8 Income Investing Tasks To Complete Before Your Financial Smarts Erode

by: David Crosetti

I'd like to share an article that I recently came across at Market Watch, titled:

Our Financial Smarts Erode Quickly After Age 60, the author, Robert Powell says:

It must be someone's idea of a joke. If so, it’s a cruel one. Consider: We ask older Americans to make complicated financial decisions about Social Security, Medicare, retirement distributions and more — just when they are losing their fast ball.

Regardless of gender or education level, Americans become considerably less literate about all things money after age 60, according to a new study.

That study is by Michael Finke, who is a professor at Texas Tech. Here is what he and his colleagues discovered, in their study.

1. Americans, regardless of age, are, for the most part, financially illiterate.

2. Financial literacy peaks in the late 40's for the average American.

The professor used a simple test, using a number of financial questions and presented those to a collection of different people, from different age groups. The article that presents this story, has selected 10 of the most frequently answered incorrectly questions from the study and they have created their own quiz for you to take. I will not tell you how well or poorly I did, until the end of this article.

Professor Finke suggest that older Americans complete three "tasks" as they begin to reach that age where their cognitive abilities go into decline:

Task No. 1: Acknowledge that your ability to make financial decisions will decline after age 60. Don’t think this won’t happen to you--it will.

Task No. 2: Set up a retirement-income plan where you don’t have to make complex decisions as you age. You could delegate those decisions to an expert whom you trust. Or, better yet, a financial-services firm where you are not delegating to a single financial adviser, but to a firm that will take care of your finances as you reach advanced ages.

Task No. 3: Consider annuitizing your income, preferably in a straightforward annuity-type product or a mix of annuity and investment products, Finke said. Consider also passive investments that automatically rebalance.

Now that's some pretty interesting advice. Especially for those of us in the Dividend Growth/Growth and Income investing fraternity. I'd like to take this time to discuss the notion of diminished capacity and to also explore some ideas that I think might be useful.

In a recent article by Tim McAleenan, "How to Build an Income Generating Dividend Machine", an interesting comment was made by a person who goes by the name, "Elmwoody." What he said, seems to sum up the situation for many older investors"

In 3 months I'll be 70 years old so building income for the future is not of too much interest to me. However, in 2006 I finally gave up looking for capital gains and devoted my investment strategy to dividend growth. 85% of my invested funds are in IRA's with the balance in a taxable account. I have about 50 positions that generate a 10.45% return at yield to cost ($1,778 per month dividends). I reinvest all dividends because I don't need that money yet. I don't do covered calls. I've never felt more comfortable investing this way.

My biggest concern is how this money is to be managed should I become incompetent or predecease my wife. One of my sons is an investor and he occasionally asks me for my spreadsheet where I track my dividend income. Over the next year I will consolidate my accounts to 10 or 15 positions that would not be too burdensome for him to manage.

Now, this gentlemen made some interesting comments. Notice that he says he has about "50 positions that generate a 10.45% return (yield on cost). Even at my age, managing 50 positions would present a challenge. I am not sure that the average individual really has the time to manage that many holdings and do a good job of it. In the second paragraph, the comments say that the "biggest concern is how this money is to be managed, should I become incompetent of predecease my wife." How is this investor taking charge of his portfolio and addressing the issues presented in the article by Robert Powell?

He has already completed Task #1.

He has acknowledged that his ability to make financial decisions will decline as he gets older.

He has already completed Task #2.

He is setting up a retirement income plan where he will eliminate having to make complex financial decisions in the future.

What Action You Need to Be Taking Now:

I think that each one of us, who are running our own personal company, have a fiduciary responsibility to our shareholders to maintain value. The way we do that is to be open minded enough to understand that responsibility and at the same time put our affairs in order so that we do not have any issues with our caretakers being able to use our money for taking care of us.

I believe the tasks that we should have in place can be summed up this way.

1. Task #1:

Build a portfolio of dividend growth stocks. Look for companies that have a long history of paying dividends; that have increased those dividends on a annual basis; that are increasing those dividends at a rate that is faster than inflation; and that have the earnings history to sustain those dividends.

A great place to start is with David Fish's dividend Champions, Contenders and Challengers lists.

From David's list of companies, you should build a core portfolio of 15-20 companies that have a dividend that is in excess of 2.5% and that has a dividend growth rate of at least 5% a year, in order to stay ahead of inflation.

Some of my favorite Champions are:

Altria (NYSE:MO), pays a dividend of 5.9%

AT&T (NYSE:T), pays a dividend of 5.8%

Procter and Gamble (NYSE:PG), pays a dividend of 3.3%

Kimberly Clark (NYSE:KMB), pays a dividend of 4.0%

McDonalds (NYSE:MCD), pays a divuded if 3.0%

Johnson and Johnson (NYSE:JNJ), pays a duivudebd if 3.5%

Abbott Labs (NYSE:ABT), pays a dividend of 3.5%

As Contenders, I like are:

Conoco (NYSE:COP),with a 3.8% dividend

Chevron (NYSE:CVX), with a 3.1% dividend

Scana Corp (NYSE:SCG), with a 4.9% dividend

Southern Company (NYSE:SO), with a 4.8% dividend

As Challengers, I like:

Intel (NASDAQ:INTC), with a 3.4% dividend

Microsoft (NASDAQ:MSFT), with a 3.0% dividend

Lockheed Martin (NYSE:LMT), with a 5.2% dividend

Reynolds American (NYSE:RAI), with a 5.7% dividend

Verizon (NYSE:VZ), with a 5.4% dividend

2. Task #2:

Get in the habit of reinvesting those dividends, until you need them as income. Either reinvest the dividends in the same companies that you own or collect the dividends in a money market account and use those proceeds to increase holding in new companies or add to existing positions.

I have begun taking my dividends and placing those in a cash account at Charles Schwab. When I get a larger sum of money in that account, I will reinvest that money in specific holding, based on my current allocation model or when I see a company trading at a discount.

3. Task #3:

Sell a position only when the company has failed to increase the dividend, has reduced the dividend, or has announced that they are suspending the dividend. If you have done your due diligence before initiating a position, then as long as the fundamentals are in place, continue to hold. That is, as long as the dividend criteria remains intact.

I have sold positions in companies that have not increased their dividends and that have cut their dividend. On many occasions, I've held a company that has violated this rule and have come to regret it.

4. Task #4:

Become relentless in your consistency in saving. Invest a minimum of 10% of your salary income into dividend paying companies as you are paid. Again, you can accumulate the money in a money market fund and move it to a stock purchase or you can set up a Drip plan.

At work, a 401k with a matching plan can be a source of savings and investing. Unfortunately, many companies offer poor mutual fund choices in their 401k. My company is an example of that. What I do is invest in Index funds in my 401k, take advantage of a considerable company matching program and the company's profit sharing contribution to the 401k. This is a "set it and forget it" opportunity, in my opinion.

If your 401k plan does not appeal to you, then look at direct deposit options to Charles Schwab or any other brokerage account as either funding for a Roth IRA or a Traditional Self Directed IRA. While there is no matching funds with this option, at least you have automatic deposits and tax exemption with a potential deduction on you contributions or a taxable deposit with a non-taxable capital gain and dividend opportunity in the Roth.

5. Task #5:

Take the time to complete estate planning before you need to. Spend the time and spend the money to complete that estate plan so that heirs will have an opportunity to keep what you have worked so hard to get and in passing you will have secured "generational wealth."

If you have a potentially large estate, it would pay you to visit with an "elder law" specialist and investigate the possible advantages of creating a Living Trust. If your state has no inheritance taxes or no estate taxes that's terrific for you, but there is always Federal tax issues to consider. An initial visit/consultation should be at no charge or relatively inexpensive. Your CPA would also be someone who you should involve with any action toward creating a Living Trust. Bear in mind that items like IRA's may present potential problems, even with a Trust.

2. Task #6:

Take the legal steps necessary to appoint someone to manage your affairs should you become unable to do so.

That person must share your own philosophy of wealth management and should be someone that you can have complete trust in. That person should be able to have access to all of your funds, regardless of where they are held. In my case, this task will be handled by my son.

If you have a Living Trust, that person can be anyone you choose. You will need to make the Trustees of the Trust and have documents that give them the right to manage your affairs if you become incapable of doing so yourself. You may find that Power of Attorney is meaningless in some jurisdictions. It is better to have that person as a Trustee and then there is generally no questions asked. This can be arranged during the creation of the Trust and allows you to designate that person responsible for making decisions in the future.

3. Task #7:

Simplify your holdings and create your own annuity. By having long term holdings in various dividend growth stocks, you should achieve a cost basis that is quite low as compared to the current value of a company. That being the case, the notion of selling those holdings to pay for your retirement years makes no sense. You should be at a point where you can live off of the dividends and additional income from Social Security.

Going back to task #1. Over time, your core holdings should have dividend growth. You income should be increasing year after year. At the same time, you may enjoy capital gains which you may want to capture when you rebalance your portfolio. Depending on the number of holdings in that portfolio, you should not be overbalanced in any one company, but instead should try to average your holding to a consistent percentage of ownership, based on the number of companies in that portfolio.

By doing this, you will be able to redeploy money in your growing companies, locking in that capital gain, and using it to add additional money to companies which have fallen below your target holding percentage.

4. Task #8:

Today is not to soon to begin.

Just Sayin'

Disclosure: I am long MO, T, PG, KO, CL, XOM, KMB, MCD, JNJ, ABT, COP, CVX, SCG, SO, FLO, SJM, INTC, MSFT, LMT, RTN, RAI, WM, VZ.