The Quest for Yield: Strategy Allocation

The biggest mistake made by "retirement" investors is one of strategy -- they think in terms of "all in."  They hear so much polarizing advice:  to be in the market, or to be out.  The average investor must read and interpret these arguments.  Too often, they get it wrong.

The Yield Quest Series

I am organizing a series of articles around the theme of "The Quest for Yield."  While this resonates with retirement investors, the series actually should have a more general application.  When I consider a client's needs, the concept of retirement is a sliding scale.  Many in the  boomer era are not sure when to retire.  The themes of needs, current assets, risk tolerance, and opportunity are universal -- not just questions for retirement investors.

I appreciate the many helpful comments to my first article in this series.  My plan is to write an additional part of the series every week, but please forgive me if I skip a week from time to time.  I want to keep each article focused on a specific point.  The first installment addressed my approach -- emphasizing total return.  While I welcome all comments, I need to keep focus on a specific topic each week.

Strategy Allocation

There is so much advice online that it can be confusing.  I realize that the readership of "A Dash" is very sophisticated and knowledgable.  I know that many readers are colleagues in the investment advisory business.  For the purpose of this series I invite you to join me in thinking about the world as it appears to the average investor.  There is a cacophony of opinion:

• Warren Buffett is adamant about stocks versus bonds. This via C0lin Barr:  

Buffett, speaking Tuesday at Fortune's Most Powerful Women Summit in Washington, said it's "quite clear stocks are cheaper than bonds" now. He added that he "can't imagine" the rationale for adding bonds to your portfolio at current prices

• Bill Miller, another legendary figure, says that it is the best time to buy stocks since the 1980's.  (This is a shift from 1951, but who is counting?)
• Goldman Sachs (via featured source Colin Barr) recommends stocks over bonds.
• The highly respected David Rosenberg challenges Buffett.
• Prechter thinks that the Dow will go to 1000.  Others predict 5000.  Fear sells.

There is a lesson in all of this.  There will always be a wide range of opinions.  When we have the ability to look backward, we know what would have worked.  When doing serious planning about our futures, we need to prepare for differing outcomes.

Here is the key point:

Learn to distinguish between market commentary and specific investment advice!

When Warren Buffett (or Jeff Miller) provides a market commentary, it is not intended as investment advice.  It is a general market observation.  Anyone who starts by saying that "he got me out of the market in 2008" or "he got me invested in 2009" is making a mistake.  This is not the right way to think about your future.

Your investment program should be like a made-to-measure suit -- just for you.

The Strategic Components

For retirement clients I consider five different strategies.

• A bond ladder -- near-term instruments roll off and we go out to the end of our time frame, currently eight years.  This leaves us less sensitive to increasing rates.  this is very important right now.

• Dividend stocks.  I emphasize the stock-picking part of this.  Buying a poor stock with a good yield is not the answer.

• Covered calls.  Writing calls against stock positions adds to income.  If you do a good job of picking the stocks and which calls to write, this can be a major boost to yield.  I have a method combining fundamental and technical analysis.  It is not just a matter of finding the highest premium.

• Stocks.  Yes, stocks belong in the portfolio of nearly everyone.  You are never too old to own a great growth stock.

• ETFs.  A disciplined ETF strategy should be part of nearly every portfolio.  There is a need to establish rules and to follow them. 

I plan to write an article on each of these components.  I'll talk about  why, when, and how.  Others may use different building  blocks.  Fire away in the comments.  I'll consider additions.

Conclusion

The most important takeawy for this article is the need to consider and to balance various strategies.  For those who rigidly adhere to one strategy, please consider the following examples:

If you have all of the money you need -- good retirement, provision for heirs, etc. -- you should be absolutely certain to set aside enough to guarantee what you have already earned.  There is nothing sadder than needless risk.

For others -- and that is most of us -- it is a balancing act.

• If someone has a rigid formula about stocks versus bonds, regardless of the relative valuations, that is a mistake.  Let's get serious.   If bond yields right now were 15% or so, the way they were in the 70's, many of us would lock in and sit back to enjoy.

• If option volatility is really high, why wouldn't we want to enjoy the benefits of selling some option premium?

• If corporate bond yields are especially attractive compared to treasuries and stocks, it is time to move.

There are no absolute answers.   You should consider multiple strategies, your own needs and  your own risk tolerance.  Find the balance that is right for you!

 

Comments

[Lurker]

While I understand THAT there's a preference by many for different strategies in retirement, and I understand the thinking process that leads many to that preference, I'm intellectually unconvinced of the need for different strategies, post-retirement, for the majority of retail investors.

For my case, the trading strategy after retirement won't change from the trading strategy before retirement (unless the asset level grows enough to handle diversified futures). For my money, whatever compounds the fastest given my volatility tolerance (or if using futures, whatever Sharpes the highest) is what I'll do. "Retirement" will just mean taking structured withdrawals from gains and/or assets to use as living expenses.

[Proteus]

Jeff, you hit the nail on the head with the last few paragraphs. I spend a lot of my (investing) time answering three questions - how much risk am I comfortable with, how much risk should I be taking, and is my long term asset allocation (say over five years or so) aligned with those risk levels?

I have a difficult time relating to All In or All Out. A few percent change in allocation to me is huge. Perhaps sometime you could write more about your interactions with clients that view investing this way.

I'm looking forward to reading about the strategic components.

[mike]

Thanks, Jeff. I've learned to simply ignore those who predicate investment results on some third or fourth order derivative of their macro economic ramblings. I find that a diversified portfolio, adjusted tactically based on Federal Reserve policy, suits my retirement needs just fine.

[Brett Alexander]

Normally I am agnostic to the economists and their forecasts, however, Rosenberg is becoming uncomfortable. Much like Lt.Col. Frank Slade at Thanksgiving dinner.

I am pretty sure Mr. Buffet was eluding to the long term forward return for stocks vs. bonds. Rosenberg's attempt to refute this using a couple of well chosen historical examples is amateurish at best.

Rosenberg may ultimately be correct, but I would expect him to at least make a professional quality argument to counter Mr. Buffett.