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Living on a Million-Dollar Portfolio AllStarInvestor.com

MILLION-DOLLAR PORTFOLIO

LIVING ON A

Your guide to navigating today’s low interest-rate maze

Ron Rowland

Copyright © 2016 Dynamic Performance Publishing Inc. All rights reserved. No part of this publication may be reproduced in any form or by any means without prior permission of the publisher.

The opinions and forecasts expressed herein are those of the author and may not actually come to pass. Any opinions and viewpoints regarding the future of the markets should not be construed as recommendations of any specific security nor specific investment advice. The analysis and information in this edition and on our website is for informational purposes only. No part of the material presented in this edition or on our websites is intended as an investment recommendation or investment advice. Neither the information nor any opinion expressed nor any portfolio constitutes a solicitation to purchase or sell securities or any investment program.

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Table of Contents

Introduction 1Why I Wrote This Report 2The Retiree’s Nightmare: Low Interest Rates 4Making the Shift: From Accumulation to Distribution 6Plan #1: Live off the Interest 7Plan #2: Get an Annuity (Guaranteed Income Strategy) 9Plan #3: Invest for Total Return 11Plan #4: Dividend Investing 13Plan #5: Tactical Income Investing 15Plan #6: The Blended Approach 17Conclusion 18About the Author 19


Income. We all need it. Of course, the amount of income you need, and its source, will change as your life progresses. No matter what happens, though, you must have income. Otherwise, your life will grow very

uncomfortable, very quickly.

As a child, you had parents. As an adult, you had a paycheck. As a retiree, you will have … what? Social Security? Savings? A part-time job? All of the above?

The stakes are high. You won’t have a second chance to get this one right.

In the pages that follow, I will help you think through the income challenge, and I’ll suggest some possible solutions. I will question some of the “conventional wisdom” you hear from financial advisors and politicians. I’m not far from retirement age myself—so I need answers, too.

Introduction


Back in March 2010, I published a blog post called Living on the Interest from One Million Dollars. The title summarized my original retirement plan crafted in 1974: I would save a million

dollars, retire, and live off the interest. No complicated investment schemes. No need to gamble. Just leave my money in the bank and live off the earnings.

Clearly, I was a very optimistic college freshman. I thought it would all be so simple since I was getting an early start, but I was wrong. My 1974 “plan” now looks more like “fantasy.”

Apparently, I’m not the only member of my generation struggling with this challenge. The article in which I told my story drew thousands of readers. Other websites and mainstream media outlets picked it up. I received responses from all over the world.

Even now—more than six years later— Living on the Interest from One Million Dollars draws several hundred readers a week. It seems I struck a nerve.

I understand the frustration: We (meaning me and my readers) did everything right. We thought ahead. We planned for our future. We bypassed immediate gratification and saved instead. We did the same things that worked very well for the previous generation. Yet for many of us the goal is still elusive. Why?

Why I Wrote This Report

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The answer, I think, is that someone changed the rules without telling us. Our company pensions have been largely eliminated. Banks pay us minuscule, if any, interest. Social Security isn’t as “secure” or plentiful anymore.

The report you are reading now expands on my 2010 article, taking a closer look at what went wrong and how you can fix it. The examples are based on a million-dollar nest egg, but the strategies I review can be scaled up or down to manage your savings.


T he plan I developed back in college is at risk for one big reason: the current era of persistently low interest rates. As recently as 2007, you could earn a 5% yield in money-market funds. At that rate, a million-

dollar balance kicked out $50,000 a year in spending money.

Interest rates have always gone up and down, but they never disappeared completely—until 2008. Faced with financial crisis, the Federal Reserve dropped short-term rates to nearly zero. Instead of 5%, savers found themselves lucky to get 0.1%.

The Retiree’s Nightmare:Low Interest Rates


Source: http://www.federalreserve.gov/releases/h15/data.htm

Will rates go back up? I have no idea—but I’ve learned a lesson. No longer will I subject my retirement plan to the whims of the Federal Reserve.

I’ve created a new plan. You may want to do likewise. Be careful, though. The days of easy, risk-free income are over.

http://www.federalreserve.gov/releases/h15/data.htm


Of course you cannot live off the interest from a million dollars, or any other amount, unless you save it in the first place. People approaching retirement with little or no nest egg need a different kind of help.

Nevertheless, even diligent savers have to make a giant leap and change their mindset when the paychecks end. At retirement, you stop saving and start spending, moving out of the “accumulation” part of life and into the “distribution” phase.

Making this U-turn can be surprisingly difficult. The size of your retirement account is only one part of the equation. How much will retirement cost? You can’t know for sure. You may die tomorrow, or you might live to 100.

This is a big range of possibilities, and covering it all is tough. The most common plans for living off your portfolio fall into six broad categories. I’ll discuss each of these below.

Making the Shift: From Accumulation

to Distribution


The main attraction to “living off the interest” was simplicity. The strategy only requires you to keep a savings account open or roll your savings from one CD (certificate of deposit) to the next.

Plus, the safety of bank accounts is guaranteed (within limits) by the government through the Federal Deposit Insurance Corp. (FDIC). “No principal risk” means “little need to worry.” The simplicity of the plan was paramount.

If you are reading this report, you are already ahead of the game. You want to improve your results. Millions of retirees don’t get this far. They just do what their friendly local banker says, perhaps never dreaming there might be better options. They accept what they’re told because it worked well for their parents.

This plan broke down because the world has changed. No one alive today has ever seen interest rates stay so low for so long. Add in the impact of taxes and inflation, and “living off the interest” is a very, very risky long-term strategy.

You could, of course, start drawing down your principal to provide income. The math on this one is pretty easy. Even if interest rates are 0%, you can withdraw $50,000 a year from your million-dollar account and the well won’t run dry for 20 years.

Plan #1 Live off the Interest


You may still have problems, though. Even if $50,000 covers your expenses now, will it do so 10 years from now? Will tax policy change? Can you count on Medicare and Social Security? What if “year 21” arrives and you are still alive and out of money?

As you can see, living off the interest is a gamble. True, it’s a different kind of gamble than investing in stocks or mutual funds, but there is still no guarantee you will have sufficient funds for your entire retirement.


You can address some of these challenges with an annuity. These insurance-based products are indeed useful in some circumstances, but they have weaknesses, too.

The life-insurance industry offers a bewildering variety of annuity policies with various complex and confusing features. For our purpose, we will consider what’s called an “immediate annuity.” You give a lump sum of cash to the insurance company, and they agree to pay you a fixed amount for the rest of your life.

The numbers can look attractive. Even today, a 65-year-old couple can lock in 5%–6% annual payments. Your million-dollar nest egg can generate $60,000 or more in guaranteed yearly income. For example, for a 65-year-old male and female investing $1 million, Immediate Annuities (www.immediateannuities.com) calculates (as of October 2016) an annuity yield of $4,306 a month, or $51,672 a year. What’s not to like?

First, your million-dollar nest egg will be permanently gone. You can’t get it back because you no longer own it. Instead, you now own an IOU from

Plan #2 Get an Annuity

(Guaranteed Income Strategy)

http://www.immediateannuities.com


the insurance company. Maybe that’s okay … but maybe not. Insurance companies can fail, and “the rest of your life” is a long time to trust one.

Second, your “guaranteed-income” payment usually has no inflation adjustment. The amount is fixed. As the cost of living rises, your income does not, and you could run into big problems.

Third, if you happen to die soon after buying an annuity, your heirs may receive little to nothing. Some annuities have a “period-certain” feature that helps, and maybe you don’t want to leave an estate anyway. It’s something to consider, though.


This is the approach financial planners typically suggest for retirees. If you go into retirement with a sizable growth-oriented portfolio, you’ll keep investing for growth in your early retirement years and slowly shift

into principal-preservation mode.

The term “total return” means your portfolio should generate a blend of growth and income. Say you have a good year and your stocks gain 20% in value. That’s wonderful, but you still need cash to pay your bills. A total-return portfolio is supposed to give it to you through some combination of interest, dividends, and return of principal.

The exact allocations depend on your individual circumstances and income requirements. Someone who retires at a healthy age 65 may begin with a majority of their portfolio in stocks. Ideally, you liquidate the growth investments a little at a time so they can keep growing as long as possible.

The “4% rule” is a general guideline that can pair well with this type of portfolio. If all goes well, you should be able to withdraw 4% of your account the first year, give yourself an annual cost-of-living adjustment, and not outlive your principal.

Plan #3 Invest for Total Return


The total return approach can work well, but experience shows it isn’t perfect. Your results are highly dependent on financial markets cooperating. A crash, or even an extended flat period, can wreak havoc on your assumptions. This is especially true if it happens in the early years.

For example, suppose you retired in 2000 or in 2006 and left the majority of your assets in domestic stocks. The idea was that it would grow enough to offset your expenses with inflation added in.

In reality, the stock market didn’t behave as planned. In both examples, the market fell about 50% over the next year or two. That part of your account is probably sitting far below the plan. Because it didn’t grow as expected, and because you still withdrew cash for income, your account balance may be significantly lower than it was supposed to be at this point.

It could be even worse. Did you hold on to your stocks through the volatility of the past decade? Few investors did. We know most investors are prone to panic. They find it almost impossible to sit still through rough periods such as the 2008–2009 crisis. Many sell at the bottom and lag behind the benchmarks.

A total-return portfolio, with proper planning, can deliver good results and provide you with a comfortable retirement. It does require a great deal of monitoring, and you will likely need professional help.

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A fourth approach is to construct a portfolio that relies on dividends from stocks. You would build a portfolio with enough dividend income to cover your needs while rarely touching the principal. This may sound

like a tall order—and it is—but can still be a valid approach.

Not every stock pays dividends, and some pay more than others. Any dividend-based strategy has to be selective. You also have to recognize that dividends are never guaranteed. Companies can reduce their dividends or even eliminate them completely. You’ll need to watch your portfolio and make adjustments often.

On the other hand, monitoring this kind of account is somewhat simpler than it is in a growth strategy. Since your focus is dividends, you don’t have to be as concerned about falling share price. What you care about is that the dividend level continues. This can be hard to grasp, so let me explain a little further.

Say you invest $5,000 and buy 100 shares of XYZ stock at $50 per share. At the time, the company is paying a 50-cent quarterly dividend. You get $50 in cash each quarter, or $200 a year. Your initial yield is therefore 4%.

Now if XYZ shares falls to $45, your principal value drops to $4,500. Oh no! You lost 10%! Yes, that’s true—but only if you sell. However, if you don’t sell

Plan #4 Dividend Investing


and the company keeps paying the dividend, your income hasn’t changed. You’re still getting your $50 quarterly payments.

What if the share price goes up? Again, the important thing is your income. If the stock goes up, then the company is probably doing well. That means there’s a good chance the board will raise the dividend. You may start getting $55 every quarter. Congratulations.

The scenario you want to avoid is a shrinking dividend—or even worse, a disappearing dividend. This can and does happen, and it usually happens at the worst possible time—when your account value has dropped. How do you protect yourself? Diversification can help. Keep your dividend portfolio balanced in various companies, sectors, and geographic regions. However, diversification is not enough if stocks are entering or in a sustained bear market.

You can diversify very easily with dividend-focused mutual funds and ETFs (exchange-traded funds). I am particularly fond of ETFs for this purpose. They tend to be more tax-efficient, you will always know what companies are in the portfolio, and the costs are usually lower.

Like the others, a dividend strategy has risks. Even if your stocks raise their dividends, you aren’t guaranteed to keep up with inflation. Most people will still need to dip into principal from time to time.


T he dividend approach is fine for many people, but for me, it has too much risk. I’ve seen firsthand how companies and dividend ETFs slash their dividends after a large drop in share price. It’s just adding insult

to injury. Your account balance drops when the market goes down, and then your income is sliced.

For myself, I have decided on an approach I call tactical income investing. I use ETFs to build a conservative fixed-income portfolio and a global multi-asset dividend and income portfolio. But I don’t stop there, because a “buy-and-hold” approach is fraught with the risks previously identified. So I continually monitor the market and make adjustments to the holdings.

My Tactical Fixed Income model is designed to provide current income while managing the risk typically associated with traditional fixed-income investments. The model actively rotates its holdings among bond and fixed-income ETFs that encompass U.S. Treasury securities, investment-grade corporate bonds, high-yield bonds, senior-loan portfolios, convertible bonds, mortgage-backed securities, international bonds, and money-market funds.

My Global Multi-Asset Income model is designed to provide current income and capital appreciation while managing the risk typically associated with a traditional multi-asset income approach. More than just your typical U.S.

Plan # 5 Tactical Income Investing


dividend-paying corporations and ETFs, this model seeks out income-producing opportunities across a wide range of asset classes and strategies, including but not limited to dividend growth, high current yield, investment-grade bonds, high-yield bonds, international and emerging-market bonds, MLPs, REITS, option writing, preferred shares, and money-market funds.

Both of these models are based on the principle that there are times when all or most of the ETFs in their target areas may be declining in value. Rather than seeking out the ones that might be falling the least or the slowest, these models have the ability to move a portion or all of their holdings to the safety of money-market funds.


The five alternatives I’ve discussed are not the only possible solutions. You have to consider your own situation.

Furthermore, you probably don’t have a “clean slate,” and you still have to get from “here” to “there” even if you know what would be ideal.

For example, maybe you put some money into an annuity last year and can’t get out now. Don’t worry about it. Just look at how much income the annuity provides and design the rest of your portfolio to make up the difference.

People with substantial savings may be able to leave more money in growth investments without sacrificing income. If this is you, a combination approach could be fine. Provide for your income needs with dividends and bonds while keeping the rest in growth investments.

Whatever you do, I think it is important to plan conservatively. Estimate high for your living expenses and life expectancy, and estimate low for investment gains. Give yourself a good safety margin.

Plan # 6 The Blended Approach


So, which is the best solution? The answer is “it depends.” It depends on your own personal circumstances, but in most cases, it’s likely to be a combination of approaches. For me, the tactical income approaches

described in Plan #5 fit well with my personal circumstances and investment risk tolerance. Social Security and a small pension will provide me with some annuity-like income, and I will have other growth-oriented investments. Over-reliance on any one method increases your risk. As I said earlier, the fact that you are looking into the subject and reading this report puts you ahead of the game.

I hope you’ve found the information in this report valuable. Even if you made other plans that didn’t work out so well, you can still bounce back.

For more details and updates on the Tactical Fixed Income and Global Multi-Asset Income models discussed in this report (as well as three other growth-oriented strategies, all based on ETFs), subscribe to the All Star Investor premier ETF advisory service by signing up at AllStarInvestor.com. We offer a two-week free trial, so you can see if it's right for you.

You can also sign up for my free weekly ETF updates at InvestWithAnEdge.com.

Best wishes for a secure, comfortable retirement!

Conclusion

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Ron Rowland is the founder of Invest with an Edge and serves as the executive editor. He is also editor of All Star Investor (AllStarInvestor.com). Quoted widely in the financial media, Rowland is the industry go-to guy for sector-rotation insight and investment strategies using ETFs and mutual funds. Having run a mutual fund, a hedge fund, and managed accounts, Rowland has experience in both money management and investment publications. His expertise,

experience, and investment strategies are valuable resources for financial publishers and institutional investors.

For more information, see InvestWithAnEdge.com and AllStarInvestor.com.

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