Category Archives: Total Return

Why do smart people use financial advisors?

What is the real value to hiring a financial advisor, and who uses them?  What is the value proposition?  What makes one car with four doors and wheels worth $300,000 and other $30,000?  Although we might have an answer, the answer differs from person to person.

People use financial advisors for many reasons.  Some use them because they absolutely need them, others because they want them. Paying a fee for advice and guidance to a professional who uses the tools and tactics of a CFP™ (CERTIFIED FINANCIAL PLANNER™) and an experienced Registered Investment Advisor who is a fiduciary can add meaningful value compared to what the average investor experiences.

Many middle-class investors are anxious about their finances and are not interested in learning the details of managing their money.  This anxiety often results with money left on the sidelines because they don’t know what to do or are afraid of making mistakes. That means earning a fraction of 1% at the bank when the Dow Jones Industrial Average (DJIA) is up over 25% in the last 12 months.

There are others who are interested in learning about investing and may want to hire an advisor to “look over their shoulder.”  They want to hire an “investment coach.”

A third category are people who hire professionals because they are busy doing things that are more important to them: building a career or a business, being with family, or living an active retirement.  They hire an expert to manage their money the same way they hire a lawyer for estate planning, a CPA to prepare their taxes, and a doctor to keep them healthy.

A fourth category is people who were making their own investment decisions but ended up making a huge financial mistake.  This leads me to a story about a really smart, highly paid high tech executive who is very knowledgeable about investing; but he hired an advisor:

It’s not because he lacks the knowledge or interest, obviously. Rather, he figured out he had behavioral blind spots and understood he was at risk of great financial loss. He’s paying someone just to take that risk off his plate.

Determining your goals, controlling risk, managing portfolios well, and knowing your limitations – knowing you have “blind spots” – has led many smart people to hire an advisor.

Vanguard, the hugely successful purveyor or no-load mutual funds (that appeal to do-it-yourselfers) estimates that a financial advisor is worth about 3% net in annual returns.  They attribute this to the seven services that a good advisor provides:

  1. Creating a suitable asset allocation strategy.
  2. Cost-effective implementation.
  3. Rebalancing
  4. Behavioral coaching
  5. Asset location
  6. Spending strategy.
  7. Total return versus income investing.

If you have an advisor but he is not meeting your objectives, ask us for a second opinion.  If you don’t have an advisor but may want one, we offer a free one-hour consultation to see if we are compatible.

Tagged , , , , ,

Are Retirees Focused on the Wrong Thing in Their Portfolios?

According to a recent study, a middle class couple aged 65 has a 43% chance that one of them will live to age 95. The challenge for this couple is to continue to enjoy their lifestyle and have enough money to live worry-free. Once you stop working you are dependent on income sources like pensions, annuities, social security payments and withdrawals from the savings you have accumulated over the years.

Most of these retirement income sources are fixed once we retire and are out of our control. It’s the retirement savings component that has people concerned. Most retirees don’t want to run out of money before they run out of time. For many they, themselves, are the income source that makes the difference between just getting by and enjoying life. Many retirees focus on the dividends and interest that their portfolios create. That may not be the best answer. Let’s examine the problems associated with this approach.

For the last five years the interest rate on high quality bonds (and CDs) has been close to zero. People who have chosen the “safety” of U.S. Treasury bonds or CDs have actually lost purchasing power after you take inflation and taxes into consideration. The same holds true for owners of tax-free municipal bonds. Those who bought bonds 10, 15, even 20 year ago when interest rates were higher have realized that bonds eventually come due. And when bonds mature, new bonds pay whatever the current interest rate is. That has meant a huge drop in income for many people who depend largely on interest payments.

Dividend payments are also subject to disruption. The financial crisis of 2008 was devastating for many investors. Those who owned bank stocks were particularly impacted. Bank stocks were a favorite for many income investors at that time because they produced lots of dividend income. Most banks slashed or eliminated their dividends, and some went out of business completely. Even companies that were not considered banks, like General Electric, were forced to cut their dividends. Dividends are nice income sources, especially in a low interest rate environment, but they are not guaranteed and you have to be careful about having too much of your portfolio concentrated in any one stock or industry.

The preferred method of planning for withdrawals from retirement savings is to take a “total return” approach. Total return refers to the growth in value of a portfolio from all sources, not just dividends and interest but also capital appreciation. In many cases, capital appreciation provides more return than either dividends or interest.

So how does one go about taking an income from a total return portfolio? Many advisors use 4% as a good starting point for withdrawals. That means for every $100,000 in your portfolio you withdraw $4,000 (4%) per year to live on while investing the rest. The goal is to invest the portfolio is such a way that over the long term, the growth offsets the withdrawals you are taking. It’s like a farmer harvesting a crop, leaving enough so that your portfolio has the chance to actually grow a little over time.

Of course, as we age other factors enter into our lives and the retirement equation, often headlined by medical problems related to aging. We will deal with these issues in another essay.

Tagged , , , ,

How do you get income with interest rates as low as they are?

I was reminded recently how low interest rates were when I downloaded my investment account activity into Quicken. Each account with a money market balance received a few pennies worth of interest, not enough to buy a cup of coffee. Certainly not enough to buy a Happy Meal. The average money market fund yields 0.02%. Every $1,000 investment will give you 20 cents in a year. And that’s before taxes. You could make more money collecting bottles at the side of the road.

There are some alternatives. One way is to invest for growth and forget about income. You can always spend some of the growth when you need the money.

But for those who want to see income flowing into their accounts, there’s always the “Dogs of the Dow.” The “Dogs” are members of the 30 Dow Jones industrial average with the highest dividend yields. This may be the result of a drop in prices, hence the name. For example, two of the highest yielding stocks in the DJIA are oil stocks which have declined in price even as they increased their dividends.

The current yield on the “Dogs” portfolio is over 3.5% and last year the total return (dividends plus capital appreciation) was over 10%. For more information on this strategy, contact us.

Tagged , , ,

Living on a fixed income has gotten a lot harder

At one time, living on a fixed income meant you were retired, received a pension and social security, and got some extra income from your savings. For our parents and grandparents, certificates of deposit, otherwise known as “CDs” were a guaranteed source of no-risk income. Back in 1981 you could put your savings in the bank and get nearly 18%. That was a period of high inflation when prices were also going up. But CDs and bonds paid investors high enough rates so that retirees were comfortable with putting their money into CDs or bonds.

But interest rates have been on a downward path since then. CD rates have dropped from about 11% in 1984 to 1% or less today.

CD rates history


Today, CDs and bonds, once the go-to choice of the thrifty retiree, pay a small fraction of what they once did, and provide very little income to supplement their other retirement income sources.
The Federal Reserve has been keeping rates close to zero for years to try to jump-start the economy, with limited success. But while it’s been good for businesses and home buyers who have have been able to borrow money at rates that we have not seen since the 1950s, the traditional saver has seen their income dry up, collateral damage of Federal Reserve policy.

Charles Schwab, in an article published in the Wall Street Journal states that:

U.S. households lost billions in interest income during the Fed’s near-zero interest rate experiment. Because they are often reliant on income from savings, seniors were hit the hardest. Households headed by seniors 65-74 years old lost on average $1,900 in annual income over the past six years, according to a November 2013 McKinsey Global Institute report. For households headed by seniors 75 and older, the loss was $2,700 annually.
With a median income for senior households in the U.S. of roughly $25,000, these are significant losses. In total, according to my company’s calculations, approximately $58 billion in annual income has been lost by America’s seniors since 2008.
Retirees depend on income from their savings for basic living expenses. Without that income, many seniors have taken on greater risk to increase the potential yield on their savings, or simply spent down their nest eggs. After decades of playing by the rules, putting off spending and socking away money, seniors have taken it on the chin. This strikes a blow at the core American principles of self-reliance, individual responsibility and fairness.

What’s a retiree to do? Let’s look at some of the alternatives that people on fixed incomes are being offered and what to watch out for. All of them involve risk that may not be readily apparent. There are traps for the unwary.

Continue reading

Tagged , , , , , , , , , , , , , , , , , ,

Income from “Total Return”

When thinking about income from an investment portfolio many people focus on interest and dividend income. That can lead to problems. In times like these where interest rates are low, the desire to get income from bonds and high dividend paying stocks can be hazardous.

Bonds that pay high yields may be low grade “junk” bonds that are riskier than high grade bonds. Or they can be long-term bonds that will lose value when interest rates rise.

Stocks with unusually high dividends may actually be paying more in dividends that they earn. How long can that go on? Focus too much on dividend income and you could be like those who, in 2008, owned lots of bank stocks that were paying some of the highest dividends. Some of these banks failed and shareholders lost all their money. The survivors cut their dividends to – or near –zero.

Don’t misunderstand; getting income from bonds and stocks is not bad. But “reaching” to get income from these sources can be hazardous.

There is another way of getting income from an investment portfolio that does not focus on just interest or dividends. It’s called the “Total Return” system.

Total Return introduces a third factor into the income mix: growth.

Let’s use a stock as an example.

Imaging that we buy XYZ company stock at $100. It pays a dividend of $3. That gives us a dividend yield of 3%. But let’s assume we chose XYZ stock not just because of the dividend but because we believed it would grow. A year later, XYZ stock is now selling for $110. The “Total Return” on XYZ is the sum of the dividend and the growth in value.

Dividend:                    $3.00 (3%)
Growth in value :     $10.00 (10%)
Total Return:           $13.00 (13%)

Under these circumstances, we could take the dividend plus part of the increased value of the stock, spend it, and still have more wealth than we had before. Viewed from the Total Return principle, we could spend up to $13 and be wealthier than before.

This example is easier to accomplish using mutual funds, and it’s one of the strategies that we employ for those who are retired and those who are still building their retirement portfolio.
If you want to know more about the Total Return way of investing, contact us.

Tagged , , , , , ,
%d bloggers like this: