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In our first live discussion on retirement investment held last month, we tackled the problem of generating income in this near zero-rate environment. For today's session (edited transcript below), we turned to stocks.

The financial crisis has left many retirement investors wondering if the old rules for owning stocks for the long run still hold true. Many are asking these days:

- Is 'Buy and Hold' of stocks no longer a prudent strategy?
- Do blue chip stocks in the traditional sense even exist anymore?
- Are traditional asset allocations to stocks vs. other asset classes relevant still?
- Does over-exposure to the dollar in one's equity investments endanger long-term growth?

Our expert participants, who are all financial advisers, explaind how the crisis has generally affected their thinking/practice regarding long term, retirement-focused equity investing and capital appreciation for retirement investors. The experts:


Andrew Horowitz - Certified Financial Planner at Horowitz & Company


Aaron Katsman - Wealth manager at Lighthouse Capital


Richard Shaw - Financial advisor, managing principal at QVM Group LLC

The panel was sponsored by Merrill Lynch.

~ Mick Weinstein, Seeking Alpha Editor in Chief

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And now, an edited transcript of today's chat:

Intro

Mick Weinstein, SA Editor: Hi everyone, thanks for joining. Our goal in this session is to explore how the financial crisis has impacted investors' thinking about stock investing for retirement, and what lessons it's taught us about long term equity investing.

Here's the format - in the first portion, we'll hear from our expert advisors about how the financial crisis impacted their thinking about equity investing for retirement-focused clients. Then in the second portion, we'll take questions from our readers.

Let's start with you, Andrew - how has the crisis generally affected your thinking or practice about long-term, retirement focused investing?

Andrew Horowitz: Often times, during a financial setback, we see a retreat. Then, as soon as the pain is forgotten investors want "all-in" again. This time it appears to be taking a bit more time for that to occur with those that are of retirement age. Many have been through two very difficult market conditions during the 2000s and have no desire to risk anything more. Even as we provided a good deal of downside risk protection, the psyche of many retirees is simple: "I have so much money that will last me so long and why take excessive risk?"

We have effectively guided them toward a position that they are comfortable with and that is what is important. While returns are important to them, many do not see the wisdom in risking their future. So, a well diversified ETF portfolio works well. (Of course we do not believe that a hold-forever philosophy will work either - downside protection is still a big part of our strategy.)

Aaron Katsman: There is no doubt that investors have been impacted by the market meltdown. It’s important though to take a step back and drill down to who was really significantly hit. Those investors who were either right on the cusp of or had just entered retirement were the ones who felt/feel the most pain. For younger investors, while they took a short-term hit, I don’t think anything has fundamentally changed. For older retirees, principal protection is more important than principal appreciation. I have never been a big fan of common financial planning wisdom which I believe has older retirees way too heavily dependent on investments in stocks for portfolio growth.

As for my practice, I have always taken a more measured approach for my clients within five years of retirement:

  • I tend to aggressively decrease equity exposure during this time period.
  • Focus on targeted stock picking and lower beta/volatile, high-quality dividend payers (dividend reinvestment is key).
  • With a large global client base, we drill down into different international markets and focus on countries with stable/strong economic fundamentals, currencies, and growth.
  • We also implement covered call strategies to help enhance yield a bit (especially important in today’s low yield environment). It also helps cushion against stock falls.

Retirement Mishaps

Mick Weinstein, SA Editor: What are the biggest mistakes individual investors make with equity investing for retirement?

Andrew Horowitz: Good question. They are either too confident or too shy. Often times, it seems that retail investors look at the wrong data. Take as a prime example the unemployment rate; every one wanted to know how the economy can recover without jobs, but fail to consider the overall trend.

Aaron Katsman: First of all, clients have to define goals and their needs and frequently, they don't do that. They tend to stay too aggressive, as if they were investing pre-retirement. Lastly, they're still investing for growth when they should be backing off the gas and should focus a bit more on capital preservation.

Andrew Horowitz: Well, I would tend to agree, but I find that most clients do not really always know their goals. It is my job to help clear that confusion...

Aaron Katsman: We tend to see that do-it-yourselfers just look at total return without looking how to generate the supplemental income (pension, Social Security) to meet their goals and needs.

Blue Chips and Cow Chips

Mick Weinstein, SA Editor: Stocks like Bank of America (BAC), Fannie Mae (FNM) and Citigroup (C) - which were considered blue chip by many - were core to many a long-term portfolio in 2008, then lost nearly all their value. How can a retirement investor avoid such a devastating loss? Is there such a thing as a blue chip stock that you can 'hold forever' any more?

Andrew Horowitz: Blue chips that turned into Cow Chips we say. One of the most important things is to consider downside protection. When C was moving down, so many wanted to hold forever. We convinced several life-long holders of the stocks to sell in the $30s. Buy-and-hold was for the mutual funds that wanted to keep investors' money. But the cold hard fact is that the market has changed, new rules apply.

Aaron Katsman: Your question is right. These were blue chips. A good investor will continue to look at the fundamentals of a company. No offense to Mr. Bogle, but buy-and-hold may no longer be relevant. Maybe it never was?? And what about ETFs? They also preach buy-and-hold. Look at the SPY over the last/lost decade...

QVM Group/Richard Shaw: Buy and hold simply has not worked for 10+ years and may or may not work in the future. We think owning rising stocks and exiting declining stocks is a better approach, based on significant trend changes. We use trailing stop loss orders on all positions, to at least prevent catastrophic loss, and in other cases as appropriate enter and exit on major trend changes.

Stop Losses

Andrew Horowitz: Regarding the trailing stops... What is a percentage you may use on it? And what kind of turnover are we talking about? (Of course we all like the sound of in for the rise, out for the fall though.)

QVM Group/Richard Shaw: For catastrophic loss protection, we use the greater of the 3-month lower price channel and the 2 standard-deviation 3-month Bolinger Band width as a percentage of current price. If you looked at SPY for example there were several years up to the 2000-2001 drop; a couple of years out of the market to 2003; then several years in to late 2007 or early 2008; a year out of the market until in the market in mid-2009; and in for a year since.

Andrew Horowitz: Buy and hold is on hold. ETFs over funds. Stocks with both good fundamentals and good technicals, but realize that the government is governing the market for now. Each and every decision to buy or sell needs to fold in that important factoid.

Social Security

Mick Weinstein, SA Editor: Aaron, you mentioned Social Security. A lot of folks are concerned about Social Security even being there when they retire - how are you advising clients on that?

QVM Group/Richard Shaw: We think a greater focus on equity income for retirement age people is important to reduce the risk of ruin, and to help gauge the probability of survivability of the companies - bank crisis not withstanding. Plus, with longer lives in retirement, fixed income (read: that doesn't grow) must be balanced with growing dividend income. I just hope the new tax laws don't kill that argument. It varies of course, but trends should hold for months and sometimes years.

Aaron Katsman: For people in or approaching retirement age, they'll receive Social Security. It's the twenty- and thirty-somethings that have the issue. We preach that clients take individual responsibility over their retirements and rely on no one but themselves. That means, saving more, working longer than previous generations. Even looking for supplemental revenue streams.

40/60 Mix and Target Date Funds

Mick Weinstein, SA Editor: What are your thoughts about that old bond/stocks age-based rule of thumb: apply your age as the bonds percentage, and the remainder in stocks. That is, a 40 year old would be 40/60 bonds/stocks. Is that helpful at all these days? Was it ever helpful?

Aaron Katsman: Exactly. As I mentioned in my opening, current financial planning models are way too stock-heavy for retirees. A 70 year-old who is not a multi-millionaire can't have 50-60% of his portfolio in stocks. He should be at about 30%. Because as I said, capital preservation is more important for him than capital appreciation.

Andrew Horowitz: Right now we think your rule of thumb holds with one important change: perhaps consider adding 10% to the bonds and subtracting 10% from equities for now.

QVM Group/Richard Shaw: If you review the holding of the leading target date funds, they are all over the lot with respect to stocks and bonds and cash and with respect to domestic and foreign stocks.

Andrew Horowitz: Richard, target date funds have been under scrutiny as they were supposed to be a one-stop shop, but ended up crushing investors. Many 529 plans were the same. My advice, maybe investors should not put the plan on autopilot...

Aaron Katsman: We're not big fans of target date funds. They're all over the place, multiple layers of fees and now need to make up for the losses they've encountered.

QVM Group/Richard Shaw: 2010 target date Vanguard 2.91%, Fideility 10.29%, Putnam 26.92%. 2010 target date U.S. stocks: Vanguard 49.37%, Goldman 29%, Putnam 15.39%. 2010 target date International stocks: Vanguard 11.76%, American Century 17.62%, Goldman 34.31%

Dealing with The Dollar

Mick Weinstein, SA Editor: How are you advising clients about dollar exposure in equities?

Andrew Horowitz: Well, there are those that think that the dollar is going to crash. We are not so sure. There are plenty of other currencies in line first. So, if you live in U.S., dollar investments are fine.

Aaron Katsman: With a large international client base, we're especially sensitive to currency movements. Let's face it: the U.S. is no longer the majority of global market cap. There are much more intriguing growth stories overseas (Asia Pacific, Lat Am, Israel). We tend to diversify currency exposure through the fixed income portion of the portfolio where yields tend to be higher anyway.

QVM Group/Richard Shaw: We like to begin asset allocation design with a world weight for stocks and bonds by region, and then deviate as appropriate.

High-Yield Stocks and Covered Calls

Mick Weinstein, SA Editor: I'm going to start bringing in some questions from our readers.

Question from Donald Johnson: "I'm assuming that by investing in 10 to 15 high-yield (5.3% to 7%) stocks and by trading covered calls for conservative, small gains, I should be able to average 10% to 12% in dividend and premium income. Capital appreciation will be a bonus. When charts show stocks are rising, I let them run rather than trade covered calls. And when stocks fall 7% below their purchase prices I'll take my losses. Working so far. What do you think of this approach?"

Aaron Katsman: That's great for part of a portfolio. We like to use covered call writing to enhance yields and lower volatility. But continual 10-12% returns are probably not sustainable - unless your last name is Madoff.

QVM Group/Richard Shaw: Sounds reasonable. Use stops to make sure you get out in time. Make sure you have an objective, non-emotional measure to determine when to stop selling calls. You can always buy back the calls and exit the stock; that is buy calls and sell stock if trending down and you cannot be naked, or buy back calls and let stock run.

Andrew Horowitz: Don: You will be fine as long as markets do not get too volatile with the covered calls. You do provide yourself with some downside protection, but, then you will be locked in...

Dividend Stocks

Mick Weinstein, SA Editor: Have you all moved to more high dividend stocks in the past few years, in client portfolios?

QVM Group/Richard Shaw: Yes. Our clients are all mature and cannot replace lost capital and are mostly drawing income. Specifically, we like pipelines very much as infrastructure plays with limited competition and obsolescence. We also like natural resource related stocks with above-average dividend yields and a history of sales, earnings and dividend growth and with positive free cash flow. There are good places to be, but if the trend turns negative we prefer to reinvest in that which is rising by redirecting funds flow.

Dave Van Knapp: Seeking Alpha recently set up dividend stocks to display them as a "separate asset class" (quote from David Jackson). Do any of the panelists regard dividend stocks as a separate asset class for asset-allocation purposes?

QVM Group/Richard Shaw: No.

Andrew Horowitz: No.

Aaron Katsman: Nope. We like dividend payers but they can get hammered like any other stock.

How Active Do Retiree Investors Need to Be?

Question from Clemens: So you're all basically saying there is nowhere to hide and our older clients have to start becoming active portfolio managers?

QVM Group/Richard Shaw: No, but full inactivity has a risk.

Aaron Katsman: Maybe investors were sold a bill of goods by the whole move towards indexing. Maybe the point is that retirement portfolios are too complicated for do-it-yourselfers and they should turn to professionals for help.

Reasonable Expectations

Question from Jason Tillberg: What would you tell clients are reasonable return expectations for the next year and 10 years - for equities in particular, and overall?

QVM Group/Richard Shaw: We don't know.

Aaron Katsman: Nor us. As my mother, of blessed memory said, prophecy was given to fools. Investors need to plan for worse-case scenarios.

Andrew Horowitz: If you all remember, preferred shares were a good place for income for a long time. That all changed last year...So, the idea of yield chasing for income needs to stop, and look at the whole portfolio instead of one-off positions; that is the best advice for now.

Just One Stock/Index

Mick Weinstein, SA Editor: My grandfather owned just one stock - AT&T (T) - for over 40 years and became wealthy in the process. Can one hold just one equity position now? Even an index fund?

Andrew Horowitz: If Seeking Alpha were publicly held, maybe, but otherwise, no.

Aaron Katsman: For every one of Mick's grandfathers, there are a lot more stories of investors losing everything with a one stock approach. Over diversification has its costs, too, though. On the other hand, Bill Gates wouldn't have become Bill Gates had he owned index funds.

QVM Group/Richard Shaw: Maybe, maybe not. The best decision would be to buy the one stock that will go up the most and put all your money there. The problem is making that pick - for every one-stock winner, there are many one-stock losers.

Mick Weinstein, SA Editor: Can you just own the S&P 500 in an index fund? Or a broader based fund that includes midcaps and smallcaps?

Andrew Horowitz: There are good ways for investors to choose a stock using disciplines that they can replicate. I wrote about the process in my book, The Disciplined Investor - Essential Strategies for Success. It outlines how to use screeners, look at ratios and fundamentals, and then when to invest using technicals. Right now, the trend is your friend, so watch trend and invest accordingly - simple. Don't get caught up in the, "When is it going to crash?" or, "I will wait until the next downturn to buy in..."

Aaron Katsman: S&P 500 is OK. But why limit your growth? Mid-cap, small caps and international all have better returns historically. And every investor is of course aware that historical results do not necessarily indicate future results.

QVM Group/Richard Shaw: Mid-caps generally outperform large caps.

Mick Weinstein, SA Editor: So you are all saying that a 30-40 year old who is saving for retirement cannot simply allocate equities to a broad-based index fund?

Andrew Horowitz: For short periods of time they are fine, as long as they are willing to ride the ups and downs. But I would not do that with my money... Would you Mick?

Mick Weinstein, SA Editor: I do, in fact. I'm not convinced that any other method is worth my time and money.

Andrew Horowitz: Then what is the point of any of the articles that discuss stocks and markets on SA?

Mick Weinstein, SA Editor: Different investors have different strategies and risk orientations, Andrew.

Aaron Katsman: We've been addressing retirees or those close to retirement age. A 30-year-old investor should have far more equity exposure. But again, it makes sense to layer in international and other cap stocks, not just S&P 500. You should read my colleague Zack Miller's upcoming book, Tradestream your Portfolio (Wiley). His methods and the hedge fund managers he profiles would be worth your time and money.

Hedging Against the Next Bear Market

Question from Richard: What are you doing now to hedge your clients from a correction in the equities market?

Mick Weinstein, SA Editor: Yes, do any of you hedge equities in retirement portfolios?

QVM Group/Richard Shaw: No.

Andrew Horowitz: Yes. We use ETFs to hedge out systematic risk when appropriate and sometimes options.

Mick Weinstein, SA Editor: Andrew, you use short index ETFs, or double short?

Andrew Horowitz: Both, depending on time frame. 2X for very short time periods.

Aaron Katsman: We "hedge" by lowering exposure/allocation to stocks. I agree with Andrew, but the problem is that they don't do a great job of full downside hedging - i.e. they don't track their index.

More on Asset Allocation

Dave Van Knapp: Just using the classes of stocks, bonds, and cash, what are the panelists' recommendations for allocations for someone just retiring or already retired? Are there any "sub-classes" within those broad categories that would be called out for specific treatment?

Andrew Horowitz: Sure there are... Single country, bond type, real estate, capitalization, etc.

QVM Group/Richard Shaw: It varies by person. If you have $50 million and need $250,000 to live you can own all stocks, but if you have $500K and need $50K to live you cannot.

Aaron Katsman: You really understand your goals and needs, income requirements, and income sources. If we lived in a bubble, a typical 65-year-old retiree would have 35% equity exposure broken up by 60% in U.S. (60% large cap, 20% midcap, 20% small). Within that, we like some real estate, health care, and technology. The other equity portion should go to a mixture of Asia Pacific (not China but yes South Korea), some Lat-Am, Israel, and a smattering of Europe. For fixed income: short-term bond laddering, some preferreds, foreign currency shares, and international bond funds. Of course this type of investment may not be suitable for all investors.

DIY or Go with the Pros?

Mick Weinstein, SA Editor: You are all investment advisors who help people build retirement portfolios. Do you think all investors should use a professional for this service? Or is there a profile of do-it-yourself investors who really doesn't need a professional?

QVM Group/Richard Shaw: Do it yourself if you can and save the money. Most people won't/can't/don't, but if they can in some cases it is a great part-time job.

Andrew Horowitz: It really depends on the amount of time you are willing to commit, your access to info and your emotions. I could cut my own hair, but I do not have the proper perspective when cutting. Therefore I use a professional...

Aaron Katsman: We've personally met very few who are capable of doing retirement investing/planning on their own. They tend not to be aware of all the available products and how to use them or the risks inherent in them. And they don't change their portfolios as their needs change (rebalancing, re-allocating as they get older). They also tend to be more emotional about their positions than we are. Just look at Mick's grandfather's AT&T today.

Sage Advice

Mick Weinstein, SA Editor: Final question for everyone: If there's just one thing you could say to every investor who is trying to figure out right now what to do with the equities allocation in their retirement portfolio, what would that be?

Andrew Horowitz: Do not fall in love. As long as the position loves you, love it back. If not, kick it out like the dog that it is...

QVM Group/Richard Shaw: Yes, don't marry your stocks. Date them, but don't marry them.

Aaron Katsman: The first thing they need to do is understand their expenses and what their needs will be during retirement. From here, you get a better picture of tolerance for risk in the equities side of portfolio. The best thing to remember is don't chase high-flying stocks but stick to good companies with rising dividends, good business models, and strong cash flow.

Mick Weinstein, SA Editor: This was great, thank you so much to our participants and to those who read along and asked questions.

Source: Stock Investing for Retirement: The New Reality