• Financial & Investment Management Group
  • Tuesday, January 06, 2009

Retired FIM Group clients

(And clients who are interested in our thoughts about the retirement income portfolios we are managing)

The six components of FIM Group's retirement income portfolios

From: Paul Sutherland
Posted October 01, 2008

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In retirement, we depend on our investment portfolios to provide us with income. Some clients depend on their investment portfolios for 100% of their income, while others supplement through Social Security or perhaps a pension. In retirement, being able to depend on a retirement income portfolio for support is essential, and therefore the long-term safety, security and predictability of that income is very important. In this letter, I want to discuss the structure of your portfolio and its positions.

Economic Landscape

First the economic landscape. Naturally, the future of the economy could be inflationary, deflationary, have elements of recession or even depression embedded in its characteristics, or we could return to steady growth. Most likely we will have elements of all of these over the next five to 20 years. The base case that we are investing for is built on the premise that a recession is the most likely scenario.

Second, we anticipate a recession could be long and quite severe.

Third, the result of government policy and economic "reaction" to the recession could be either inflationary (e.g., U.S. in '70s and early '80s) or deflationary (e.g., Japan in '90s and early 2000s).

Fourth, the malaise will not be just a U.S. phenomenon, but a global one.

What is an investor to do? Invest wisely, of course.

Income is King

In England they don't have "millionaires," they have "100,000 pounders." As I was told by an old English gentleman, "The English have land or large estates that, if sold, would be worth millions, but to sell would offend the family history. Often these estates can barely pay their way." He went on to explain, "What counts in England is income. Income from investments like shares, and lots of it, is what makes you rich in England. Not a bunch of land, jewels or art that you can't sell or collect any rents or income from." He concluded his lesson by stating, "Income is king in England."

When investing for retirement, we must acknowledge that predictable income is very important and must be balanced with security of principal. However, I would rather have income predictability than just principal predictability. Consider, for example, the Japanese investors of the 1990s. Investor number one decided against a long-term investment and purchased treasury bills, waiting for maturity and assuming that the principal was safe. Unfortunately investor number one watched as rates went to less than 1%, eventually devouring his principal, as Japan entered into a long recession. Investor number two, on the other hand, decided to go with a diversified long-term plan, including dividend-paying stocks, longer-term bonds, and other income- and growth-oriented securities. If in the 1990s the diversified investor number two purchased Japanese government bonds issued on November 1, 1990 that paid 7.3% fixed yield until maturity in 2014, he would have watched the value of that bond rise by 73% and then fall over the years to the current 15% gain, all the while collecting interest at the rate of 7.3%.

Today, some naíve retirees are selling everything to buy Treasury bills and CDs because they can't stomach the volatility of a longer-term retirement income strategy. This action reminds me of a bumper sticker I saw that said, "RETIREMENT AIN'T FOR SISSIES."

If we move into an official recession, interest rates on so-called safe investments could stay down under a few percent ranges for an extended period. After taxes, inflation and needed income, a retired investor using a CD orientated strategy would see the erosion of principal over time. The comfort with CDs and T-bills is that they are simple and typically don't fluctuate. Stocks, bonds, preferred stocks, U.S. Treasury inflation securities and plain old U.S Treasury bonds can fluctuate. This volatility can be unnerving, especially in times like today. However this volatility is the side effect of a solid, thoughtful, well-constructed long-term income strategy.

Last Friday, I watched the value on a short-term AAA bond move down 5% in just one day. Today, a long-term AAA 30-year U.S. Treasury bond was up 4% in one day. Talk about volatility! Of course, the dividends and interest on these investments tend to be much more stable over time, especially for guaranteed U.S. Treasury bonds. The bottom line is that, for retirement, we need to have good income characteristics embedded in our portfolio strategy and management.

So how are our FIM Group retirement income-oriented portfolios structured? They are structured to perform and provide income through the thick and thin of a lousy economy. They are not constructed on the hope the economy will recover. They are not constructed on the hope that the government will bail out the markets. They are constructed assuming we could have a rough go for quite some time and that interest rates could fall, especially after inflation and taxes bite on them. So how are our portfolios structured? They contain six categories of securities:

  • Great global companies that pay dividends of between 4% and 10%. We feel these dividends could grow over the years to help offset inflation.
  • Income securities with rates that fluctuate with the rise and fall of short-term interest rates that may be tied to the prime rate, LIBOR of T-Bill type rates plus a premium. Most of these securities are paying around 6% to 12% today, largely because people have sold them down to such a price that their yields are high based on their current price.
  • Global and domestic fixed-rate investments, such as fixed preferred stocks, corporate bonds or diversified funds, or trusts that own them.
  • Global inflation hedge investments like gold, energy, real estate, property and other "real stuff" investments that tend to be very responsive to inflation. Especially helpful to retirement portfolios is the fact that many energy and real estate securities pay solid dividends each month, quarter or year.
  • AAA U.S. Treasury Inflation-Protected Securities (TIPS) that guarantee a certain percent return over inflation.
  • A Treasury inflation security ladder that allows us to relax if we end up in a long, volatile recession. If you look carefully in your portfolio, you'll discover U.S. Treasury inflation linked bonds (TIPS) that mature in 2010, 2011 and 2012. These bonds are issued and guaranteed by the U.S. government and pay a return of principal that is based on the inflation rate (CPI) until maturity. Your TIP ladder, as we call it, adds predictability to your portfolio, and along with the income from dividends and interest on your portfolio, allows us to maintain a long-term income strategy with your portfolio without having to worry about selling out of a security and depleting principal, at an inconvenient time (like today) in order to provide for income needs.

In summary, your portfolio is carefully constructed, attentively managed and contains diversified holdings of investment from the categories described above. Of course, you'll notice other investments that have various maturities in your portfolio, but this laddering helps us manage risks, allows us to have maturing investments to roll into new investments in the future and helps add stability. If you have any specific questions regarding your portfolio please feel free to call us to discuss further.

Blessings,

Paul

 
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