Should The Retired Dividend Growth Investor Really Be Building Cash?

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Includes: CSCO, ETY, PFE, PG, STK, STOR, XOM
by: Adam Aloisi

Summary

Regarded Solutions authored a thoughtful piece on the rationale for raising cash in the current market.

I posed a similar thesis here on SA several years ago.

What is the difference between a market timer and an investor merely acting on a thoughtful tactical level?

Why a retired dividend growth investor might be less likely, or inclined, to make even minor allocation tweaks, as compared to a younger DGI.

Some DG stocks that might be at attractive nibbling points.

Regarded Solutions recently wrote a timely article concerning the wisdom of building a cash position in today's market. I agree with him that the market doesn't "feel good" right now, with seemingly few data points to hang a broadly bullish thesis on. There does seem reason to believe that market indices haven't reached a trough of near-term correction.

And for pretty obvious reasons, the platitude "cash is king" earns its true billing during a market downturn such as we are currently witnessing.

About two years ago, I wrote a similarly themed article as a counterpoint to one Chuck Carnevale authored that opined that it was a certifiable "mistake" to move monies earmarked to equities into cash. I think both articles generated discussions that are worthwhile reviews for anyone looking at acting on RS' recent or my somewhat dated advice.

While RS' article scratched the surface on the issue, I think it merits a more in-depth discussion.

Timing Versus Time In The Market

The average investor may view positions and allocation as an "all or nothing" thing. Large positions, or conceivably entire portfolios, may be built on the spur of the moment or even torn down on a fearful or knee-jerk whim. Massive cash is deployed or built instantaneously.

These are blatant examples of market or security timing. The investor is making a decision, whether calculated or not, based on near-term price movement expectations. In terms of risk taking, these types of decisions are amongst the most risky an investor can make.

If you are wrong on your timing, you may have another difficult decision to make. Do you wait until things turn back your way, or do you accept the mistake and return your portfolio to its prior composition. If you wait, thinking things will ultimately go your way, how long do you wait? What if they never turn your way?

While building cash in the way RS suggests may come across as a light example of market timing, he certainly isn't pounding the table on selling every stock you own. To that extent, I would argue that building cash when you feel individual equities are expensive, or when there are severe macro issues facing the market as a whole, is more of a tactical investing maneuver as opposed to a timing decision.

Tactical Total Return Investing Versus Dividend Growth Investing

After studying the dividend growth philosophy for many years now, it is clear to me that this is not a homogeneous belief. Unquestionably, there are different ways of engaging and practicing dividend growth or dividend growth-like strategies. Further, as I spoke of in my most recent article, life stage is an important factor in how the do-it-yourselfer crafts a portfolio and the way in which they might forward manage it.

The more "purist" of dividend growth investors seem to attend a church of being fully invested - or near fully invested - as their prime DG religion. More liberal types may raise levels of cash when appropriate and/or be more active or aggressive in portfolio management. Rotation from fully or overvalued equity into cheaper, higher-yielding equity, with a specific goal of raising income levels, may be part of an ongoing regimen.

Whether management of this type moves one from the "true DG camp" into something more tactically total return-oriented or not might be argued. Semantically speaking, I suppose if one is still making decisions where the dividend and portfolio income is the prime consideration, they are still a practicing DGer. Let's just simply say that there are, indeed, differences.

The Question Of Retirement

The Regarded Solutions article title includes "retirement strategy," so I'll proceed from here with the presumption that his article was speaking to that demographic. My article, which promoted the idea of a cash raise, was written more to an agnostic, non-specified group. I believe Chuck's was as well.

The DG-inspired retiree, in my opinion, should be making decisions that do not expose a portfolio to unnecessary risk. The problem with this seemingly commonsense, simplistic statement is that risk may be viewed in a variety of ways by even the narrow retirement demographic.

One of the top risks - if not THE top risk - that retirees may face is not generating enough cash flow or enough dividend growth to support their entire length of retirement. Taken from that perspective, there is a lot of merit in the cafeteria list of reasons that investors may have to build cash, according to RS. The following was taken directly from his article:

Of course, none of this comes to fruition if the market or individual stocks that you put on your buy radar don't actually decline. Worse, if you raise capital through incremental equity sale, your income immediately declines, which is obviously in conflict with what it is that the DG-inspired retiree is attempting to accomplish.

The more optimistically inclined could certainly rebut each of the above bullets with a reason why incremental cash raising could be a less profitable endeavor. One could also argue that RS' advice has too much price overtone that runs counter to the somewhat price-agnostic philosophy of the more stringent dividend growth investor.

RS stated in his article,"... when the market is so easy to read, as it is now." While I reiterate agreement that that risks may be in capturing additional downside as opposed to missing upside right now, I don't think there's anything "easy" about this market. Many companies are hitting the skids, but there are those that are operating quite well in what is starting to seem like a mild recessionary environment.

If things were that easy or obvious to read, the recommendation should be to liquidate a portfolio, or minimally, go to majority cash. Making the mistake of becoming overly bearish at the wrong time could be a costly error.

Keep in mind that the market has already sold off about 12% from last year's highs, and market indices have already retraced to levels seen about 18 months ago. Some blue chips find themselves much more significantly - to the tune of 20% or more - in the hole. Doesn't mean there isn't further to go, but it does mean a significant level of price risk has been taken off the table.

So, to an extent, I'm wondering how much extra cash RS has in mind for the retiree. My personal opinion is that it may actually be a mistake for the retiree to get slap happy with a cash raise, or maybe any cash raise at all. At the end of the day, it may come down to your personal thesis as to how deep and long the now 18-month long malaise may last.

For most retired dividend growth investors, the answer may be to do nothing, ride out the near-term volatility, but own only companies with strong balance sheets, little commodity price exposure, or otherwise recessionary resistant characteristics. But raising cash is not the only option. There are other income-generating ideas.

Other "Options"

While I won't go into much implementation detail, I will generally state that simple income-generating options strategies can fill the void that going to a straight cash position creates.

Covered call selling, - basically, receiving cash in exchange for someone else's right to take a stock you own at a stated price and date - would be one such strategy. Cash-secured put selling - or receiving cash in exchange for the right of them to sell you their stock at a stated price and date - is another.

If you raise portfolio cash, you can continue to generate income by utilizing the cash-secured put option. The better alternative - if you believe the market, but more importantly, the stocks you own will flatline or continue to drift lower - is to sell near- or even in-the-money calls.

For those that don't feel comfortable with this strategy, there are a variety of CEFs that take the mystery out for you. I have been pounding the table on these products for several years now. While I utilize individual options for income, I also own Eaton Vance Tax-Managed Diversified Equity Income Fund (NYSE:ETY) as well as Columbia Seligman Premium Technology Growth Fund (NYSE:STK) for a managed, simpler boost. Visit CEFconnect.com for a listing of other available options.

Assuming you don't think the market will crater by a large margin, option income may be a middle-of-the-road solution that doesn't force you to make quasi-timing decisions relative to the market or stocks in your portfolio. Still, while options may fill a void or generate supplementary cash, they don't eliminate risk. Straight put options are the only method of straight price protection, and they aren't available for every equity, and come with an income diluting price tag.

Should You Be Spending Instead Of Raising Cash?

Given some of the rapid moves that dividend stocks have been embarking on, it seems like that if you blink, you've missed an opportunity. For the first time in many years, I recommended nibbling on Procter & Gamble (NYSE:PG) in the upper $60s late last year. With a 3-month, 20% move, I no longer think you should buy.

I told a reader that I would be interested in IBM at $120 and a 4% yield point. The stock got that low, but has quickly bounced up $10 a share. While I never bit, I think the dividend growth potential there is rather robust despite the company's failed-uptil-now efforts to get traction in some thick mud.

I still say avoid Big Oil, although the price trough formation is probably beginning. Until it appears retooling efforts have stabilized, there may be dividend and price risk in even your integrated oils. One bullish note out of OPEC, however, and the drought might end with a V-shape recovery. The only equity I own and would even mildly recommend at this juncture is behemoth Exxon Mobil (NYSE:XOM).

My favorite triple net REIT remains STORE Capital (NYSE:STOR), but the triple nets have been all bid up as the 10-Year Treasury declines. I think you take your foot off the gas there, although I opine that the dividend growth potential for STORE, in particular, is quite bright.

In tech, Cisco Systems (NASDAQ:CSCO) approaching a 3.75% yield with a strong balance sheet looks tempting, as does Pfizer (NYSE:PFE) now with a better than 4% yield.

Still, while I might be willing to add or accumulate a growing list of dividend growth names, the general headwinds out there point to the difficulty in being a table-pounding bull.

Conclusion

While there has much reason to believe a cash raise may be a tactically shrewd move for the more total return-motivated investor, I'm not quite sure whether the same type of tactical investing is appropriate for the retiree dependent on generating durable, growing income.

That decision, indeed, may not be not wholesale for all retirees. Regarded Solutions opines that a cash raise is somewhat of a no-brainer and risk mitigator in an "easy to read" market. If that assumption proves wrong, then there could be tremendous opportunity cost and risk associated with the decision.

I will leave you with one last rhetorical question as you ponder how much cash you might raise. If you truly feel right now is an opportune time to do so, what exactly, fundamentally speaking or otherwise, might cause you to lean in the opposite direction?