Protected Principal Retirement Strategy: It's That Time Of Year - Reallocation

by: Akaralph

I love Christmas - mostly for its true meaning, along with the celebration, gifts and Christmas carols that go with it. That's part of the reason for the song excerpt from "The Christmas Waltz" by the Carpenters in the title of this article.

Back in July of this year I began the Protected Principal Retirement Strategy series with three articles focusing on one approach to retirement investing. It is geared to those of us who I choose to refer to as "Mid-Rangers" - individuals and families who do not possess the proverbial $1 million plus in retirement savings, but instead have +/- $500K in their nest eggs.

Part I (here) advanced the overall concept for retirement investing in such a manner that our nest egg principal would remain untouched for as long as possible.

Part II (here) enumerated basic financial principles for retirement living and provided information relative to the asset classes that would comprise our portfolio.

In Part III (here) we delved into the actual percentage allocation among these asset classes.

Subsequent articles in this series addressed specific stocks that I believed fit our strategy going forward.

I can't express how much I appreciate the positive comments made by my readers. No one strategy fits all, and many of you made suggestions that I incorporated into some of the later articles in the series.

As the end of 2012 draws near I have begun the process of reviewing both the overall portfolio strategy and have identified specific allocation changes based upon how I perceive both the domestic and international scenarios heading into 2013. I will not burden readers with an extended series of articles this time - instead I will compress the re-allocation process into two installments; the first to include our asset class breakdown, and the second to discuss specific stock positions.

The Outlook Going Into The New Year

The following lists highlight (perhaps a poor choice of words) what investors will be facing in 2013.

Domestic Issues

  • The "Fiscal Cliff," including increased taxes on almost everything and expiration of the Bush tax cuts
  • The potential for inflationary increases
  • Interest rates and interest rate spreads
  • Continuing high "real" unemployment
  • Untenable debt levels
  • The real prospect of "double dip recession"
  • Continued 24/7 printing of money
  • Etc. (Feel free to add your own)

International Issues

  • Potential global recession
  • Collapse of the European Union
  • Continuing country bankruptcies
  • A possible Middle East war
  • Etc. (Feel free to add your own)

I just re-read these lists and I want to go back to bed for a week.

Wither The Stock Markets?

Based on the above, I may be wrong (hopefully) but I cannot see the markets performing well in 2013. On the brighter side, I see where a lot of market pundits are claiming that we can anticipate a major rally if the clowns (being kind here) in Washington can solve the fiscal cliff issue. That really only solves a small portion of our domestic problems, so I would guess any rally, while possibly significant in magnitude would be short-lived.

So, how do we Mid-Rangers adjust our portfolios to maximize our total returns while minimizing risk? Not a simple task. Remember, if there is a bear market all stocks will decline. Since we rely to a large degree on investment income for our living expenses, most of us will have to be certain that we remain in stocks offering us the potential for continued dividend/distribution stability and/or increases despite potential significant declines in the underlying price of our stocks.

Re-Allocation Scenario

In Part II (published July 22, 2012) I presented the rationale for allocating our retirement investment nest egg among several asset classes: master limited partnerships [MLPs]; royalty trusts [RTs]; real estate investment trusts [REITs]; business development companies [BDCs]; and foreign stocks. I also included closed-end funds [CEFs] as an additional component of the portfolio, realizing that these should not be a separate asset class, but could fit within the foregoing five asset classes as necessary.

The goal of the portfolio is to produce a total yield of plus/minus 8 percent to 9 percent from dividends/distributions. While some might disagree, I do not consider a portfolio yield of 8 percent to be "yield chasing." The reason I do not consider this to be excessive is due to the fact that relatively safe investments such as MLPs, etc., typically sport yields in this ballpark. For those interested, my take on low, medium and high yields are defined as follows:

  • Low yield - < 5 percent
  • Medium yield - 5 percent to 9 percent
  • High yield - 10+ percent

Looking back at the last bear market (2008-2009), each of our asset classes declined; however, MLPs, some RTs, and a number of REITs maintained, or even increased dividends/distributions. This was particularly of note with the MLPs, where several of the midstream and downstream players increased their distributions.

Despite stock prices collapsing, many investors were able to purchase or add to existing MLP positions at significant discounts. The result was the ability to avoid capital gains taxes on MLPs they had held for years while increasing yield on their original invested capital into the mid-double digits.

I am not trying to imply that this scenario will repeat itself, but I feel a certain level of comfort holding most MLPs through another bear market.

Going forward, I have increased the percentage allocation to the MLP/Energy category and reduced the RT percentage from where it was in July.

I am decreasing the allocation to REITs to reflect my disdain for the mortgage REIT sector which is already showing signs of decay.

Similarly, I have reduced the allocation to the BDC sector some, since they are quite sensitive to interest rates, availability of capital and other potentially negative economic factors.

The foreign sector allocation remains the same; however, it is becoming more and more difficult to identify dividend payers from economically stable nations.

It is also a goal for 2013 to retain approximately 10 percent in cash to afford the opportunity to add to portfolio positions as appropriate.

The following Table depicts the allocations for 2013 compared with those of July 2012.

MLPs 55% 40%
Royalty Trusts 10% 15%
REITs 5% 10%
BDCs 5% 10%
Foreign Stocks 15% 15%
Cash 10% 10%
Click to enlarge

With each category are subcategories, representing different asset classes.

In the MLP asset class we divide our 55 percent overall allocation among upstream, midstream and downstream sectors.

Royalty Trusts are subdivided between U.S. and Canadian trusts (or corporations). I might mention that I have been very disappointed with the performance of our U.S. trusts over the past six months, and I think it has been overdone to the downside, resulting in a number of trusts that are significantly oversold looking out over a two- to three-year time frame.

In July 2012, we divided our REIT positions between equity REITs (eREITs) and mortgage REITs (mREITs). As many of the mREITs had been reducing dividends over the past several quarters, coupled with declining interest rate spreads, I have eliminated them from the portfolio. I think it is very possible to see mREITs go through another debacle similar to the one they suffered through in 2008-2009. I also am not showing a significant allocation to U.S. eREITs at present, as appreciation of stocks within this sector has reduced yields to fairly low levels.

Within the foreign component of our portfolio we allocate a portion to equity/income stocks and a portion to emerging markets.

The following Table depicts these more detailed allocations.

MLPs 55%
Upstream 5%
Midstream 35%
Downstream/Specialty 15%
Royalty Trusts 10%
U.S. 5%
Canadian 5%
REITs 5%
U.S. 0%
International 5%
BDCs 5%
Foreign Stocks 15%
Equity/Income 12%
Emerging Markets 3%
Cash 10%
Click to enlarge

Earlier in this article I mentioned closed-end funds (CEFs) as a means to enhance the portfolio and its overall yield. In a recent article (here) I discussed recent performance of CEFs as an asset class.

I research and monitor a wide range of CEFs, and anticipate using them among our portfolio's asset classes as appropriate to gain diversification where there might not be enough cash reserves to purchase several stocks, or to access options, currency or commodity positions.

In the next article I will discuss specific stocks in each asset class that I believe to be applicable for inclusion in the Protected Principal Retirement Strategy portfolio.

Just want to let you know that I am beginning work on an interactive book. I do not have a final title as yet, but it will focus on investing for women who are either single, divorced or widowed.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: This article does not constitute a recommendation for portfolio allocation. It advances one possible strategy only.