The last “all-time high” on the S&P 500 (2,873) was reached just over six months ago, on January 26. Since then, it’s down roughly 10% on three separate occasions, with no shortage of “volatility,” and a host of expert explanations for this persistent weakness in the face of incredibly strong economic numbers.
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GDP has risen, unemployment has fallen; Income tax rates are lower, the numbers of unfilled jobs are increasing … The economy is so strong that, since April, it has become stable or rising in the face of higher interest rates and a war trade imminent. Go figure!
But what impact does this pattern have on you, especially if you are withdrawn or “future”? Does a flat or lower stock market mean that you will be able to grow your portfolio income or that you will have to sell assets to maintain your current disposition of your investment accounts? For almost all of you, unfortunately, it is the latter.
I have read that 4%, after inflation, is considered a “safe” portfolio withdrawal rate for most retirees. However, most retirement portfolios produce less than 2% of actual income to spend, so at least one securities settlement is required each year to maintain power.
But if the market goes up on average 5% every year, as it has since 2000, everything is fine, right? Sorry. The market just doesn’t work that way, and as a result, there is absolutely no doubt that most of you are not prepared for a scenario half as bleak as various of the accumulated realities of the last twenty years.
(Note that it took about sixteen years for the NASDAQ Composite Index to rise above its 1999 high … even with the mighty “FANG.” Its entire 60% + rise has occurred in the past three years. , almost the same as in the “worthless” rally from 1998 to 2000).
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The NASDAQ has risen just 3% annually for the past 20 years, including producing less than 1% in spending money.
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Despite the dot-com rally from 1997 to 1999, the S&P 500 lost 4% (including dividends) from late 1997 to late 2002. This translates to an asset loss of nearly 5%. annual or a total loss of capital around 28%. So his million dollar portfolio became $ 720k, and he was still yielding less than 2% per year of real spending money.
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The ten-year scenario (1997 to 2007) saw a modest 6% gain on the S&P, or growth of just 6% per cent per annum, including dividends. This scenario produces an annual asset reduction of 3.4%, or a loss of 34% … his million dropped to $ 660K, and we have not yet reached the great recession.
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The 6 years from 2007 to 2013 (including the “great recession”) produced a net profit of approximately 1%, or a growth rate of approximately 17% per year. This 3.83% annual reduction reduced the $ 660,000 by another 25%, leaving a savings of only $ 495,000.
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The S&P 500, gained roughly 5% from late 2013 to late 2015, another 5% tie, reducing “the egg” to roughly $ 470k.
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So even though the S&P has gained an average of 8% per year since 1998, it has failed to cover a modest 4% withdrawal rate almost all of the time … that is, in almost all but the last 2.5 years. .
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Since January 2016, the S&P has gained roughly 48%, bringing the ‘ole nest’s savings back up to roughly $ 695k … roughly 30% below where it was 20 years earlier .. with a “safe” draw of 4%.
So what if the market performs as well (yes sarcasm) for the next 20 years and you choose to pull out at some point during that period?
What if the 4% annual retirement rate is an unrealistic barometer of what the average retiree wants (or has to) spend per year? What if a new car is needed, or there are family health issues / emergencies … or you feel the need to see what the rest of the world is like?
These realities drive a big hole in the 4% per year strategy, especially if any of them have the audacity to occur when the market is in a correction, as it has been almost 30% of the time during this 20-year bull market. We won’t even get into the very real possibility of bad investment decisions, particularly in the final stages of rallies … and fixes.
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The market value growth approach, focused on total return (modern portfolio theory) is simply not enough to develop an investment portfolio ready for retirement income … a portfolio that actually increases the income and capital of Investment work regardless of the turns of the market shares.
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In fact, the natural volatility of the stock market should help produce both income and capital growth.
So in my opinion, and I have been implementing an alternative strategy both personally and professionally for almost 50 years, the 4% reduction strategy is more or less a “trap” … of disinformation from Wall Street. There is no direct relationship between the growth in the market value of your portfolio and your spending requirements in retirement, nadda.
Retirement planning should be income first planning and investing with a growth goal perhaps. Investing for growth purposes (the stock market, however hidden from view by packaging) is always more speculative and less productive in terms of income than investing in income. This is precisely why Wall Street likes to use “total return” analysis rather than simple “return on invested capital.”
Let’s say, for example, you invested the $ 1 million savings from 1998, demand retirement, which I referred to earlier, in what I call a “Market Cycle Investment Management” (MCIM) portfolio. The equity portion of an MCIM portfolio includes:
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Dividend-paying individual stocks rated B + or better by S&P (so they are less speculative) and are listed on the New York Stock Exchange. These are called “investment grade value stocks,” and they are regularly traded for 10% or less in earnings and reinvested in similar securities that are down at least 20% from year-highs.
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Also, especially when stock prices are bubbly, equity capital funds (CEFs) provide diverse exposure to equities and levels of return on the money they typically spend above 6%.
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The equity portion of such a portfolio generally yields more than 4%.
The income portion of the MCIM portfolio will be the largest investment “segment” and will contain:
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A diverse variety of income purpose CEFs containing corporate and government bonds, notes, and loans; mortgage and other real estate-based securities, preferred stocks, senior loans, floating rate securities, etc. The funds, on average, have an income payment history that spans decades.
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They are also traded regularly for a reasonable profit and are never held beyond the point where one year’s interest can be realized up front. When bank CD rates are less than 2% per annum as they are now, a short-term profit of 4% (reinvested between 7% and 9%) is not something to despise.
The MCIM portfolio is allocated and assets managed so that the 4% reduction (and a reserve for short-term contingencies) consumes only about 70% of total revenue. Those are the “things” needed to pay bills, finance vacations, celebrate important life milestones, and protect and care for loved ones. You just don’t want to sell assets to deal with essentials or emergencies, and here’s a fact of life from investing that Wall Street doesn’t want you to know:
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Stock market turns (and interest rate changes) generally have no impact on the income paid for the securities you already own and, falling market values always provide the opportunity to add positions …
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Thus reducing your cost per share basis and increasing your return on invested capital. Falling bond prices is an opportunity of much greater importance than similar corrections in stock prices.
At 40% equity, the 60% income asset allocation (assuming 4% income on the equity side and 7.5% on the income side) would have yielded no less than 6.1% in real money for spending, despite two major market crashes that shook the world during those twenty years. And that would have:
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eliminated all annual reductions, and
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produced nearly $ 2,000 a month for reinvestment
After 20 years, that 1998 million dollars, the nest’s savings would have turned into approximately $ 1.515 million and would be generating at least $ 92,000 in spending money per year … note that these figures do not include earnings from Net capital per negotiation and no reinvestment at rates better than 6.1%. So this is perhaps the worst case scenario.
So stop chasing after that higher market value “Holy Grail” your financial advisers want you to worship with every emotional and physical fiber of your financial conscience. Free yourself from the limitations of your ability to earn money. When you leave your last job, you should be earning almost as much in “basic income” (interest and dividends) from your investment portfolios as in salary …
In some ways, income production is simply not an issue in current retirement planning scenarios. 401k plans are not required to provide it; IRA accounts are generally invested in Wall Street products that are not structured for income production; financial advisers focus on total return and market value figures. Just ask them to evaluate your current income generation and count the “ums”, “ahs” and “goals”.
You don’t have to accept this and you won’t be ready for retirement with either a market value or a full return approach. Higher market values feed the ego; higher income levels fuel the yacht. What’s in your wallet?
