Could it be that there’s been a paradigm shift in our needs as we head into retirement?
Two or three decades ago, seniors could depend on some combination of pension plans, retirement health benefits, social security, income from fixed income investments such as Treasury Bonds and capital upside from stocks – with the classic stock allocation model where investors moved more of their holdings from stocks to “the safety of” bonds as they drew closer to retirement. Their retirement calculations too were based on assumptions such as 6% to 9% annual returns on stocks and 3% to 6% bond returns. Moreover, back then, the US government was fiscally a lot stronger with nowhere near as much national debt or budget deficits. And American corporations were champions.
The Times, They Are A-Changing: But today, we tend to jump from job to job, companies rarely offer significant pension plans, health care costs are soaring, fixed income returns are close to nil and stocks aren’t necessarily all that dependable over the intermediate run (stocks essentially lost value from 2000 to 2006, rose a little thereafter, then lost a lot, and by the end of 2009 were essentially back at their 2000 levels – the lost decade of stocks that we’re all pretty familiar with). And, on top of all this, our government’s finances are in pretty sorry shape with massive debt, unfunded social security obligations and various deficits. Many states and cities are on the verge of bankruptcies that threaten things like pensions and jobs. American companies are still champions but not in as many sectors as before.
Viable Income Generating Alternatives: So if you don’t have a substantial pension plan and social security, if interest rates are at all-time lows and if stocks aren’t dependable for their anticipated 6% to 9% annual returns, how do you make enough income to tide you over retirement?
Well… you look beyond the traditional asset allocation model to investing in securities such as:
- dividend stocks and DRIPs
- real estate investment trusts (REITs) that pay over 90% of their earnings as dividends
- foreign bonds that pay 9% or more in annual interest that’s guaranteed by relatively credit-worthy countries
- foreign currencies ETFs to protect yourself against currency fluctuations that hurt the dollar – think of investing in some of the world’s stronger currencies such as Kuwait’s Dinar, Oman’s Rial, Canada’s Dollar or Swiss Francs
Also get to know the basics of simple Call and Put options and simple strategies such as covered calls that generate income, reduce long-term stock ownership costs and limit downside losses.
Seek Beta Independence: Learn a little about portfolio beta – the degree to which your portfolio is correlated with the broader market. For example, a stock with a beta of 1 moves in lock-step with the broader market at all times. A stock with a beta of 2 rises twice as high and drops twice as low as the market. And a stock with a beta of zero is essentially market neutral. On the flip side, a stock with a beta of -1 falls when the market rises, as much in % terms.
To disengage from the vagaries of the market, investors must include zero and negative beta securities in their portfolios. If the market drops, your negative beta stocks will rise and help you stay ahead, even in down markets. So talk to your financial advisor on how you can generate reliable income in a low interest rate and uncertain market and economic environment.
Dividends & DRIPs: Solid dividend stocks generate substantial cash every quarter and pay dividends even in bad markets – so dividend investing buys you some independence from the market, at least in so far as your dividend income stream is considered. With solid companies, a drop in share price is little reason to not pay dividends – so you’re slightly more assured of income that’s not completely dependent on the market. You should also take advantage of DRIP plans that give you the benefits of dividend reinvestments and compounding. And build a portfolio of dividend stocks that are not correlated.
While capital gains are closely tied to the broad market, dividend income is beta-independent to some extent if you pick solid cash-generating companies.
REITs and MLPs: Consider building a portfolio of REITs – many have payouts in the low double digits such as a 12% dividend from Hatteras Financial Corp. (HTS). REITs like Hatteras are also safer because they typically invest in what-are-called agency bonds where the risk of default is shouldered by housing agencies such as Fannie Mae and Freddie Mac. And REITs have an average beta of 0.6 – not fully linked to the market – because REITs generate income from the interest rate spread between the lower cost of their borrowings and the higher interest earned from their mortgage investments – so REIT returns are less impacted by consumer or business spending but depend more on interest rate patterns.
Similarly, master limited partnerships (MLPs) such as in the energy sector are good payers of reasonably high dividends.
Foreign Currencies & Bonds: With America’s fiscal house much weakened compared to a few decades ago, consider getting some of your income from investments in foreign currencies, such as the Canadian Dollar, that could hold up significantly better over the long run while we work through our fiscal liabilities. This gives you the opportunity to convert your foreign funds back into US Dollars at a later date and benefit from relative declines in our own currency.
Investing in currencies is fairly complicated if you decide to do this on your own without a Ph.D. in Economics or Finance, so stick with exchange traded funds (ETFs) such as CurrencyShares Canadian Dollar Trust (FXC), CurrencyShares Swiss Franc Trust (FXF), WisdomTree Dreyfus Emerging Currency Fund (CEW), etc.
Related: Bonds or Bond Funds
Also consider parking some money in higher interest-rate foreign debt – through securities such as EverBank’s Commodity Basket CD that invests in certificates of deposit and fixed income in commodity-rich Canada, Australia, New Zealand and South Africa.
Retirement isn’t pretty if you’re not financially prepared. And it’s no longer the same retirement environment as your dad’s or grandpa’s. So, in this low interest rate and uncertain economic environment, try some of the ideas outlined above to develop an income-generating portfolio that isn’t overly tied to the market.