Where we left off:
At the end of Part III, our intrepid heroes were about to begin a reallocation and rebalancing of their portfolio to:
- Reduce risk.
- Attain the yield they need in an income stream in order to maintain their current lifestyle.
Nothing unusual there, that's what most retired investors are trying to do.
What we did first:
First, we executed some trades that we talked about at the end of Part III. We sold half our position in two of our mREITs. We put the profit in our cash account and used the net proceeds to increase one of our MLP positions.
We took a little hit in yield, as we expected, but we reduced our risk as planned. We are going to do the same with a few other mREITs, but we're waiting for several dividends to come in the next few days.
Next we sold a couple of our muni bonds. We're convinced that we can get a better yield on the money we had in the bonds, even after taxes.
We made a profit on both of these so that a portion of the proceeds also went into the cash account, and the amount equal to our cost will be reinvested.
Finally, we sold our much too large position in VFIIX. The reason the position was so large to begin with was because it was one of the very first things we bought when we began investing. It was rather safe and the yield wasn't bad and we just didn't know enough at the time to realize that the investment was too large. We've lost a little money on the sale, but we now know that we can get a higher yield with relative safety.
After the First Steps, Analysis:
So now we have a huge pile of cash ("huge," that is, relative to our portfolio) and must begin to find the right balance between risk, yield, and growth potential and begin to replace the names we've sold.
Getting ready to do that brought us to an analysis of our portfolio. We began by reclassifying our holdings after finding out that some of our initial classifications presented in Part III were incorrect. The new classifications are in the table below.
But that exercise presented us with a big question. What about understanding our allocations? The simplest allocation method, of course, would have been just stocks and bonds, and we would have seen that we essentially had a not too unusual 65/35 split. Though that might be a little heavy in stocks for many retirees. But looking at the allocation that way didn't seem to tell us anything, really. The 35% in bonds is quite clear. They're all the same kind --munis -- and the yield and risk are very well balanced.
But the other 65% has a very broad spectrum of yield and risk made up of several different types of asset classes, and we thought it is prudent to granulate it in order to get a more detailed and helpful picture.
One thing we noted almost immediately is how much our holdings are geared toward income. Well, duh, of course, income is the purpose of the portfolio. But we hadn't realized that the names we selected were mostly names that had to do with income regardless of yield and growth. All of our ETFs and our open-ended fund are income oriented. Add that to the munis, and that part of the 65% looks like a rather conservative income stream generator.
Here's a snapshot of our portfolio as of last Wednesday with its asset classifications, current yields, position weightings, and asset class weightings. Below I'll discuss our understanding of the portfolio's structure, and then draw some conclusions, describe our immediate next steps, and ask some questions that are quite important for us as we continue our learning process to become more effective dividend investors.
The Rice's Portfolio as of 02/06/2013
What we classified as equities in the table, that is, not bonds or funds or REITs, seem to be pretty solid.
There's one preferred name with a nice yield that seems rock solid. Three of them, the SAN Preferred, TOT and VOD are not domestic, so we have a bit of foreign coverage for diversification. T is solid with a nice yield. Our position in RTN is very heavy. But there's a reason for that. I hope you'll find the following little digression interesting.
Here's why we have such a large position in Raytheon. In 1942, 70 years ago, my wife's grandfather, a poor farmer in rural Tennessee, helped a rich man build his farmhouse. As part of the payment, the rich man gave the grandfather a few shares of RTN. My wife's mother inherited the shares from her father. When she passed away about three years ago, those few shares had increased more than a thousand-fold from splits over the years, and she left half of them to my wife and the other half to my wife's brother.
My wife would never sell these shares unless she were totally destitute, and so we'll keep that over-heavy position. But it's been interesting watching them over these three years. They go way up and they go way down and then they come up again. Right now, they're way down in the last few weeks, but they'll come back eventually for sure; they always do. And the dividend is 3.74% right now. Not bad. According to FAST Graphs, RTN is seriously undervalued. But obviously the last thing we need is a bigger position.
So all in all, it appears that what I've called the equities part of the portfolio is pretty solid.
That brings us to our BDC names. I like them because they have very nice yields, they're currently undervalued, and their future earnings yield estimates look good. But when I look at them, I have a question that I don't have an answer for.
It seems to me that like mREITs (more about this below), BDCs are also dependent on the interest rate spreads. If this is so, then maybe I ought to lump these in with my REITs when looking at how much of a percentage of our portfolio our asset classes comprise. I hope some of my readers make comments about this question.
Then there are our ETFs. I'm really not too sure about these particular ETFs at all. They certainly have nice yields, but I don't have a solid feel for the level of risk they hold. Morningstar doesn't rave about any of the three for which they have analyst coverage, and they only rate one of them with below-average risk.
It's clear that I have to get a better understanding of how to evaluate these ETFs. I'm still lost in that sense. The good news is, besides the dividends that we've already collected, the price has appreciated on all of them except one since we've had them.
Our five MLPs seem to be doing OK. As far as appreciation, we're about even. The outlook for them seems good and the yields are very good, too. Our plan is to keep a close watch on them, but we're currently not planning to either sell them or acquire any new ones.
And this brings us at last to the thorniest part of our portfolio for me: the REITs. I made an executive decision and decided to split the equity REITs and the mortgage REITs into two asset classes, which is why they're separated the way they are in the portfolio table at the beginning of the article.
I'm convinced that the equity REITs, while not without risk, of course, are much less risky than the mortgage REITs. But I'm lumping mortgage, agency, and hybrid REITs together in one class. At 16.5% of the portfolio in mREITs, we're considerably over extended. Obviously, the dividends are lovely and extremely seductive.
I know that many people seem convinced that the inevitable coming rise in interest rates will hurt the mREITs badly, though I've read some counter arguments, too. In either case, however, I think there's still time to hold on to these names because interest rates are not going to rise precipitously overnight anytime soon. For an attentive investor, there will be signs that will give us enough time to act.
Conclusions, Next Steps, and Questions:
Looking at the above, my sense is that we should augment what I've called our equities with some solid blue chips with good dividends.
I also think we made a mistake in getting rid of several preferred stocks early on. As I study more, it seems to me that preferred names definitely have a place in an income-oriented retiree's portfolio. My thinking now is that we'll acquire some more preferred names. In general, our equity holdings seem to be suitable for our aims and we just need to increase them.
Our muni holdings fit nicely in our portfolio and are pretty safe. There doesn't seem to be much chance of any of them defaulting and the yield is nice. I'm not too worried about rising interest rates currently because we intend to hold them to maturity or death, whichever comes first.
Our positions in ETFs are, I think, a good example of the pitfalls that await an inexperienced investor, especially one that is focused on yields and income. As I've pointed out, we've not done too badly with them thus far. But I got into them through recommendations from some people for whom I have a great deal of respect.
But there was no due diligence on my part. I didn't understand what I was getting into and I feel I've been lucky that I haven't fared worse. Now that I'm learning so much more and feel a greater need to truly understand my investments, I've learned that recommendations from respected people are a great way to come upon names to look at and study to see whether they're suitable. But people like my wife and me - and from the comments I've received there seems to be many of them - must make the effort to become much more deeply educated.
I keep reading that these bond ETFs are at risk because, yet again, of the possibility of rising interest rates. This continues to be a conundrum in deciding what to do.
As far as our mortgage REITs go, there's a lot of risk here, more than I care to expose us to. I do like the idea I mentioned previously; that is, selling half of our shares in the mREITs. We've done that in two of them already. This will reduce our exposure, which means reducing some of the risk and the overall percentage of our portfolio invested in REITs. But we'll still have excellent yields on the remainder, and the sales I spoke about will give us the funds to buy other asset classes.
And that brings me to the really thorny questions (thorny for me at least) of asset classes, the portfolio's diversity, and the percentages devoted to each holding and the total percentage of each asset class in general.
I just don't know whether I have enough different asset classes represented in our portfolio. Do I have the kind of classes where, when one type gets hit the other might do well? Do I need that?
And what about sectors? I clearly don't have a lot of diversity among sectors. Do I need more? Is there a reasonable trade-off to be had between sector diversity and the focus of the portfolio?
I've read so much here on SA about not having an individual name represent a percentage that would be more than one is willing to lose. I understand that.
As I look at the percentages, leaving out RTN for the reasons explained above, and also leaving out the munis because of the reduced risk as far as our particular situation is concerned, I still see many holdings that in dollar value are greater than I'm willing to risk. But most of them are solid companies, for example, AT&T. I can't bring myself to believe that my holdings in AT&T are going to evaporate. And as long as I keep close tabs on the portfolio, which I do, when a loss equals my risk tolerance, which is moderately high, I'd just sell and eat the loss. I don't do panic selling.
But what about all the holdings in a single asset class that is by nature risky -- the mortgage REITs? Even though I'm reducing my position in individual REIT names, I'd still have a much bigger position in total for that asset class than I'm willing to risk. But would I get wiped out there overnight the way one commenter who messaged me explained he was wiped out from one day to the next when Lehman Bros. went under? I simply don't know.
And then there's the purpose of our investments. The income stream. We need a stream yield of about 8%. And I can't lose sight of that.
Thus, as you see, I have many more questions than answers. Naturally I'll keep studying and thinking to try to learn enough to resolve some of these questions. But I'm also hoping that some of my experienced readers will be able to take the time in their comments to help me answer some of these important questions.