Investment Help

If you are seeking investment help, look at the video here on my services. If you are seeking a different approach to managing your assets, you have landed at the right spot. I am a fee-only advisor registered in the State of Maryland, charge less than half the going rate for investment management, and seek to teach individuals how to manage their own assets using low-cost indexed exchange traded funds. Please call or email me if interested in further details. My website is at If you are new to investing, take a look at the "DIY Investor Newbie" posts here by typing "newbie" in the search box above to the left. These take you through the basics of what you need to know in getting started on doing your own investing.

Tuesday, October 29, 2013

Create an Income Stream Versus an Annuity

An ongoing conundrum in the financial community is why single premium immediate pay annuities (SPIA) aren't more widely accepted?  After all, they go a long way towards avoiding running out of money in old age (the number one fear of retirees), no matter what the market does.  Furthermore, used intelligently, SPIAs can be used to enable a retiree to take on a bit more risk in the other assets they own.

So what's not to like?  First off, retirees lose control of the money.  For example, suppose the retiree comes home and finds a leak in the attic crawl space?  The roofer guy is going to come out and tell the retiree he or she needs a new roof!  Where do you get the money from?  Hint:  not the annuity. Secondly, though useful, today the timing may not be right with interest rates close to historically low levels.  With the yield on the 10-year Treasury note at 2.50% and the Federal Reserve printing money akin to Anatasios Arnaouti on steroids, many feel that higher yields will be available down the road. Thirdly, most people would rather wallow in their own fear of a market collapse than talk to a silver-tongued insurance agent who has been trained to sell you products that will destroy a retirement portfolio faster than you can get out a high-powered electronic microscope to read the fine print.

So, does it leave the retiree at the mercy of the usual portfolio approach trying to beat the market?  Not necessarily.  Some are constructing a sort of hybrid portfolio whereby the allocation to fixed income is replaced partially with high dividend stocks.  This is not a couch potato approach in that it does require some time on the part of the DIYer but could pay high dividends (sorry, couldn't help it) if done correctly. And, as a matter of fact, a whole industry of bloggers (see below)  has arisen to help the DIYer in this endeavor.


To see one way to approach this, let's look at an account I recently set up.  We began with the usual important first step of doing an asset allocation.  This is for a couple in their 60s.  Income will become important to them shortly.  The allocation was 50/50 stocks/fixed income.  The stocks portion was invested in low-cost diversified index funds.

The twist came with the bond portion.  Instead of bond funds, the fixed income portion was invested in dividend stocks that have a dividend of 3% or greater.  It was decided that the dividend stock positions would be less than 5% of the overall exposure in the dividend sector, making each position less than 2.5% of total assets.  Importantly, it was agreed to carefully look at diversification - the last thing you want is to load up on bank stocks, energy stocks, etc.

With these specifications, here is a partial listing of the  portfolio that was constructed:

Source: Schwab

You'll notice that NLY is in for a lesser amount.  It is a riskier issue with a yield in excess of 11%.  Its purpose is to juice up the yield of the portfolio a bit with the understanding that its dividend is considerably less secure compared to the other holdings.

The thing to get your head around is that, in one sense, you really don't care about the prices of the stocks.  After all, if you had put the money in an annuity, you would be dealing with an income stream!

Having said this, if prices move higher and this is a taxable account (which, in this case, it is), you have some options.  You can realize long-term gains if you find better replacements and can actually take advantage of tax-harvesting by capturing losses.

Once set up, the next step, which takes all of 30 minutes, is to do an Excel sheet showing dividends received:

The portfolio will be comprised of approximately 20 stocks.  The bottom line is to seek to have income increase over time.  This, of course, won't happen with a bond.  Buy the 10-year Treasury note and you'll get a fixed interest payment every 6 months for the next 10 years.

Here's the bottom of the Excel spread sheet:
The arrows show that already the dividends have increased and, in fact, they will increase this month with the final payment due in.  The goal is to see them double approximately over the next several years.

Obviously, unlike the annuity situation, the investor has control over the assets.  If  the roof leaks or Aunt Maude in Stuttgart Germany kicks the bucket, the investor can sell assets to pay the roofer guy (or gal) or get on an airplane to Stuttgart.  A DOWNSIDE IS THAT THE YIELD WILL BE LESS THAN WITH AN ANNUITY, AT LEAST AT THE BEGINNING!  This is because, with an annuity, you are receiving an actuarial rate based on a group's mortality.

The newbie DIYer should be able to find on his or her brokerage site a history link that shows all cash flows that come into an account.  This is a convenient place to track your dividend receipts to put into your Excel spreadsheet.  In Schwab, it looks like this:

If this intrigues you in the least bit, you should realize you can go at it at whatever size you want.  For example, if your asset allocation calls for 40% fixed income, you could consider putting 20% of your fixed income allocation in dividend stocks and think of the allocation as your personal annuity!

The obvious question is how do you find good dividend-paying stocks without having to spend an inordinate amount of research effort? Actually, today this is easy because there are several really good blogs dedicated to finding good dividend payers.  Here are a few:


Disclosure:  This post is for educational purposes only.  Individuals should do their own research or consult a professional before making investment decisions.

Monday, October 28, 2013

Comment on Risk Tolerance Questionnaires

Here is a good, short article from the online Financial Planning site on risk tolerance questionnaires by Alan S. Roth:  Why Risk Tolerance Questionnaires Don't Work.  For those who might not know, risk tolerance questionnaire are a favorite tool of the financial planning crowd, frequently presented with an aura of scientific precision.

But this scientific precision is too simple.  In fact, at the extreme, some people are taking unnecessary risk!

In the article, William Bernstein (author of The Four Pillars of  Investing) poses the question: “if you’ve won the game, why keep playing?”

This question is especially relevant today with the S&P 500 and other indices at all-time highs.  It takes me back to the year 2000 when I attended an event for investment professionals and a young investment professional was bragging about his $3.0 million portfolio of internet stocks.  Someone asked why he didn't sell and take a profit, and his response was "with a portfolio going up $50,000/month, why would anyone take a profit?"

This young man was hardly the exception.  Back then, many had a portfolio they could have retired on comfortably at a young age but let ride. 

Later, someone told me he eventually finally sold out after the portfolio had dropped to $150,000.

The same behavior frequently occurs with state pension funds where they become fully funded, or close to fully funded, as markets rise but then become more aggressive with their asset allocation.  All of this points out the astute observation, made in the article, that risk tolerance isn't some stable magnitude that can be measured by a risk tolerance questionnaire.  Instead risk tolerance changes as markets change.

I would add that there is a difference between a highly volatile market that is trending upwards versus a highly volatile market trending downward!

Tuesday, October 1, 2013

Year-to-Date Performance - 9/30/2013

My favorite investment chart is the BlackRock 20-year sector performance.  It details the relative ranking of asset classes on an annual basis as well as the performance of an easily replicated low-cost diversified portfolio comprised of 65% stocks, 35% bonds.  The diversified portfolio returned 12.2% over the 12 months ended 12/31/2012 and 7.9% on an average annualized basis over the past 20 years.

The diversified portfolio allocation is an appropriate benchmark for individuals in their 40s and even early 50s, depending on risk tolerance.  The table contains sufficient data, however, to construct a benchmark for any specific allocation; and, in fact, the allocation can be changed over time--as it should be as the individual ages.

Voluminous data from unbiased academic studies have been presented over the years showing that a diversified portfolio of low-cost funds outperforms upwards of 70% of active managers over the longer term after all costs are taken into account.  These studies cover various time periods, countries, asset classes, and investment methodologies.  In line with this data, the low-cost diversified approach warrants consideration as a benchmark for investors.  It shouldn't go unnoticed that the approach economizes on the investor's time.

Here is an update showing the approximate performance of the diversified portfolio for the 1st nine months of 2013:

Return (%) 9 months ended 9/30/2013
Expense Ratio
AGG  (Barclay’s Aggregate Bond Index)
EFA (EAFE Index)
IWM (Russell 2000)
IWF (Russell 1000 Growth)
IWD (Russell 3000)
The overall return of the diversified portfolio was approximately +13.06% over the first 9 months of the year.

Disclosure:  This post is intended for educational purposes only.  Past performance is not indicative of future performance.  Individuals should consult a professional or do their own research before making investment decisions.