Summer Stroll #18 - Retirement Respite

You have just retired. You have a million dollars to live on the rest of your life. Who do you trust to guide you? What do you put the money in? Where do you start? The old Who, What, Where questions bombard you with a weight that is surprising and unrelenting. You may be good at sales, or a whiz at accounting, fly a plane like nothing, or sing like a bird, but you are leaving your active career, and you are now faced with a job just as big and potentially more important that the job that produced this wealth. You are about to enter the world of Retirement Roulette. I keep using the term Roulette because unless you are very wise, you will do what most "financial planners" are recommending, and the moment you start down that road you are sowing the seeds of depleting your assets, if not literally, then figuratively. The reasons are two fold: 1. The annual fees of the financial planning crowd, which can run between 2% and 3%, are too high to permit investing in much fixed income securities. 2. This means that advisors who use only mutual funds must rely heavily on stock funds, whose volatility we believe many people in retirement find psychologically difficult to live with. There is a way out of this game of chicken that is practical, doable, and livable. Let me go back to my idea of the buckets. In this case, I want to use the concept of what I will call the three buckets of retirement. The first bucket will be invested in fixed income securities. Today it is possible to buy investment grade fixed income securities that yield near 6%. Let's say we have put half of our money in the fixed income bucket. At 6% it will produce annual income of about $30,000. This bucket will not grow, but its contents are safe and its principal and income will be very steady. In bucket number two, we will invest in selected rising dividend stocks. The stocks we want in this bucket are stocks with as much dividend yield and dividend growth as we can find. Currently our Rising Dividend Model Portfolio yields 3.5%. That means if we invest the other half of our million dollars in bucket number two, we can expect to produce $17,500 in dividend income. Almost all of the companies in bucket number two have raised their dividends for years and possess strong finances so statistically we believe the odds are in the 90% range that this income will grow. At this point, our portfolio will produce $47,500 in annual income. The first question you should ask is, "Why don't we put more money in bucket one? If we put it all in that bucket, we would have $60,000 in safe annual income." Yes, you would but you would miss the rewards of bucket three. This bucket contains the price appreciation of the stocks in bucket two. Our Rising Dividend Portfolio has enjoyed annual dividend growth over many years of just over 7%. Indeed, over the past two years its dividend growth has been near 10%. But let's stick with 7% for the illustration. If dividend growth averages 7% over the next few years, we would expect the price appreciation of the portfolio to also grow by at least 7%. In addition, in most of the stocks in which we invest there is a high correlation (80%-90%) between dividend growth and price growth. Thus if we have the right stocks in bucket two, it is statistically a near certainty that we will achieve price growth in bucket three. Bottom line we expect bucket three will produce near $35,000 in average annual appreciation. Our best guess is that the three bucket approach would produce $82,500 in average annual benefits. That's good news, but the best news is that only about 40% is in price appreciation. The other 60% would come from the income out of the other two buckets. Another good thing about the three bucket approach is that it is only approximately one-third to one-half as volatile as the standard asset allocation being recommended by many investment people today. Or said another way, it is an order of magnitude more predictable, thus livable. We believe the secret to the three bucket approach is to keep expenses down by investing in individual stocks and bonds. In this way, we save the whole layer of fees that the mutual funds charge. We are money managers, and we charge a fee to manage accounts, but because we do not use mutual funds our total fees are a fraction of those that are routinely charged by the planning crowd. The money we save by cutting out the funds goes into our clients pockets. And because of our lower fees, we can invest in more income producing securities than can the typical recommended mutual fund asset allocation. Additionally, by investing in more income producing securities we can dramatically lower the volatility and risk. There are of course all the usual disclaimers about trying to project the future by looking into the past, and there are questions that I have raised and not answered, but at the end of the day, your retirement years should not be a time when you are timing the market or supporting a financial planner's lifestyle, needlessly. Ninty-nine percent of those of you who are reading this blog are probably clients or prospects of Donaldson Capital Management. If you are not, you owe it to yourself to see if an individually crafted three-bucket-investment plan would work for you. My email is gdonaldson@dcmol.com. My phone number is 800-321-7442. Email me or call me. I'll get you in touch with one of our portfolio managers. It does not make any difference where you are. We have clients in 28 states. In the past week we have been in Arkansas, Alabama, Kentucky, Illinois, Tennessee, and Indiana. We are harping on this not because we think we have the only answer, but judging from the new accounts that our firm is adding every day, the name brand investment firms in the Midwest do not have a clue about how to construct a portfolio that will stand the test of time and provide "Retirement Respite," instead of a Retirement Roulette.