Here at "A Dash" we have a special concern for the individual investor. I always appreciate communication from those who are managing their own accounts and from colleagues in the advisory business. While I write many pieces on the economy, trading, and the short-term market outlook, I try not to forget the needs of the average investor.
On my recent travels I used some of the airplane time on a subject that has been troubling me -- the challenges for people nearing retirement. Much of what they are thinking and doing is misguided. Either they have no plan, or they have one that will not work.
I want to explain this, but it is too long for a single article. I am going to split the analysis into several parts with the general title, "The Quest for Yield."
In each article I will present a positive, empowering idea that the investor should embrace. There is also a corresponding mistake, usually something that is currently popular.
The First Empowering Concept: Think Total Return
Let me start with the most important proposition:
Retirement investing depends upon total return -- not just yield.
If you are managing your own retirement account, your job is to generate needed income while not outliving your resources. If you did not need to worry about any heirs, you would implement a plan that gradually depleted your "nest egg" to augment your current income. Just fine, as long as you do not do so too quickly.
If your portfolio is growing, you can sell a little each year. There is no rule saying that you can only derive current income from bonds or dividends. For a professional manager, this is obvious. For most retirement investors it is a mystery. It is part of the reason for the current quest for yield -- a race into fixed income and away from stocks.
Looking for total return was the positive statement. The mistakes are the opposite, and each will need more detailed discussion. Here are the first and most basic errors:
- Focusing on bond yields rather than prices. There can be nasty capital losses in bonds if yields move higher.
- Focusing on dividend stocks that are bond substitutes. They will also have losses if yields rise. (Some investors compound this error by using stop-losses, confusing trading with investing).
- Choosing REITs or MLPs. These instruments enhance yield, but do it by returning part of your principal. It is done at a rate determined by the manager, not you. Why not make your own asset allocation decisions?
Retirement investing is not about fixed income. It is about total return and risk control. Each investor is different in terms of needs, current assets, and risk tolerance.
I want to emphasize that this series (like all of my work) is not intended as individual investment advice. You mileage may vary! Having said this, nearly everyone who comes to me is trying to squeeze income out of low-yielding instruments or reaching for yield by taking a big risk. Most do not understand the total return concept. They are under-invested in stocks. They have been scared silly by 2008, the flash crash, the political circus, and the media.
Their solution is to reach for yield in things that seem appetizing, without realizing the essential nature of risk and reward.
As I develop this series, I will depend upon reader feedback. If you are uncomfortable with sharing things in the comments, please write to my personal address: jmiller at newarc dot com.