Since 1978 With a 32 Year Vacation
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Making money with your money is a no-brainer. Take a look at the difference in returns between two $40 investments in Coca-Cola in 1919. One had dividends put into a piggy bank. The other had dividends reinvested. Without reinvesting, the initial $40 investment grew to $456,273 by 2012. With dividends reinvested, the value increased to $9,876,106. That’s a difference of over 2060%. That’s the power of compound interest.
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You can be sure that 90% of what you read about retirement investing is either (A) not very helpful or (B) confusing. Yet there are some simple solutions and tools to use that are helpful and easy to understand. One of them is a fund to which I recently made a sizable contribution. But first let’s look at the dismal reality of the 401(k), which most baby boomers will depend on in retirement.
Your 401(k) isn’t worth as much as you think it is. That’s because at age 70½ you need to begin making annual withdrawals based on an IRS life expectancy table and pay taxes at your ordinary income rate, not at the lower capital gains rate. What’s more, there’s a good chance you’ll live longer than the IRS life expectancy, ensuring that your entire balance will have been subjected to income taxes well before you die. Isn’t that uplifting?
How about giving your money to the government today? That’s what you’ll do by converting to a Roth IRA. If you’re in your prime earning years, you’ll pay taxes at your highest tax bracket. What’s scarier is that after conversion, some investors may think it’s time to get even more aggressive since they’ll never owe taxes on the gains. This is retirement money we’re talking about. You’re no longer a teenager. If you lose it, you don’t have forever to make it back.
You should begin investing for retirement the day you’re born. Most investors start way too late. It’s up to parents and grandparents to get involved with educating children about money. Help them start today. Don’t let them grow up believing the way to riches is playing poker on ESPN.
You need to save until it hurts. How about refinancing to a 15-year mortgage? Or if that isn’t an option due to high closing costs or being too far underwater on your existing 30-year, how about making larger payments? The real-estate market as a supplement to your retirement left the station in 2008.
In 1968, it wasn’t out of the realm of possibilities to be able to buy your home for an amount equivalent to your annual income. Nowadays, in Newport, Rhode Island, for example, even after the crash, it’s difficult to find a home for sale for less than $300,000. If you earn $50,000 per year, that’s six times your income. Why not consider renting and see if you can handle the monthly payments before locking yourself into something you may not be able to afford?
Here’s my number one recommendation for do-it-yourself investors. Keep your investments simple: buy two or three mutual funds and call it a day. Don’t listen to your stockbroker. They’re salesmen, and very good ones at that, but they’re not investors. They may be nice people, but they don’t know how to build your wealth.
I recently bought the Vanguard Wellesley fund for my family because it embodies what investing is all about. It is a balanced fund with roughly 60% in bonds and 40% in equities. It was down only 9.8% in 2008, compared to a loss of 38% in the S&P 500. Investing math is simple: if you lose 9.8%, you only need a gain of 10.9% to get back to square one, whereas if you lose 38%, you need a gain of 61.3%.
At the core of Wellesley is compound interest. Anyone who knows anything about investing understands the importance of compound interest. Warren Buffet’s right-hand man, Charlie Munger, sings its praises, and Albert Einstein referred to it as the Eighth Wonder of the World. If you compound $10,000 at 6% for a year, you’ll have $10,600; compound that at 6% and at the end of year two you’ll have $11,236, and after 60 years it will be $300,000. Do this for a loved one and he or she will never forget you.
So where are we today in terms of valuations for bonds and stocks? Add the yield on the three-month T-bill and the Dow Jones Industrial Average yield to find out. Historically, retirees could purchase T-bills with a yield somewhere between 5% and 6% and forget about stocks. They could be comfortable in retirement with the risk-free rate of return and the full-faith-and-credit pledge of the U.S. government. And historically, the Dow yielded between 3% and 4%.
A solid number for the sum of the yields on T-bills and the Dow has been around 9%. Today, with T-bills yielding a pathetic 0.13% and the Dow yielding a measly (post-crash, mind you) 2.41%, you have a sum of 2.54%. Not good at all. Write this number on a stamp and put it on your fridge.
All you need is your postage stamp, the definition of compound interest on a three-by-five card, and the Vanguard Wellesley prospectus. Use the tools I outlined above, open an account for yourself, your kids or your grandkids, and your family will be on the right path to retirement riches.
Do you invest in stocks for income? Is your portfolio focused primarily on U.S. stocks? If so, you might consider diversifying globally. The dividend yield on the U.S. stock market is one of the lowest yields in the world. In the chart below, I show the yields of 23 of the world’s major stock markets. The dividend yield on U.S. stocks is only 2.11%, compared to an average of 3.09% and a high of 5.45% in Spain. The U.S. is the sixth-lowest-yielding stock market in the group. If you invest in stocks for dividends or income, a global approach is advisable.
When you take a global approach to dividend investing it is possible to craft a portfolio that is better diversified across industries than a U.S.-only portfolio. Take the U.S. oil and gas industry as an example. Oil and gas production is a capital-intensive business. In the U.S., the independent oil and gas companies fund their capital expansion projects primarily with internally generated funds. After capital expenditures, there is often not much cash left for dividend payments. But in a country like Canada, there are oil and gas production companies that offer high dividend yields—in some cases yields north of 5%. How do the Canadian oil and gas companies pay such high dividends? Instead of funding capital expansion plans with internally generated funds, they tap the capital markets. For income-oriented investors, the strategy has appeal.
In Young Research’s Global Investment Strategy, we advise high-yielding international stocks that you’re unlikely to find in any other investment strategy report. We also cover special situations, global fixed-income markets, and commodities and currencies. If you are not now a subscriber, please join us.
For over four decades I have used a simple strategy to successfully invest in the stock market. I invest exclusively in dividend paying stocks. I especially favor those with high yields, a strong balance sheet, and a history of annual dividend hikes. This strategy is simple, but it works.
Historically, high dividend payers have outperformed non-dividend payers. In the chart below I show the growth of $1 in non-dividend paying stocks to the growth of $1 in the highest yielding quintile (top 20%) of U.S. stocks. The difference in performance is profound. $1 invested in non-dividend payers in June of 1927 grew to $696. That same dollar invested in the highest quintile of dividend paying stocks rebalanced each year, grew to over $4,500.
You may study my chart and wonder why any investor would bother with non-dividend payers. This strategy is not complicated. Anybody with access to a financial database and some time can run a few screens and come up with a list of candidates to buy. As I see it, the reason more investors don’t focus exclusively on dividend payers is because they lack patience. Building wealth in dividend paying stocks is a slow process. Most high dividend payers are mature stable businesses with modest growth prospects. They don’t offer the prospect of spectacular short-term gains. With dividend payers, you profit over the long-term through the power of compound growth. That requires patience.
At Young Research my Retirement Compounders list includes only dividend paying equities. Today, the average dividend yield on the RC’s exceeds 5%–more than twice the yield on the S&P 500. Young Research’s Retirement Compounders forms the basis for the stocks I recommend in Intelligence Report and the equity portfolios we manage at my family-run investment company.
If you are interested in having a portfolio of global dividend paying equities managed check out younginvestments.com.
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Punishing yields of 0.05% on three-month T-bills and .85% on short-term Treasury notes are devastating to the millions of investors who rely on income from their portfolios to fund living expenses. The temptation for many of these investors is to reach for yield. Some investors are loading up on long bonds. You can pick up an additional 3% in yield by moving into long bonds, but you also add an extraordinary amount of risk. If rates move up, investors in long bonds will get creamed. I’m talking about losses that dwarf what many investors experienced in the recent bear market in stocks. If long rates increase by just 1%, 30-year Treasury zero-coupon bonds would fall by 25%. If rates rise 2%, forget it-your portfolio is toast.
There is a better way to add yield to a fixed-income portfolio. Individual issue selection is the key. The idea here is to move down in rating and up in yield without sacrificing quality. You want to own a portfolio of both highly rated issues and those rated below investment-grade where there is tangible value to protect your principal in the event of default. In Young Research’s Global Investment Strategy, we recently recommended a five-year corporate bond with a yield of close to 7%, or 4% more than comparable treasuries. The bond is backed by a portfolio of some of the most valuable energy resources in North America. If you are retired or soon to be retired and are looking for ways to boost the income on your fixed-income portfolio, please join us.
The #2 item on my list of the ten most common mistakes investors make is discounting the importance of compound interest. Albert Einstein described compound interest as the greatest mathematical discovery of all time. Charlie Munger, Warren Buffett’s longtime partner, said: “Understanding the power of compound return and the difficulty getting it is the heart and soul of understanding a lot of things.” My son, Matthew Young, puts it this way: “Compound interest is your silent warrior for long-term investing.” The key to compound interest is not interest, but interest on interest. In fixed-income investing over long periods, interest on interest can account for over 60% of your returns. To harness the power of compound interest, you need time and a rate of return. In my monthly strategy reports and at my family-run investment company, I make compound interest a focal point. If you are not already with us, please join us. If you want to study the power of compound interest, spend some time with a compound interest table.
#10 Not Recognizing that a Recession is Over
#9 Investors Fail to Make Dividends Their #1 Priority
#8 Overreaching for Yield
#7 Failing to Fortifying Your Financial Future in Turbulent Times
#6 Failing to Focus on the Fed’s Federal Funds Rate Beacon
#5 Focusing on Potential Return Before Risk
#4 Ignoring Cost – A Vital Determinant of Investment Performance
#3 Chasing Performance
#2 Discounting the Importance of Compound Interest
#1 Taking a Casual Go-It-Alone Approach to Investing
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How can I say this best? Stock market valuations are not low. If you are retired or saving in hopes of retiring, you must laser focus on having a consistent flow of cold cash to pay the tab for your weekly grass-fed-to-the-end beef, fresh-ground flax, coconut milk loaded with medium-chain fatty acids, and omega-3-loaded Country Hen organic eggs. In other words, you will want to rely on high-dividend yields for compound-interest power. The two most important words in investing are “compound interest.” Please don’t buy into the jive that trying to buy stocks cheap and then trying to dump them on the suckers has anything to do with a conservative compounding story.
The rubber hits the road with a consistent flow of one item – dividends. In my monthly Intelligence Report and at our private investment management company (www.younginvestments.com), I rely on the historical yield range and the DJIA as a conservative investor’s best gauge for assessing dividend value. When the Dow’s yield is between 4.5% and 6.5%, I gauge stocks as cheap. When the Dow’s yield is between 3.5% and 4.5%, it’s neither fish nor fowl. Below 3.5%, I’m not being paid well for investing in stocks. Well, the yield on the Dow, as I write you with ever-increasing concern, is a paltry 3.1%. No, stocks are not cheap, and values are lacking. And while I’m at it, intelligence in Washington is lacking even more!
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The terror of outliving your money has now taken hold for too many investors. It’s not hard to see why, given that discerning investors remember like yesterday the 1965-1981 16-year bear market, where the Dow ended up at 875, 10% lower than its 1965 peak of 969. A little closer to home, we all recall with concern the 1999-2008 nine-year bear market, which left the Dow down a frightening 24% from its 11,497 peak of 1999. For all retired and soon-to-be-retired investors, there is a fast and hard lesson to be learned here. Look to dividends and interest and the miracle of compound interest. Let capital appreciation come as it may or, as I have shown, may not. My Retirement Compounders Program, outlined monthly in my Intelligence Report and at my family investment management company (younginvestments.com), will guide you.
Ah, retirement. Congratulations. You made it. Whether you got here by selling your business or working your way through corporate America, you’ve made it and you must feel relieved, excited, and probably a little nervous. Your retirement years should be some of the best in your life. But they are also some of the most nerve-racking, with no job to easily fall back on. With this in mind I’ve constructed a list of potentially catastrophic thoughts you might have and how to handle them. Picture yourself 10 years from now with the memories you might have of you and your spouse with grandchildren, friends, or relatives, or of trips to places you always dreamed of seeing. Imagine how great you’ll feel if you remember that you enjoyed the moment. Secure finances can help you do that. So let’s get started.
You will have plenty of free time and access to information when you’re retired. Unfortunately, access to more information does not mean more wisdom. Knowing how to achieve long-term investment success is a craft. It is part art and part science that takes years of seasoning and discipline to do well. Try to spend your time defining your goals and objectives as you construct an investment plan. Don’t seek exciting investment ideas. Keep it simple and don’t worry about your portfolio being boring. You didn’t get here by being foolish with your money, so practice being smart about what you invest in so you can enjoy the time you spend with your loved ones. Imagine how at peace you will feel knowing you’re leaving your spouse in a position of financial strength.
Everyone thinks they can avoid the next disaster. In reality they can’t, and it’s an expensive lesson. Very few predicted the demise of Long-Term Capital Management, the dot-com bust, 9/11, the war in Iraq, or the subprime-mortgage meltdown. Moral: If CEOs of the major banks didn’t understand the risks they were carrying, how could you?
Expect more disasters in your lifetime and prepare to manage your portfolio unemotionally. In retirement you’re managing more money than ever, making it a daunting task. You may find that you sell too early or inertia sets in. If this is you, then seek help from an advisor. You may question your trusted advisor during the next disaster, but your emotions should not impact his or her decisions. Oftentimes it’s the patient investor who profits when others head for the hills.
By definition not everyone can be a contrarian investor. But that’s exactly how investors described themselves in a recent poll. Rather than investing with the herd, you may want to become an expert in understanding risk in your portfolio. Only you know the level of risk you can stomach. You may find your tolerance for risk is lower than you thought. If so, make the appropriate changes and sleep better at night.
Seven of the ten largest equity mutual funds are offered by one company and carry a 5.75% front-end load. You can see this in the Wall Street Journal on page C4 under “How the largest mutual funds did.” Scanning down the page to the largest bond funds, you’ll notice the same company offers a bond fund with a front-end load of 3.75%. A front-end load is an upfront fee a broker receives when selling a mutual fund to a client. Loads are an unnecessary cost if there’s a similar no-load fund available that investors can buy on their own. The fact that seven of the ten largest equity funds carry loads illustrates my belief that investors are sold what they own. I’m not so sure all the advice investors receive is in their best interest.
A sure recipe for disaster is when you feel you need to be more aggressive to get your portfolio to a certain preretirement level. Being aggressive when you’re 30 is fine because you have time to wait out the market. But when you’re in your late 50s or early 60s, aggressive means a higher probability of losing money in retirement. Now is not the time to lose money. It’s hard to come back from market losses. You don’t want to be deprived of taking a once-in-a-lifetime trip just because the market falls.
At 4% spending, you and your spouse shouldn’t outlive your money. I’d be concerned about the longevity of a portfolio exceeding this annual withdrawal rate. Try to live within your means. You don’t want to be seeking employment in retirement. Your retirement spending should be part of a plan, not an impulse. Imagine how proud you’ll feel being able to share with your children how smart you have been with your money.
In a recent WSJ article, “Rough Waters Are Market’s Rule,” the low volatility of recent years is discussed:
“In late 2006 and early 2007…[the S&P 500] dropped into the lowest 3% of all periods since 1950,” says Ed Easterling, director of Crestmont Research. “Easterling goes on to say that the smooth sailing seems to have ended. Since the early 1960s the average daily trading range has been around 1.4%. After a stretch from 2003 to mid-2007, when the average range was under 1%, it has increased to more than 2%. The market could now see an average daily swing of +/-2%. Having the right mix of investments helps reduce volatility and puts you in a position of strength by not being forced to sell at the wrong time.
If you do your quarterly income planning for the year based on prior year-end values, you may overspend drastically. For example, if at year-end your portfolio is at $3,000,000, you calculate $120,000 as your 4% annual draw. You tell your broker to send you 1% or $30,000 per quarter beginning right away, leaving you $2,970,000. If volatility is here to stay (see “Catastrophic Thought #7”) and you get caught on the wrong side of a 2% swing, your portfolio could be worth $2,910,600 after the first quarter. At the beginning of the second quarter, you take your second quarterly $30,000, leaving you with $2,880,600. Your portfolio declines by $120,000, but you’ve only spent $60,000. At this pace, you’re depleting your portfolio by 8% annually. I recommend a withdrawal rate of 1% or $30,000 per quarter, whichever is less. If you follow this recommendation, you’ll be keeping your promise to not exceed the 4% per year. If you can do this, then chances are you’ll be at peace with your portfolio in old age.
As you approach retirement, you need to make sure you have a solid bond component. I would estimate as much as 50% to be an appropriate starting point. In a front-page Wall Street Journal article, “Stocks Tarnished by ‘Lost Decade,’” E.S. Browning reviews what has been a most disappointing decade for many soon-to-retire or retired investors:
Over the past nine years, the S&P 500 is the worst-performing of nine different investment vehicles tracked by Morningstar, including commodities, real-estate investment trusts, gold and foreign stocks. Big U.S. stocks were outrun even by treasury bonds, which historically perform much less well than stocks. Adjusted for inflation, treasuries are up 4.7% a year over the past nine years, and up 5.8% a year since the March 2000 stock peak. An index of commodities has shown about twice the annual gains of bonds, as have real-estate investment trusts.
You want to work with someone who can help you craft a balanced portfolio. You don’t want to miss the boat in the next decade.
You want to gauge your expectations to the market you’re investing in. In the past, stocks returned about 10% per year (6% growth, 4% dividends) on a P/E backdrop of 15. With today’s P/E of 18 and dividend yield of 2%, a 7.5% return is implied. If you invest $1,000,000 and reinvest your dividends over 10 years at an annual compound return of 7.5%, you’ll have turned your $1,000,000 into $2,061,031.56. It’s with the help of compound interest that your money doubles in 10 years. You’re never too old to let interest on interest work for you. I think you’ll agree that making money while doing nothing is a pretty good job description in retirement.
You hopefully found this list to be helpful in getting you thinking about investing in retirement. Do your best to avoid these catastrophic thoughts and you may avoid having to learn the hard way. Share this list with a loved one or a friend and enjoy your retirement. You’ve worked too hard to be deprived of the stress-free retirement you deserve.