Difficult But Not Impossible

by: Roger Nusbaum

Over the weekend I read a post at Seeking Alpha titled "Will Your Retirement Savings Last?" It was a dividend oriented post that drew a lot of comments including the following:

After reading your article,it would seem to me that the average retired investor needs a 7% yearly return to simply keep pace. Example 4% dividend to live,and 3% return on shares to keep pace with inflation. Thats a pretty scary thought.

This is an interesting comment and an astute observation. This doesn't have to be that scary, challenging yes, but not necessarily scary or wildly unattainable. It seems like the commenter is a dividend investor of some sort but I cant be certain but that was the orientation of the article and most of the comments.

(Click to enlarge)

In past posts I have been pretty clear (I think) about believing heavily in dividends but not believing in making them a priority ahead of proper diversification. My idea of proper diversification is building the portfolio to include stocks with various types of attributes including exposure to lower yielding higher growth names.

It has become easier in the last five years to build a somewhat diversified portfolio that yields 4% but doing still requires skewing the portfolio away from growthier names assuming you don't want to load up on BDCs and mortgage REITs. Targeting closer to a 3% yield or even 3.25% would obviously leave a little more room for a couple of growthier names that don't necessarily bring much yield to the table.

My experience with individual stocks under the hood of a diversified portfolio tells me that if you own 30-40 names with all different attributes you will have at least one name that goes up 50-100% in a year or maybe every other year assuming you are just an average stock picker. Obviously having that many holdings is a function of time available and interest in investing.

The importance to this is that if you have one stock that starts out at a 2% target weight and goes up 50%, it will obviously deliver 1% to the entire portfolio leaving 29 other holdings to average out such that they deliver another (in the reader's example) 2% in growth. Having one stock that goes up 50% is harder to do if too many of your holdings are like Chevron (NYSE:CVX) and Procter & Gamble (NYSE:PG).

The logical question here would be that if one name can go up 50% then why can't another go down 50%? Of course it can but it is very rare for stocks to go down that much over night. So assuming getting ambushed by an overnight 50% decline is just a once or twice in a lifetime event then this issue can be mitigated with some sort of sell discipline based on price, fundamentals or anything else you think would get you out before absorbing the full brunt of a protracted 50% decline.

Looking at the very long term an average annual increase at the index level in the mid single digits far from heroic. Yes the U.S. has been on a 13 year round trip to nowhere but that is not true of global markets. And to paraphrase myself, a 13 year round trip to nowhere is a lot less likely after a 13 year round trip to nowhere.

I don't think we can expect 10% annualized anytime soon but I do think mid single digits for global markets is plausible for the long term. Of course there will be years that are far better and years that are far worse but an average 4-5% is plausible provided truly stupid or self destructive behavior can be avoided -- easier said than done.

One last layer is whether or not the full brunt of large declines can successfully be avoided. Going down 20% in a down 30% world offers the opportunity to increase the average annual number by quite a few basis points but among other things this requires being able to take a long term perspective which is also easier said than done.

One big and visible fly in the ointment to the above (and there are several) is inflation. Reported inflation has been running low and so has been easier to manage. If much higher inflation comes from current Fed policy then this all becomes much harder because you can only take what the market gives. What I mean by that is if inflation were to rise to 7% and the stock market were to average 8% then investors would have very little margin for error because in an up 8% world investors cannot count on being up 15%. Maybe they can average 10% but 5-6% is more likely.

The big idea here is looking at each aspect of a diversified portfolio as a separate task toward the bigger goal of having a portfolio that gives you right combination of yield, growth and sleepability for your circumstance. None of this is easy but it can be defined ahead of time which can make it a little easier.

The picture is from our hike yesterday.