Showing posts with label Financial Planning. Show all posts
Showing posts with label Financial Planning. Show all posts

Friday, March 8, 2019

The Christmas Correction helped seniors

Economic reports are coming in as we try to measure where we have been and use that to help determine where we are going.   Today the Wall Street Journal reported  "Household Net Worth Fell Late Last Year."

Here is my take on that headline. Yes Net Worth fell if you are measuring the value of retirement holdings in stocks.  Even if you think you are not in the stock market you are.  Every teacher's pension plan or state retirement plan is invested in "the market."

Without any action on your part, you got a gift when the market tanked at the end of 2018 if you are over 70 and 1/2 years of age.  Seventy and a half is when you have to pay the piper for all the money you saved in a qualified retirement account without paying tax on it.

Regulations demand Required Minimal Distributions from individual retirement accounts to make sure you pay tax on the money you saved for your retirement and which you must then distribute to youself as income.  Regulations allow you to save money on which you didn't pay tax and now you must pay tax on the distribution.

As you age the percent you are required to distribute to yourself goes up and therefore your taxable income goes up.

The market tanked at the end of the year which means that:

  • Retirement Account Values used to determine the income you must distribute lost value.
  • Taxable income as a percent of the retirement account value is less.
  • Combined with charitable giving, your 2019 tax bill can be positively affected.

Reducing the size of your portfolio is hardly considered a good thing but there are exceptions.  When you fund a charity with a gift from your qualified retirement, you reduce the value of your retirement plan.  Sending money directly to one or more charities of your choice means the value of your retirement plan goes down by the amount you sent to charity.  And therefore, the amount of money you must distribute as income would be less.

Since your income tax rate is determined by the amount of taxable income, you can see using charitable giving to reduce the value of your account and therefore the amount you are taxed will affect your tax rate.

This year we had an anomaly.  The market tanked just before the date at which we value our retirement funds.  With stock market values going down at the end of the year we will have to distribute less as income during 2019 than we would with the normal "Santa Claus" rally.

Charitable transfers are an active process but this little gift required no work.  We income investors know that long term, the market will come back and indeed the market has recovered much of that odd sell off.

If you were clever enough to fund your charitable obligations through Retirement distributions, you got a double holiday gift:  a market swoon just when we could use it that reduces your account value and next year's taxable income and decrease in your account value from the charitable gift.

M* Money Madam 
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Wednesday, December 5, 2018

Inverted Yield Curve - Another blow to Seniors

Just when you think inflation will work in your favor, the yield curve threatens to invert.

  • Inflation exists for ordinary investors despite low interest rates
  • Low yields push income investors into higher risk investments 
  • An inverted yield curve is negative for banks and insurers but positive for stocks with solid debt management

Conventional wisdom suggests inflation is a hidden tax because it erodes your purchasing power.  In this case, conventional wisdom is accurate.  For instance, according to the official U.S. inflation calculator site,  a  $5,000 bond purchased at par 20 years ago in 1998 would cost more than $7,700 to buy today.

Annual Inflation Rate Chart

The Federal Reserve is in charge of regulating bank lending rates.  Theirs is a dual mandate to maintain a reasonable level of inflation and employment and in so doing, they use many metrics to determine if inflation exists.  Some of their measures include food and energy, some do not.  Some measure wholesale prices and some measure consumer prices.

Inflation exists for ordinary investors despite low interest rates

I measure my family's personal expenses and through nearly three 20 year cycles, I know that my expenses double every 20 years.  That computes to about a 3% annual inflation rate.  Yet during these nearly 3 decades interest rates on a government insured certificate of deposit have ranged from .5% to more than 20%.  A brief history of CD rates can be seen in here.

Cost of goods, cost of wages as well as cost of money weigh on inflation.  Why then is inflation considered so low that the yield curve which is the difference between a longer term bond and a 2 year bond and therefore flat when I know chicken and hamburger cost more.  Going out to eat costs more.  Luxury goods cost more.  Health insurance costs more.  Houses and when you can't buy a house or for seniors when you are done owning a house and want to rent or go to senior living, renting costs more.

Go back 20 years and look at your property taxes, your home owner's fees, your car insurance.  All are higher.  My point is that for individuals, inflation is a cruel tax but it is foreseeable and manageable.  The future is not as clear for income.

Inflation can work in your favor

When I state that I thought inflation would work in my favor, I speak as a person who remembers safe government insured money that paid 7%.  Just when we retired for the first time, our long term planning hoped for at least 50% of our portfolio earning at least 7% safe income.  Today safe government insured money pays barely 3%.   If inflation could deliver 7% in U.S.guaranteed investments, that would be a gift.

Successful seniors have everything paid for.  They do not need a new house. They are probably thinking of how to monitize that asset to go to a senior living facility.  If they need a new car, they have the cash.  We may need a new hip, but we are not in the asset acquisition phase of our lives.

Younger investors have the cash flow from working to buy things.  In this case, younger people need to plan their purchases carefully to avoid the negative effects of inflation until they get to the point where their money needs to create income to replace their earnings.   At this point in your life, it is good to have everything paid for already and ignore the inflation tax.

An inverted yield curve is negative for banks and insurers but positive for stocks with solid debt management

Our investment need is to create income from savings,  Today we need to invest in assets higher on the risk scale than U.S. guaranteed bonds.

Source Incredible Charts: Yield Curve

Real Estate and stocks are the few options we have.  If, however, the Federal Reserve continued to increase interest rates on, we could get closer to an environment where we could get competitive yields on government secured investments.   Investors who end up living off of the income from their investors will need to retire with income that grows because inflation will eat away at the earnings power of their income.

Many but not all people end up with multiple sources of income during retirement.  Social security, company pension plan, military pension, Uncle Henry's trust, or an inherited IRA.  Yet nearly every successful retiree will need income from their savings.   Where do you get that today?  Certainly not from a safe U.S. Treasury or even a G.O. (general obligation) municipal bonds.

Some investors chase yield and buy too risky an asset.  If you pay $115 for a municipal bond so that you can get 6% yield, you are fooling yourself.  In 20 years, as noted above, when that bond matures, you get back only $100 not $115 and in 20 years that $100 buys a lot less.  Do not chase yield in the bond space.

Stocks and Real Estate

Not all stocks work during periods of low inflation. For instance, the way banks make money is to pay less to their depositors than they can lend out.  There is where the yield curve hurts these types of stocks.  They just have so little margin for profit.

When inflation is realized in higher lending rates that will help banks and hurt people who need to buy assets but it will help savers.

Chart courtesy of Bigger Pockets.  S&P is the S&P 500 index and HPI is home price index.

Today the stocks an income investor needs must pay a dividend greater than the 2 year U.S. Treasury, they need to make more money than paid out in the dividend.   Two other factors are in play, the dividend should increase regularly and their balance sheet needs to be pristine.

Avoid stocks that use a lot of debt to grow.  You can find growth stocks with no debt.  Garmin, symbol GRMN, is a good example.  You can find a lot of stocks with very manageable debt.  Intel and Apple have very little debt.  Pay attention to stocks with a lot of debt especially those who recently borrowed at very low rates.  It seemed like almost free money.  But if they did not lock in those low rates over time and have to roll that debt in a few years, they could face much higher interest rates and that will affect the stock's profitability.

I do not cover real estate in this blog but I do hold nearly 1/3 of our portfolio in income producing real estate.   For ordinary investors REITs (real estate investment trusts) can provide an investment opportunity if you do not want to own real estate out right.

Chart from Nareit illustrates the return on REIT's versus stocks.  Even here you can see the benefit of holding some real estate in your income portfolio. 



Until inflation can help us, we have no choice but to go up the risk scale for our investments.  Lets us do it with great care.

M* MoneyMadam

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Tuesday, September 20, 2016

ETF versus Semi - Active Managed Income Portfolios

The purpose of this post is to present a simple comparison of two income investing strategies.  One strategy is totally passive and employs two well respected ETF’s.    The other strategy uses individual stock picking.  I call that strategy a “semi-active managed” strategy.  Every stock selected in the semi-active strategy is held no matter what.  All spin offs and splits are included in the portfolio.  In that way, it is semi-actively managed as a long only portfolio with no trades.

Accumulate over five years

Beginning in November, 2010 and continuing for the next 12 months, I added one stock per week to the “semi-active” portfolio.  I used my standard four criteria of dividend yield 3% or greater, EPS (earnings per share) greater than dividend paid out, history of dividend increases and D/E (debt to equity ratio) of 1 or less or equal to industry standard.  This is called the 2011 model portfolio. 

Simultaneously, I created two parallel portfolios using SDY and VIG two ETF’s with similar goals to my portfolio.  I added the number of shares of these two ETF’s equal to the amount invested in a given stock.

For instance, the very first stock I picked was Microchip Technology, MCHP.  This stock was added on November 12, 2010 at a basis of $33.55.  The post was published on November 14, 2011.

Simultaneously, I started the SDY and VIG portfolios.  I needed a bench mark against which to compare my portfolio and I chose SDY an ETF that concentrates on dividend income and VIG which concentrates on dividend increases.   SDY on November 12, 2010 closed at $51.37.  I added 65.437878 shares of SDY equal to the $3,355 invested into MCHP.   VIG closed at $50.60 and I added 66.304 shares also equal to the $3,355 invested into MCHP.

I continued these multiple channels of investing over five years.  The total basis is $710,000 in all three portfolios M* (my stock picks), SDY and VIG.

Capital Gain Results

The table below shows the result of holding these three portfolios as of midday (1:32PM Eastern time) on September 20, 2016.

You can see that all portfolios performed quite well.  Picking stocks did beat both SDY and VIG by between 8 and 10 percent.   Actual dollar difference is between $58,000 and $72,000 over the five years.

Will having an average of $65,000 more in your portfolio make a difference in five years?  Only you can determine that.  However, I find solace and comfort in all three approaches.   I have often encouraged people who do not have the time to invest by themselves and do know how to direct an investment adviser or cannot find one they trust, to use these two ETF’s and now I feel good about the results.
Readers have to consider that these five years have been very good to equity investors as well as bond investors.  It was hard to lose money over these five years.

As one of my former clients recently told me “I don’t expect to beat the market, I just want to at least keep up.”  All three portfolios “kept up.”

Dividend Increases

As I am an income investor first and foremost, I like capital gains but I really like income increases.   Trust me, your expenses will double every 20 years so if you expect to retire at 60 and live to be 100, your expenses will double twice.   Let’s see how these two approaches did on income increases.

Comparing dividend increases is a complicated task.  You don’t buy everything at the closing price on 12/31 of a given year and then look at how that holding performed using 12/31 values of the next year.  This is how the experts track mutual funds etc.   You buy every week or every month sometimes you wait 90 days for the first dividend.  I tried to simplify the process as you can see in the table below.

The table above shows that VIG is the winner on dividend increases.  SDY is the loser and M* came in second.   To be fair to SDY, I used only dividend payments in this analysis.  Keep in mind that SDY also delivered some healthy capital gain distributions in 2014 and 2015.   My 2011 portfolio suffers because several stocks were bought out and that cash sits in the portfolio (no transactions allowed in order to report good data) not creating any income or capital gain.


For me, I prefer using my four criteria (which I adjust and update each year) to pick income stocks for the majority of my income investing portfolio.  However, in certain accounts that have limited investment options like my Health Savings Account, I use SDY and VIG in equal amounts for my investments.

M* MoneyMadam
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Tuesday, July 5, 2016

RMD - Table III How long will your stash Last?

I recently wrote an article about distributing IRA funds in accordance with the required minimal distributions imposed by the IRS.   I used the example of a person who inherited an IRA worth $1,000,000 and had to distribute income using the IRS Table I or single life table.  This table does not apply to the ordinary investor.
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Friday, June 3, 2016

Manage your RMD for the next Twenty Years

You are 70 and a half and now is the time you have to take money out of your IRA.  Your circumstances are such that you are the survivor and will use Table I, single life expectancy. 

Assuming you will live 20 more years, let’s look at several scenarios on using your RMD (required minimum distribution.)

The theory of the RMD is for the government to receive taxes on the portion of your retirement savings that were tax deductible when you saved it.   Got to pay the piper one way or another.  This post concentrates on the savings in your traditional IRA not Roth IRAs.  
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Sunday, January 31, 2016

Young investors advised to create multiple spigots of income for retirement

Advice to young investors.

Create multiple spigots of income for your retirement.

The end is the beginning.  When you retire you are at the end of your earning career but at the beginning of your investment career.    Some large corporations provide investment assistance for a period after retirement, but in the end, whether you worked for a big corporation or ran your own beauty salon, you will need to manage your finances during most of your retirement.

Wealth Managers

High net worth people often times use a wealth manager and pay a fee.  Their holdings can be complex with both tax and estate factors that make paying a fee for multidisciplinary investment help worth the expense.  Believe me, the client who turns over all of their money with both discretion and custody to a wealth manager is taking on enormous risk.    Look at what happened to Bernie Madoff’s clients. (See notes 1 and 2 for definitions of discretion and custody.)

In my blog I have written about one investment manager that is public and shares with you the money they make from managing other people’s money through a dividend.  That stock is Westwood Holdings symbol WHG.

Ordinary Investors         

Ordinary investors who start saving for retirement in their mid-thirties and get really interested in creating wealth in their 40’s are my target for this article.  If you invest with the goal of creating income later in life, you will be a very successful and happy retiree.

Multiple Spigots of Income

My best advice to young investors is to execute a plan designed to develop multiple spigots of income.  Do not depend on any one source be it social security, your teacher’s pension, your defined benefit plan, your stock option, the lottery or Uncle Henry’s promised bequest.  Don’t depend on any one, but use them all. 

The easiest example to understand the concept of multiple spigots of income available to ordinary investors is to think about the investor who spent time in a government career.   The government allows people in its employ to serve enough time to create a government pension yet leave the government at a time of life when they are still productive.  Government law enforcement employees like those with the USPS actually must retire at age 55 when they could and should pursue a second career.   10 years in the private sector provides this person with social security benefits as well as the opportunity to contribute to a qualified retirement plan.  I know more than one of these talented, resourceful, energetic people who went on to teach at the university level creating yet another spigot of income.  

Every successful investor needs to invest with the purpose of creating multiple spigots of income using whatever resources are at your disposal.  Be creative in determining the resources at your disposal.

Use Real Estate 

Real Estate is a frustrating but very rewarding spigot of income to cultivate.   It is not easy but the tax advantages and the potential for future income is undeniable.   

The riskiest but most rewarding real estate investments are done privately. I personally have been involved with winners and losers.  You have to cultivate relationships with proven real estate investors and hope you have saved enough money to invest with them.

Leverage is a necessary part of real estate. For the average investor, it takes too long to save up enough money to buy an income property outright.   You have to use leverage.   For instance: you buy a one hundred thousand dollar rental property using only 10% down or $10,000.  Your tenant covers the cost of the leverage, better known as a mortgage, and the ongoing expense through the rent you charge and then you sell the property for two hundred thousand dollars.  After paying off the $90,000 of leverage you just turned $10,000 into $110,000.  Turn that $110,000 into income through more real estate or take your gains and move into another asset class like stocks.  Personally I think, if you are successful enough to have created this capital gain and you did cover your expenses from rentals, you will find a property that will turn $110,000 into $1,000,000.  

Most ordinary investors who create multiple spigots of income have some real estate income.  It may be a condo bought for income, it may be in partnership with others to buy something bigger than a single condo.  It may be in a real estate investment trust. 

For investors who do not know how to manage a rental condo or who do not know a reputable general partner for a private real estate deal, you can consider a REIT (real estate investment trust.) REIT’s can be a good vehicle to create a spigot of income for retirement.   Your income and your gains may not be as grand, but a well selected REIT can deliver a good spigot of income.  Taxes are little complicated but not something your accountant cannot handle.  See Note 3 for an Investopedia explanation of REIT taxation.   The best REIT performer of my M* portfolios has been a health care REIT, National Health symbol NHI.

Build your own Business

Build equity in a business and use your success to leverage the purchase of the real estate your business runs out of. Now you own two assets.  One is the ongoing business and if you sell it and help the purchaser of that business be successful you may end up with a capital gain and a long term tenet providing another source of income.

Use every retirement vehicle available

Work your personal budget so that you can fully fund or match every 401K, 403B, pension plan, IRA, Roth IRA possible.  I like to see young people devote no less than 10% of their gross income into retirement vehicles.  If 10% of your gross income is greater than you are allowed to contribute by law to qualified retirement or pension plans, then consider tax advantaged savings such as municipal bonds, annuities, or a foundation.  But if you have so much income that a foundation is one of your options, hire a wealth manager.

Costs can eat up savings which is why I do not like annuities; they are too expensive.   Corporate pension plans provide mostly mutual funds and you have no choice but to pick one or more of those funds and suffer the costs.   But for the self-directed money you have saved, I recommend using ETF’s.    My favorites are SDY and SPY and I have been looking at VIG as good sources of steady, and rising income. 

I find that few young people, especially those raising children, have enough time to execute a disciplined investment plan by themselves.  ETF’s are low cost investments that concentrate on both growth and income.   It is always nice to have income while you wait for growth.  ETF’s are the best alternative, in my opinion, to managing your stock portfolio yourself.

Diversify, Diversity, Diversify

Be as diversified as your experience and your contacts allow you to be.  If you have tried and you just cannot manage your investments, then your alternatives are ETF’s or mutual funds.   If you have success with real estate or second trust deeds, then go with those investments.   Learn while you invest.  If you know other people who invest money cultivate contacts that could help you invest in private real estate.

Diversity in a portfolio means you have investments in multiple asset classes, some in stocks some in bond or trust deeds, some in real estate, some in your small business or stock in your corporate employer.   Diversity also means to have diversity within each asset class.   Don’t count on one very expensive property to deliver the income and growth you’ll need in the future.  It is better to have multiple smaller properties that cover more than one geographic area.

Use stocks and bonds and covered calls

Have a game plan for stocks. Use ETF’s until about five years before you quit working then merge into individual stock holdings. Learn how to sell covered calls. Covered calls are relatively easy to learn.  Do not mistake learning how to sell covered calls with an options trading strategy.   Options trading is a completely different animal that is a hobby not an investment plan.

Never, ever use a bond fund.   Bond funds pool their bonds and you are not guaranteed return of principal as you are with an individual bond.  This is why I am not a fan of target date funds.   Target date funds move the client between and stocks and bonds based on their age but the bond holdings are pooled.  This is not a good way to invest the bond portion of a well diversified portfolio.

When interest rates are more favorable than they are now, invest in individual bonds that you buy at no more than par and possibly at a discount.  Ladder your bonds by maturity.  Every major brokerage house, I use Schwab and Co., has a bond desk that will help you create a laddered portfolio but you must set the guidelines for them and you need to understand the concept of bond ownership and laddering maturities.    

Principle value will vary but a bond held to maturity will give you back your money.   Never, ever use a mutual or ETF to build your bond portfolio.

When investing in stocks, stick with US companies and to get global exposure go with the big cap companies.  Mc Donald’s symbol MCD or Johnson and Johnson symbol JNJ or Pepsi symbol PEP, I can go on and on, are the kind of stocks you want to buy.   Learn enough about the fundamentals of a stock to make a reasonable choice.   Make a list and buy these good companies when it appears there is opportunity.   

Opportunity moves around the universe of stocks.  Commodities stink right now but they have been good several times in my lifetime.  Energy is weak but has delivered a lot of good income to investors who already retired.   Research suggests 20 well diversified stocks will be enough to create a good portfolio. (Note 4)   Gradually leave the world of ETF’s and begin to develop your portfolio about five years before you retire.  The market will be volatile enough that you can pick from your wish list and add stocks when you see opportunity then reinvest the dividend until you need it   When you do this in a qualified retirement account the results are stunning due to the fact you are not taxed on the growth or the income until you take the money out.

Use Patience

Be patient as asset classes will go up and down in value.  Be patient as specific holdings within asset classes will go up and down.   Don’t be afraid to make a mistake; correct it as soon as you can but be sure to consult your plan so that you are not making emotional rather than disciplined decisions about your assets.

Good luck and good investing.

M* TheMoneyMadam

Note 2  Custody by investment advisers means holding client funds or securities, directly or indirectly, or having the authority to obtain possession of them.
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