Retirement Portfolio: Three Strategies, Which One Is Right For You? – Seeking Alpha

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One size does not fit all. It applies to investment strategies as well. Investment strategies can range from a very simple one to fairly complex depending on how much interest you have, the amount of time you want to devote and your income-needs vis-a-vis your portfolio size.

For managing your financial assets, what you need is a well laid out strategy, discipline and will to execute it. The 34th American President, General Dwight D. Eisenhower said, “Plans are nothing. Planning is everything.” Make your goals and objectives, know your risk-tolerance and start planning. Write it down and most importantly, execute it. Review it periodically, what is working and what is not, and adjust accordingly.

Strategies:

In this article, I am going to lay out three strategies, starting from a very simple one to fairly complex. The first two strategies aim at 3-4% income to be withdrawn like the traditional norm that we have heard so often. However, the third strategy aims for 6% income. So, what is a good and reliable withdrawal rate? Is 4% withdrawal rate good enough for everyone, or is it too much that you may run the risk of depleting the portfolio before its time. The answer to this question is not that straightforward. However, if your income needs are greater than 4%, traditional approach may not work. As we will see in the third strategy, the solution may lie in diversification by deploying multiple strategies. So, just relax, let your guard down, read away and you be the judge!

For the sake of illustration, we will assume $1 million in investment assets. It does not mean that everyone needs to have that amount to retire. It all depends upon your expenses in retirement.

Strategy # 1:

The Lazy Man’s Portfolio:

I do not take credit for inventing this term. It is widely used in reference to the financial portfolios. It probably means a financial portfolio that is left on auto-pilot. You may have too many other interests to pursue than just looking at financial screens all day long. Even if you are retired, you may have better things to do than trading stocks and worrying about your stock holdings at night. If you fit into this category, you set up a lazy man’s portfolio, which does require some planning and work in the beginning but not much after that. It just needs a few hours of yours every year or may be a day or two maximum.

You could simply be invested in two securities SPDR S&P 500 (SPY) and Vanguard Total Bond Market Index Fund (VBMFX) in the ratio of 60:40, rebalanced annually. The table below shows the annualized returns from this simple 60:40 portfolio and growth of $10,000 from the year 1994 until July 2017, depending on which year you had invested.

Portfolio Assets: (Re-balanced annually)

  • 60% SPDR S&P 500 (SPY),
  • 40% Vanguard Total Bond Market Index Fund (VBMFX).

*CAGR – Compounded Annual Growth Rate

You could make the Lazy Man’s portfolio a little bit more balanced by diversifying into several assets-classes.

Yearly rebalancing: It may be the Lazy Man’s portfolio, but you should not miss this annual date. Once the rebalance schedule has been setup, it should be completed without emotions on the schedule.

Here are performance results from the above sample portfolio since the beginning of the year 2008 until July 2017.

Assumptions in the above table:

  • Re-balanced annually.
  • The above model shows two rates of income-withdrawal, 4% and 6% (both with 2.5% inflation adjustment annually).
  • No first-year income withdrawals.

It is clear that this model will only allow 3 – 4% of income (3% will be much safer, 4% is the max). If you were to withdraw more, it would start depleting.

Strategy # 2: Balanced Growth And Dividend Portfolio:

This strategy is somewhat of a middle-ground between Lazy Man’s portfolio and Active Investor’s portfolio. It does require some work at least on a periodic basis but still structured in an easy to understand and implement manner.

  1. You will need to do some work, in the beginning, to select roughly 20 Dividend stocks. There is a lot of help available on Seeking Alpha on how to select good Dividend stocks. Allocate from 40 to 50% of the assets, depending on your risk-profile.
  2. Growth Stocks: You will need some growth in your portfolio to give it the energy for the long term. Allocate from 10% to 15%, depending on your risk tolerance. Fill it up with stocks from growth industries like Technology, Healthcare, and Financials. Some well established and cash rich companies like Microsoft (MSFT), Alphabet (GOOGL), Facebook (FB), Apple (NASDAQ:AAPL), Amazon (AMZN), MasterCard (MA), Visa (V), etc. If we were to select 10 such stocks, we are only allocating 1% to 1.5% to any one of them.
  3. International: We could choose one of the mutual funds or ETFs with a good track record and liquidity. Some examples: Templeton Foreign Fund, Advisor (TFFAX), Vanguard FTSE All World Ex US ETF (VEU), iShares MSCI EAFE Index Fund (EAFE), iShares MSCI Emerging Markets Index (EEM), etc.
  4. Bonds: Unless you have knowledge in this area, just go for a total bond fund like like Total Bond Fund (BND) or Vanguard’s fund VBFMX.
  5. Treasury Funds: You could diversify in three types of Treasury funds, short-term, mid-term and long-term funds.

There was no way I could back-test this model without introducing some personal selection bias. But I went ahead anyway and tried to think what I would have picked in 2008, and without knowing what I know today. This is what I selected:

This is what we got in performance results:

Assumptions in the above table:

  • Re-balanced annually.
  • Income withdrawn is 4% initially and increased by 2.5% annually for inflation.
  • No first-year income withdrawals.
  • The investor needs to have some fair ability to pick good growth stocks.

This portfolio had a maximum drawdown of -24% in the year 2008, which was probably too high for many, but still, it was half of S&P500. Overall, this portfolio was a winner and provided income and balanced growth. However, note that the outperformance was partly due to the recent boom in the Tech sector stocks. A 4% income withdrawal rate is ideal for this portfolio, leaving ample room for growth. The biggest challenge, we see with this portfolio will be the ability to pick the right growth stocks, especially the technology stocks.

Strategy # 3:

High-Income And Growth Portfolio With 6% Income

(for Active Investors)

This strategy is suitable for active investors only. We are assuming someone who is willing to put in between 3-5 hours a week on reading, studying, trading, portfolio management, etc.

For the sake of this discussion, let’s assume one such investor is John. John retired at the end of December 2007 at the age of 60 with $1 million in financial assets, plus enough in savings for first year’s expenses. He wanted both a high level of income without selling shares (or depleting the capital), as well as a reasonable growth of his capital. John wanted roughly 6% income so that he could get $60,000 a year of spendable income to maintain their current standard of living.

(Please note that we selected end of the year 2007 as the beginning of the portfolio, a peak time for the stock market at that time, just before the financial crisis, can’t think of worse timing than this).

To meet his objectives, let’s assume John deployed our 3-bucket strategy, as described below.(This bucket strategy is different in many ways than what we discussed in our previous article).

Bucket 1: (33% of the Capital) – DGI Portfolio

John deployed 1/3 rd of the capital in a DGI (dividend growth investing) portfolio, with 20 individual stocks. Incidentally, 17 of them were the same stocks as in our example above in Strategy-2. He just added three more, namely AT&T (T), VZ (VZ), and Home Depot (HD). Each of the 20 stocks was allocated 5% of the assets in the portfolio.

At the start of the portfolio in January 2008, John was earning roughly 3% average dividend on the portfolio. Luckily none of the companies cut their dividends during the financial crisis in 2008-2009. An average dividend rate of 3% was not bad but much short of the 6% target. But John was still happy with it because this was a low-risk long-term blue-chip portfolio and he knew that over time the dividend yield on cost (YOC) would increase more than the inflation.

Starting with an initial yield of 3.0%, John would withdraw roughly $10,000 (3% of $333,000) every year from this portfolio, starting January 1 st, 2009. He would also take in a yearly raise of 2.5% on income from this portfolio.

Table with performance results:

Assumptions in the above table:

  • Income withdrawals are at 3% initially and increased by 2.5% annually for inflation.

Bucket 2: (33% of the Capital) – The 8% Income Portfolio

John wanted a higher rate of income from this portfolio, primarily to compensate for the shortfall in income from Bucket-1. So, he went for a high-risk, but high-income portfolio. The one place he could find an 8% income was from CEFs, BDCs or mREITs. Knowing that it was a high-risk portfolio, he decided not to invest the entire amount in one go, but over a period of two years, roughly 12.5% of the amount every quarter. He also decided to put 15% of the capital in this portfolio in treasury funds to balance the risks and rest left in CASH in the intervening period. In the rear view mirror, we know that the markets crashed in 2008, and his decision to buy in eight lots proved to be very wise. The purchases were made during 2008 and 2009 each quarter.John’s example highlights the importance and benefits of staggered buying and dollar-cost-averaging.

Since this was an income portfolio, John made sure that all dividends and distributions were deposited in CASH in the portfolio. John withdrew $26,500 (roughly 8% of $333,000) every year from this portfolio starting January 1 st, 2009.

Author’s Note: This portfolio model (The 8% Income portfolio) is part of our ‘High-Income DIY Portfolios’ SA Marketplace service.

Here is the portfolio performance at the end of July 2017. Please note, a total of $238,500 ($26,500 per year, with no raise) was withdrawn over nine years as roughly 8% Income.

Assumptions in the above table:

  • Income withdrawals were at 8% ($26,500 per year) starting Jan. 2009, with no raise.
  • All the securities were acquired in 8 different lots (every quarter starting Jan. 2008 until Oct. 2009).
  • Dividends/distributions were not re-invested but deposited in cash to keep the cash-flow positive in the account.

The growth of the capital was only about 3% (on annualized basis), it still met its goal of providing high income and capital preservation. Taking high income from this portfolio allowed the DGI portfolio (Bucket-1) to grow the capital and the yield on cost.

Bucket-3:(33% of the Capital) – 6% Income Risk-Adjusted

John was able to balance out the low-income, high-quality of Bucket-1 with high-risk, not-so-good quality of Bucket-2. He would get to an average of about 5.5% when two buckets combined.

For this last and the 3rd bucket, John wanted to preserve the capital and wanted to create a portfolio which would not have severe dips (like S&P500 had in 2001-2002 and 2008-2009). At the same time, he wanted an income withdrawal rate in the range of 6%. With these objectives in mind, John selected our ‘6% Income Risk-Adjusted’ model portfolio. This is actually a defensive strategy, but still, aims for 6% income from dividend/distributions. There can be several variations of this model that can be used. It is difficult to predict with any certainty which one would work better in the future on the basis of past or back-testing results. But they all seem to work and provide a higher degree of protection for the invested capital during crisis situations or big-time corrections. But remember, John also had a 6% income goal, which was met squarely by our ‘6% Income RA’ model.(The readers of our previous article may find some commonality here, but it was necessary to include this part for the sake of completeness of the strategy.)

Author’s Note: This portfolio model is also part of ‘High-Income DIY’ SA Marketplace service.

Portfolio Structure:

This portfolio selects (and buys) three securities every month out of total six, on the basis of ‘Dual Momentum’ techniques. Out of these six securities, four of them are CEFs (Closed End Funds) along with two treasury funds, namely iShares 20+ Year Treasury Bond (NYSEARCA: TLT) and iShares 1-3 Year Treasury Bond (NYSEARCA: SHY). For crisis situations, portfolio switches fully (or partially) to Treasury and CASH. The criteria for CEF selection are as follows:

  1. The selected CEF has a substantial history and favorable track record in maintaining its NAV.
  2. The fund provides at least 6-8% (or higher) yield. The dividend (or distribution) is preferably paid monthly.
  3. The yield is largely provided from the generated Income, rather than “return of capital.”
  4. Most importantly, the four selected CEFs should come from different “asset” classes to provide a wide diversification and least correlation with each other. The reason the four CEFs were selected for this portfolio, as opposed to, say ETF or mutual funds, because they provide high yield on a monthly basis, normally in the range of 8%. By selecting CEFs with about 8% yield will balance out the low-yield periods when the portfolio may be invested in treasury funds or CASH and thus aim to provide an overall 6% income yield. CEFs allow us to capture the monthly dividend/distribution, before selling the security at month end.

The securities selected were: 1) Eaton Vance Tax-Advantaged Dividend Income Fund (NYSE: EVT), 2) Flaherty & Crumrine Preferred Securities Income Fund (NYSE: FFC), 3) Kayne Anderson MLP (NYSE: KYN), 4) Nuveen Municipal High Income Opportunity Fund (NYSEMKT: NMZ), Plus Treasuries and/or CASH.

This list is not set in stone; one can use any other set of CEFs as long as they meet the broad selection criteria. They need to be from different asset classes, provide monthly dividend/distributions and should have the least possible correlation (when one zigs, other one zags).

Back-Testing Results:

The following strategy was used (these are the results from back-testing).

We assume that we invested 333,000 on January 1st, 2008 and stayed invested until July 31’ 2017. The “dual momentum” method will consider the performance of six securities in two different time periods, namely 62 days and 21 days. We will assign 60% weight to 62 days momentum and 40% weight to 21 days momentum. Our model will pick the top three investment picks (out of six) to invest for the next rotation period. Investment dollars will be divided equally among the top three picks. We will present the results using a monthly rotation of assets. Income was withdrawn at 6% rate at the end of each year, with a 2.5 % increase every year to account for inflation. The performance of the 6% RA Timing model is dramatically better when compared to S&P500. The main reason being the large drawdown that S&P500 suffered during the 2008 financial crisis, whereas the 6% Timing model was almost even at the end of 2008. A note of caution: This kind of portfolio will generally underperform the broader market slightly during the bull-markets as we have witnessed in the last several years, but it is likely to outperform and makeup during a crisis or a recession.

Combine All Three Buckets:

When we combine all three buckets, we got a CAGR of over 7% in addition to 6% income a year. Also, in the year 2008, which was the worst year and the only negative year, the combined 3-bucket portfolio was down only -12% compared to over -37% for S&P500. We believe it would be a lot easier to sleep well at night with your portfolio balance down by -12% only, at a time when the broader market was down by -37%.

Here is a snapshot of income and growth of the combined portfolio.

Conclusion:

So here we are. We have presented three entirely different approaches on how to structure and manage a portfolio. Obviously, there are pluses and minuses with each one of the strategies. One should choose carefully according to his/her interests, knowledge, time availability, income needs and above all the risk-tolerance.

Author’s Note: Two portfolios namely “The 8% Income Portfolio” and “6% Income Risk-Adjusted Portfolio” are part of our SA Marketplace service “High Income DIY Portfolios.” To know more, please see on the top of the article just below our logo.

Disclaimer:

This article is for information and educational purposes only. The intent of this article is not to provide any financial advice or any recommendations to buy or sell any securities and should not be construed as such. Please always do further research and do your own due diligence before making any investments.

Other Disclosures:

I/we are long on ABT, ABBV, JNJ, PFE, NVS, NVO, CL, CLX, GIS, UL, NSRGY, PG, MON, ADM, MO, PM, KO, DEO, MCD, WMT, WBA, CVS, LOW, CSCO, MSFT, INTC, T, VZ, VTR, CVX, XOM, VLO, HCP, O, OHI, NNN, STAG, WPC, MAIN, NLY, PCI, PDI, PFF, RFI, RNP, UTF, EVT, FFC, KYN, NMZ, NBB, JPS, JRI, TLT.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: Please see ‘Other disclosures’ at the end of the article.