Derailing Your Retirement Plan
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Baby Boomers. We're not such babies any longer, and 10,000 of us are moving closer to the finish line each day. Yes, hoards of us are turning 65, the traditional retirement age, each and every day.
While most of us were consumed with thoughts of work, commuting and everything else concerning our workaday world, our thoughts now are turning inexorably toward the day of reckoning. Should we retire? If so, when? Should we work part time, either because we need the extra income, or because we'd still like to feel productive?
These are important questions that each of us has to reckon with, at some point or another. The decisions we make can also be fraught with mistakes that could have negative impacts upon our "golden" years and derail our plans. By design, or not, some of our decisions could have the result of shooting ourselves in the foot.
Here are some decisions that could have ever-lasting negative impacts and consequences on our retirements, if we choose wrong.
Savings Procrastination
Millions of folks live in the here and now. They are pre-disposed, many of them, to give in to instant gratification. Life is for the living, and they want those shiny new toys, today, this minute, this second.
This type of mindset, living above their means, spending even more than their take-home pay, ultimately will lead to a retirement that is sorely lacking the funds necessary to make it a comfortable one.
This, it turns out, is the biggest regret expressed by folks over 50. Getting within hailing distance of that finish line, it seems, serves as the wake-up call. For some, however, it is too late.
For others, willing to double down on discipline, it can become a time to make a budget they never bothered with before. This can aid in determining where spendable income is going and help point to areas where cutbacks are possible and desirable.
Even the government can be a source of help in this regard. IRS rules allow for catch-up contributions to retirement accounts for those 50 and over. Today, a 50-year old can deposit an additional $1,000 into an IRA, above the usual $5,500, each year. This means that those folks taking advantage of the catch-up provisions can put away $6,500 each year in their IRA, opening a path towards an additional accumulated deposit of $15,000 by their 65th birthday, or $20,000 by their 70th birthday if they so choose. All of this extra investment will be working tax free for them in traditional IRA accounts, or Roth IRAs.
With the traditional IRA, besides being able to put away a total of $6,500 for 20 years, from their 50th birthday till they turn 70, they will enjoy a full tax deduction of that $6,500 each and every year. This reduces their taxable income, which enables them to save money in that way as well. Industrious savers could put away those savings (perhaps another $1,000 to $1,600 based on his tax rate) into a taxable account and earn additional dividend income on that $20,000 to $32,000 over that 20-year time span.
So, the late blooming saver could make some progress towards retirement saving, investing that $6,500 per year for 20 years. If we assume a conservative return, including capital appreciation and dividend income, of perhaps 8%, that cumulative $130,000 could grow to:
$6,500 deposited per year for 20 years at 8%
Source: Bankrate.com
After 20 years of diligent saving, those annual $6,500 investments could grow to a tidy sum of $362,470.
Results Summary
Here you can see how each of the annual contributions to the IRA grows with compounding to the final result.
If this same investor chooses to invest those $32,000 in tax savings, $1,600 per year, also assuming an 8% total return, he could wind up with additional savings of:
$1,600 deposited per year for 20 years at 8%
That very diligent procrastinator turned diligent savor at the age of 50 could accumulate an additional $89,223 after 20 years. When added to the original sum accumulated on the $6,500 annual contributions, this saver can wind up with a sum of:
$362,470 + $89,223 = $451,693
Procrastinators turned diligent super savors can turn things around, if they choose. Confirmed procrastinators who do not make this transition will regret their decision to not save, when retirement rolls around.
Putting Your Child's Interests Before Your Own
All of us who have children always want them to have a better life than we did. That's part of the American dream, after all. We want them to be cultured, so we send them to art school and dance school. We pay for music lessons on not just one instrument, but as many as they care to learn.
We want to send them to the best schools, private high schools, and high-tuition colleges so they get the best possible start and chance in life.
If we have the means to do all of this for our kids, fine. If, however, we raid our retirement savings, drawing down those funds and paying consequent penalties for doing so, we're not doing anyone a favor.
If we wind up with insufficient funds to fund our own retirements, we may be turning to our children for comfort and support in old age, becoming a burden to them, just when they're burdened by their own expenses of raising their own family and trying to build a life for themselves. This is the bane of the sandwich generation, caring for their folks and children at the same time.
Possible Solutions
Rather than bankrupting our own retirements, it may be advisable to guide our kids to pursue other methods. Children can look into local, regional and national scholarship programs to help fund their education. They could take on reasonable, responsible amounts of student loans that will have the desired risk/reward component. They might apply for grant-in-aid programs, working limited hours on campus jobs to receive grants they can use toward tuition or living expenses.
They might attend a local community college for the first two years at very low tuition rates, and then transfer to a desired four-year college to finish their degree.
Choosing To Avoid Investing In The Stock Market
Very conservative types make the mistake of viewing the stock market as too risky a place to invest their savings. Certainly, those who invested with the Wolf Of Wall Street would agree. Those who invest in savings accounts, short-term bonds or CDs take comfort in the lack of volatility of their investments and the comfort they get from knowing their initial balances will be there for them when they need them.
On the other hand, going back to 1926, the long-term return, counting dividends and price appreciation, has been on the order of 10% annually in the stock market.
What the conservative saver has done is traded his sense of comfort and security for a dismal return on those savings. Now that we are living in a NIRP (negative interest rate policy) world, these savers are earning less than nothing on their savings, when inflation and taxes are considered.
In effect, this conservative saver has traded the risk of temporarily losing some of his principal in the stock market to the very clear risk of his money in a bank account not keeping up with inflation and the ever-higher cost of living.
Conversely, savers who take the next step out on the risk curve and buy high-quality dividend stocks with many years' history of paying a growing income stream have the pleasure and comfort of seeing their investments grow and compound over long periods of time, enough to overcome the effects of both inflation and taxes (qualified dividends are taxed at a preferential lower rate of 15% for most investors and 0% for investors in lower brackets).
Don't Take A Loan On Your 401(k) Plan
Often, when larger expenses present themselves, people are tempted to look at their 401(k) plan, if they have one, as their piggy bank. After all, the thinking goes, "It's my money, and I can do whatever I want with it".
It's true, everything in that account, aside from your employer's match contribution, is in fact your money. So, it can be tempting to turn to this account to borrow against it, to pay for the kids' tuition, to buy a new car, or put a new roof on the house.
Doing so, however, will lead to all sorts of negative consequences that will be ultimately self-defeating.
Negative Consequences of Raiding the 401(k)
The first, obvious downside is that the investor will lose any earnings he may have earned on the amount he withdraws. Then, there's the loss of the compounding effect. Whatever he might have earned on his earnings will be gone. The investment growth that would have occurred on those contributions and employer matches will vanish.
Usually, when someone takes out a loan against the 401(k), he's consumed with making the payments to pay back the loan balance. The years he spends doing this are a bunch of years that are wasted in terms of 401(k) contributions. With today's maximum 401(k) contribution at $18,500, those lost years of contributions can add up to very large sums in short order. On top of that, when the employee is making loan payments and not making contributions, he's also missing out on tax-free matching funds from his employer, adding further salt to the wound.
In addition to these dire consequences, the borrower will be paying interest on those loans, further decreasing his 401(k) balance.
If you should leave your job, those loans are usually payable within 60 days. If not repaid within this 60-day period, those loans are then considered to be distributions and taxes will be owed on the amounts withdrawn.
Better Course of Action
Instead of allowing yourself to be subject to all of the above dire consequences, other avenues to obtain funds might be pursued.
A home equity loan secured by the equity in your home at a low interest rate could be considered to pay for that new roof. A student loan for your child, college student, or scholarships, grants, grants-in-aid, or part-time jobs might be pursued to ease the burden of college costs.
0% car loans might be available for that shiny new car you need. Or perhaps you might buy a used car to save money on the purchase or put off the purchase for a few years while paying for other large expenses. In effect, this would amount to triaging your expenses to make them more manageable.
In each instance, these ideas would be preferable to drawing down your retirement savings and investments, possibly ruining your retirement in the process.
Remember the Procrastinator Turned Saver/Investor?
Those folks willing to take saving and investing seriously can turn things around, even if they get a late start. The investor who takes this guidance and begins to put away that preferential catch-up amount of $6,500 each year and the $1,600 tax savings as well can have the chance of growing those contributions over 20 years' time to the $451,693 illustrated earlier.
The investor should not put his retirement plan on retirement when he stops working. As long as inflation is with us (the Fed continues to try to bring inflation up to its desired upper band of 2%), we will always need our retirement funds to continue growing for us to counter this ever-present threat to our spendable income and what it can buy.
The investor who achieves this $451,693, or any amount above or below it, might consider what we've achieved on our initial investment of $411,600 in the Fill-The-Gap Portfolio, publicly illustrated on Seeking Alpha since December 24, 2014. These are the types of equities that can take him the rest of the way through his retirement.
The Fill-The-Gap Portfolio At A Glance
I began writing a series of articles on December 24, 2014, to demonstrate the real-life construction and management of a portfolio dedicated to growing income to close a yawning gap that so many millions of seniors and near-retirees face today between their Social Security benefit and retirement expenses.
The beginning article was entitled "This Is Not Your Father's Retirement Plan." This project began with $411,600 in capital that was deployed in such a way that each of the portfolio constituents yielded approximately equal amounts of yearly income.
The FTG Portfolio Constituents
Constructed beginning on 12/24/14, this portfolio now consists of 19 companies, including AT&T, Inc. (NYSE:T), Altria Group, Inc. (NYSE:MO), Consolidated Edison, Inc. (NYSE:ED), Verizon Communications (NYSE:VZ), CenturyLink, Inc.(NYSE:CTL), Main Street Capital (NYSE:MAIN), Ares Capital (NASDAQ:ARCC), Reynolds American, Inc. (NYSE:RAI), Vector Group Ltd. (NYSE:VGR), EPR Properties (NYSE:EPR), Realty Income Corporation (NYSE:O), Sun Communities Inc. (NYSE:SUI), Omega Healthcare Investors (NYSE:OHI), StoneMor Partners L.P. (NYSE:STON), W.P. Carey, Inc. (NYSE:WPC), Government Properties Income Trust (NYSE:GOV), The GEO Group (NYSE:GEO), The RMR Group (NASDAQ:RMR) and Southern Company (NYSE:SO).
Because we bought all of these equities at cheaper prices since the inception of the portfolio, the yield on cost that we have achieved is 6.63%.
Here is how the FTG Portfolio closed trading on Wednesday, September 07, 2016
FTG Portfolio close, 9/7/16
While the S&P 500 closed down .02% on Wednesday and the Dow Jones Industrial Average closed down .06%, the FTG portfolio closed up .5%. Year to date, the S&P is up 6.96%, the Dow is up 6.32%, and the FTG portfolio is up 15.10%, showing a capital gain of $68,512. This translates to outperformance of 139% by the FTG portfolio this year compared to the Dow. For almost two years now, the FTG portfolio has been enjoying similar outperformance of the broad market indexes.
Over the past 10 months, since inception of our premium newsletter service on the Seeking Alpha Marketplace, the subscriber portfolio has been enjoying the very same type of outperformance.
Real-Time Portfolio Tracker
The Real Time Portfolio Tracker enables us to examine current portfolio positions in relationship to income production from each component.
Aside from grabbing real time, updated prices on all of our positions throughout the trading day, we have dividend rates, current dividend yields, yield on cost, buy price, share counts annual dividend amounts and percentage of income contribution from each of our positions. Here is where we are able to see if a certain position is under-represented in its income contribution to total portfolio income.
Viewing Success in Stages
I believe in the concept of building a portfolio one dividend at a time. I also believe it is important to see our rewards in a simple, straightforward manner, one which reinforces our proclivity to invest, and then reinvest our dividend in order to compound our income.
In an effort to stay connected to our portfolio dividend income and the successful stages of growth of that income, I'll enter our positions in both the public Fill-The-Gap Portfolio and subscriber portfolio into the Dividend Growth and Income Spreadsheet. It keeps me focused on my bottom line of producing income. When dividends are raised, I'll enter that into the assigned column. My algorithms then compute for me my new income on each portfolio constituent, the new income when a raise occurs, the yields, the increased percent of income and total portfolio income. This focus helps keep me on track toward my goal of building and growing income.
Dividend Growth And Income Spreadsheet
Matching Dividend Income To Expenses
We find it helpful to track our monthly dividend income, and can even build a portfolio that will produce the amount of income we need on a monthly basis to pay the bills. I do this using the Real Time Dividend Minder.
Real Time Dividend Minder
By simply entering the ticker and number of shares we own in the appropriate month/sector, the real-time function grabs the dividend rate for us and automatically calculates our quarterly and annual income, the percent of portfolio income that stock represents and the dividend pay date.
Dividend Investors Focus On Income
Generally speaking, most dividend investors do not concern themselves with the topsy-turvy minute-by-minute pricing of their stocks during the trading day. If the fundamentals of a company are such that it can continue to pay the dividend, and grow that dividend, then a dividend investor is satisfied with his investment and stands pat. Momentary, temporary paper losses are not a catalyst for him to sell like so many other investors. On the contrary, if the downdraft is not related to fundamentals, it presents the dividend investor with an extra opportunity to bulk up a position and buy more shares at cheaper prices to obtain a higher yield and more income. This is the principle we discussed in an earlier article. Higher interest rates begets lower REIT prices begets higher income for us and a pay raise.
And so, we are always on the hunt, considering additional share purchases in names we own when price compression gives way to a higher-yield component.
Both our FTG portfolio and the subscriber portfolio are based on protecting and preserving our income stream by buying shares in such a way that each of our portfolio constituents produces essentially equal amounts of income.
Equal Weighting To Income Production
Equal weighting for essentially equal income production can help preserve our income stream that we've worked so hard to produce. We make this principle paramount to our portfolio construction. Since we are income focused, we are most interested in preserving and protecting that income stream.
Being that our subscriber portfolio currently has 21 active positions, equal weighting has us striving to gain approximately 5% of dividend income from each of our portfolio constituents.
If at some future point, one of our constituents reduces their dividend by 10%, that would occasion a temporary loss of income to the portfolio of just .5%.
.10X.05=.5%
If another constituent did the same thing, we'd suffer a temporary loss of:
.10X.05X2= 1%
Most folks could live with small, temporary reductions to dividend income like this. I say temporary because several factors could come into play to mitigate this situation:
1. Our remaining 19 to 20 companies could give us dividend raises during the year that could easily overcome a small .5% or 1% temporary dividend cut.
2. We might decide, if company fundamentals have changed, to sell the offending dividend cutter and buy another company to replace that position with a yield equal to or greater than the offender.
3. The company might reinstate the original dividend amount in one or two quarters and make us whole again.
Conclusion
Any investor willing to step a bit away from the comfort of a bank account or CD, even late in the game at age 50, can make the moves necessary to make a comfortable, secure retirement a reality. Inflation will always require us to be vigilant with our investments and invest with an eye toward combating and overcoming the deleterious effects it has on our purchasing power. High-quality dividend stocks with long histories of paying growing dividends can deliver this future to all of us.
Author's note: Should you be interested in reading any of my other articles detailing various strategies to enhance your returns on a dividend growth portfolio, you will find them here.
As always, I look forward to your comments, discussion and questions.
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Retirement: One Dividend At A Time
Disclaimer: This article is intended to provide information to interested parties. As I have no knowledge of individual investor circumstances, goals, and/or portfolio concentration or diversification, readers are expected to complete their own due diligence before purchasing any stocks mentioned or recommended.