more in 2037 for the same stuff in the shopping cart today? Are retirees confident that their retirement portfolio will be enough?
Does a retirement portfolio in income investments make sense? Income investments yield a reliable 4% to 6% that provides adequate income now but, in 15 years will likely only buy a little over a half of what it buys today and in 32 years probably less than a quarter of what is in a shopping cart today. But, what investment can grow enough to provide 4% to 6% for annual cash flow and still keep ahead of 4.5% inflation? That would be an average annual growth of around 10%. What investment can be expected to return a 10% average annual rate over 32 years? From 1973 to 2005 the S&P 500 returned an average 11.5% and from 1941 to 1973 the S&P 500 returned an average 12.7%.
Yes stock prices go up and down a lot and past performance is no guarantee of future return but, in the long run of retirement, stocks consistently beat a certain losing portfolio of income investments.
Fight Back Against Identity Theft
By Gregory Claude Fetters, CPA/PFS CFP®
Approximately 7 million people became victims of identity theft in the prior 12 months according to July 2003 studies by Gartner Research and Harris Interactive. According to the Identity Theft Resource Center victims can spend an average of 600 hours recovering from this crime, often over a period of years.
Reviewing your credit report is your main line of defense. On September 1st 2005 you will be entitled to receive one free credit report every 12 months from each of the nationwide consumer credit reporting companies – Equifax, Experian and TransUnion. The old requirements that you first must suspect fraud or were turned down for credit will no longer apply and you do not have to sign up for any credit protection services.
On December 4, 2003, President Bush signed into law the Fair and Accurate Credit Transactions Act of 2003. The legislation gives every consumer the right to their credit report free of charge every 12 months. The program began its roll-out across the country in January 2005 starting on the West coast and arrives in the Northeast September 2005. You can get your credit reports through the Annual Credit Report Request Service secure website www.annualcreditreport.com, or request by phone or mail and it will be mailed within 15 days.
To request by phone, call 877-322-8228 and give your phone number, address, name, social security number and birth date to the automated voice recognition system. The system may have a hard time understanding your voice if there is a poor phone connection.
The mail-in one page form is just as easy as phoning and asks for the same information. The form takes less time than addressing the envelope and getting a stamp. You should consider filling out all the information except which company you are requesting from. Make copies, then every four months check off one of the three companies and mail for a continuous program of monitoring your credit. We have blank forms available at our front desk.
Active Management of Passive Investments
by Joseph E Fiorile CPA/PFS
When looking at the different approaches to portfolio management investors should strongly consider passive investments such as index funds and exchange traded funds.
These investments carry extremely low internal costs usually with nominal transaction fees. They are broad market investments which mirror the holdings of the various exchanges or indexes found in the financial world. They are termed “passive” because there is no active manager selecting individual stocks or bonds but instead these funds pool investor’s resources to purchase a broad variety of the stocks or bonds that comprise a particular index.
Then why the title of this article? Though the uses of index type funds expose an investor to the broad market it is in the active allocation between stocks and fixed income indexes that additional returns can be derived.
An investor usually allocates their investable liquid assets in certain percentages of stocks, fixed income and cash (with sub-categories of each). Investors should consider the concept of using index funds to fill each category and then actively adjusting the allocation percentages of the categories and sub-categories at specific times or for particular reasons. Strategies such as periodic rebalancing of portfolios or reallocation to short- term bond index funds in times of rising interest rates are examples of this approach.
In summary, this approach offers an investor low cost, broad market investment exposure with spread out risk. By periodically analyzing and adjusting the allocation percentages an investor has the opportunity to achieve superior returns. This type of investing can be the cornerstone of achieving your financial goals. However this method can be complicated and time-consuming because of trying to sift through the myriad of index funds and in knowing the appropriate allocation strategies. Working with a credentialed fee-only financial planner who successfully manages assets in this manner can help an investor enjoy a healthier financial life and allow the investor the freedom to do what is really important to them.
Please contact us if you would like to discuss this approach to investing.
The Automatic Millionaire,
A Powerful One-Step Plan to Live and FINISH RICH
by David Bach
as reviewed by Gregory Claude Fetters, CPA/PFS CFP®
David Bach author of Smart Couples Finish Rich and Smart Women Finish Rich presents in his newest book recommendations:
Pay yourself first.
- Make it automatic and make it into a tax deferred account.
- Become debt free
- Invest the money in an asset allocation fund and leave it.
- Own don’t rent your home
Of all these points “paying yourself first” is the most powerful. It recognizes that we spend whatever we have. By paying yourself first ie putting 10% to 15% of your income in savings as soon as you get it you will automatically adjust your spending habits to live on what’s left and don’t make up the difference with credit cards. Staying out of debt, Bach’s third recommendation is essential to becoming an automatic millionaire.
Where do you find this 10 to 15%? This is where Bach’s “Latte factor” comes in. When we really look at where we spend our money chances are each of us has our own daily $10 version of a Starbucks latte and muffin. This $3,650 annual amount is half of a target savings amount for someone earning $50,000 a year. Then link Bach’s second piece of advice to save the money in a tax deferred type account like an employer’s 401k or 403b and you’ll save another $1,000 in taxes. Throw the employer’s match in and you could end up with $6,150 a year, all by skipping a coffee and muffin each day. If you do this each year increasing by 3% as you get raises, invest for a 10% return you would have $1,000,000 after 26 years. This should provide a retirement income of $20,000 a year after inflation (double these numbers for a couple).
Where do you get a 10% return? That’s Bach’s fourth recommendation. A portfolio invested 60% in stocks would have returned an average of 10% since 1970. Keep things simple put your savings into a balanced fund or asset allocation fund which automatically keeps this 60% stock allocation.
Bach’s fifth recommendation is to make your home do double duty as both a place to live and as a place to stash money. Buying and not renting results in all those monthly payments for mortgage and taxes we automatically make instead of rent becoming a piece of real estate you own after thirty years. At the historical 3% to 4% appreciation of real estate you end up with an asset worth two and a half to three and half times what you paid for it thirty years before.
This is a great book to inspire those with twenty to thirty years until retirement.
Portfolio Management and Motorcycles
by Gregory Claude Fetters, CFP® CPA/PFS
It was late summer and I was enjoying refreshments with good friends at the Spitfire Arms Ale House in Windsor, Nova Scotia after a day of spirited motorcycle touring. The conversation moved from the day’s ride to the relative merits of WWII fighter planes and eventually to retirement and investing. In response to a question from Rob, I suggested that based on his age and retirement goals he should consider an aggressive portfolio with 80% invested in stock funds. He nodded his head in acknowledgement. Of the three of us, Rob, was the most skillful. His aggressive riding style reflected his competitive nature. I further suggested that the 80% stock fund allocation should be invested in index funds. Bill, an indexing convert, nodded in agreement but a look came over Rob’s face similar to what I would imagine he got when a line of cars blundered in between him, the bike, and a set of sweet high speed sweeping S turns.
“It just doesn’t make sense to me to follow the crowd” he said.
“Rob, do you think you are smarter than the collective knowledge of the millions of investors who make up the market” I replied.
“I guess I’m a contrarian”, Rob said.
Boy was that a blinding flash of the obvious, I thought. Sure motorcyclist by nature are contrarians. If the images of Brando on his Triumph Thunderbird and Fonda on his Harley chopper hadn’t stamped that impression into our collective culture then the fact that all us were riding bikes made before 1984 on this 2,200 mile trip made the contrarian tag an understatement. Hek, even turning a motorcycle is contrarian. At any speed over a couple miles per hour a rider, whether he knows it or not, pushes the handle bars in the opposite direction of the turn! This phenomenon is known as counter steering and by doing so the rider causes the motorcycle to fall over into the turn where it is then caught by outward centrifugal forces. The result is an addictive magical Newtonian balance of gravity and centrifugal force that leaves the rider suspended throughout the turn subtlety controlled by pushing the handle bar away from the turn and rolling on the throttle to maintain velocity and centrifugal force. Rob, the contrarian, was a master at snapping the bike over and instantly establishing this balance.
“Fet’s (even a couple of old CPA’s dispense with formality after 20 years of motorcycling), if the market is so smart why was there a dot com bubble and a panic downward spike after 9/11?”
“Rob, I didn’t say the market doesn’t make mistakes. It just consistently makes fewer and smaller mistakes than any one individual. I’ll admit many professionals sidestepped the dot com bubble and 9/11 panic but I don’t know of anyone who was pounding the table to buy stocks on October 9, 2002 when they were poised for a 49% gain over the next 16 months. Some are great at seeing the tops and some seeing the bottoms but consistently seeing both as they are happening is very rare. In the words of the Vanguard Group founder John Bogel, “After nearly 50 years in this business, I do not know of anybody who has done it successfully and consistently. I do not even know anybody who knows anybody who has done it successfully and consistently.”
“Fet’s, I don’t know about market timing but, we are experts on setting the ignition timing on your Bonneville”, Bill interjected. “I bet we had to set it a dozen times trying to diagnose that ignition problem. You should have used German ignition coils (Bill and Rob were riding immaculately prepared BMW R100’s) instead of the ones from Taiwan.”
“Hey, speaking of China, that’s the place to invest for growth” Rob said and continued. “I found this company on the internet, the Yang Si Railroad. They are doing so much business they can’t find enough freight cars to haul all the stuff.”
“Rob” I said, “I bet there are at least a thousand people who know more about the Yang Si Railroad than you. If they thought it’s stock was under valued they will bid up the price to fair value before we are ready to order another round. Bill promptly put in his bid with Samantha the waitress for another round. I continued, “if they didn’t it would be like stepping over a $100 bill without bothering to pick it up. It’s not easy to consistently pick a portfolio of stocks that outperforms the market. I periodically run a screen on the Morningstar data base for funds that have been run by the same guy for the last ten years and investing in large cap U.S. stocks. It always comes up with only about a dozen funds that have beaten the S&P 500 over the last five and ten years and they are different funds each time. There are about two hundred of these fund managers. They are getting paid around a half a million dollars a year and have full research staffs and they still can’t pick stocks that beat the market. How are you going to do it and keep your fifteen motorcycles running at the same time (Rob enthusiastically embraces the principal of diversification in his motorcycle portfolio).
After Samantha delivered the last round with a tip teasing smile Rob admitted “I’m just not comfortable investing in the stock market. It’s just too easy to loose money.”
“Yeah”, I said, “the stock market is volatile, but since 1926 there has never been a 15 year period where you would have lost money and despite all that happened an aggressive portfolio would be up 10% over the five years ended August 2004. Jeremy Siegel down at Wharton has gone back 200 years and shown stocks have averaged a little under 10% return. That would double your money on average every seven years.
Rob, look at this way there are only 168 hours in a week. How do you want to spend it? Eating, sleeping and trying to be the first guy John Bogel knows who can consistently time the market and researching the Yang Si Railroad or letting the market stager along throwing off its historical 10% return while you are riding motorcycles?
Rob replied, ”168 hours a week. Isn’t that how much time you spend fixing that old Triumph Bonneville your riding?”