First, I want to thank SA readers for their constructive comments on the initial article. When I came up with the idea for this series, my intention was to make it as interactive as possible. I am certainly not an expert in the financial planning arena, but I do have a potential strategy for the middle income retiree. I am also aware that there are several SA writers whom are quite astute in the discipline of retirement resources, and I am hoping that with their input we might come up with a workable solution.
In Part II I want to touch on some basic financial principles for the retiree (or near retiree), and provide initial insights as to how I am developing my allocation model.
I base many of my financial decisions on the wisdom gained from persons such as the late Larry Burkett, Ron Blue and Dave Ramsey. All three have written volumes on money management, but one book co-authored by all three kind of stands out - "Your Money After The Big 5-0: Wealth For The Second Half Of Life".
Specifically, I offer the following financial guidelines that will enable one to maximize their opportunities for pleasurable, meaningful elder years:
1. Spend less than you earn.
2. Stay on a budget.
3. Be debt-free (or as close as you can get).
4. Don't stop working - remain productive by working part time at something you enjoy.
5. Sell what you no longer need - you can't take it with you!
6. Stay on top of your investments - do research; manage your own wealth. Nobody knows you (or your needs) better than yourself.
7. Learn how to allocate (and re-allocate) your funds.
I'm sure everyone has heard these before - but have we all listened and applied them?
Let's look at a typical middle income husband and wife, empty nesters in their 60's, both receiving social security with an investment nest egg in the $500K range. Let's assume the husband receives $1500 a month in social security and the wife $750.
I believe (your opinions might differ) that a couple like this one, that has followed most of the aforementioned financial principles can live quite comfortably on an after-tax income of $55K (would have to adjust annually for inflation). I am also assuming that this couple has enough deductions that they will fall into the 15% tax bracket, so gross income would have to be around $65K. I am not a tax person, so this is an approximate figure. If your lifestyle is (has been) a more extravagant one you will have to increase the after-tax number.
So, after reducing the $65K pre-tax income by combined annual social security proceeds of $27K, this couple must generate approximately $38K in investment income. This equates to a required annual yield of 7.6 percent on a $500K investment portfolio, or 9.5 percent on an investment portfolio of $400K.
Let's look at the investment vehicle types from my initial article and determine the type of allocations necessary to attain these levels without having to "chase" unrealistic yields.
Master Limited Partnerships - I personally discovered MLPs about eight years ago when yields were higher; however, solid opportunities still exist in this space. Very few reduce their distributions, the number of which can probably be counted on one hand. In fact, during the second half of 2008 when the MLP sector tanked, virtually all maintained their distribution levels. Most issue K-1s while some are LLCs - I will not discuss the tax aspects as there are many articles on SA devoted to this topic.
I divide MLPs into three categories: upstream (exploration and production); midstream (pipelines/infrastructure); and downstream (gathering/storage/other). Of these, the upstream MLPs are most sensitive to fluctuations in the underlying commodity prices, followed by downstream. The midstream MLPs are most immune to commodity price fluctuations since they move oil, natural gas and liquids for a price that is relatively fixed. Even so, these stocks will also at times be subject to volatile price movements.
At present, I am allocating 40 percent of my investment portfolio to the MLP space (7.5 percent to upstream, 25 percent to midstream, and 7.5 percent to downstream).
Real Estate Investment Trusts - There are two principal types of REIT - equity REITs (which own buildings, shopping centers, warehouses etc.) and mortgage REITs (which finance various types of mortgages). In the past I have owned individual equity and mortgage REITs, but bailed in the 2008 debacle. I have recently eased back into equity REITs via closed-end funds and have purchased a few individual mortgage REITs (which I consider the most speculative portion of my portfolio).
I am presently allocating 10 percent of my portfolio to equity REITs (four percent to those in the United States and six percent to international ones). I have set aside a maximum of five percent of my portfolio for mortgage REITs.
Royalty Trusts - By way of a quick summary, a royalty trust is a type of corporation owning energy producing entities or mineral rights. An outside company operates the entity and the trust distributes 90 percent of the profits to shareholders. The majority of royalty trusts have a finite life, and distributions in the initial years are the highest, declining as the trust approaches its expiration date. Most energy trusts are U.S. or Canadian corporations. As with MLPs there are many informative articles on SA about royalty trusts, and detailed research is a necessary part of placing one, or more into an investment portfolio.
I believe that I have a decent handle on how they operate, so I presently have a 15 percent allocation for them in my portfolio (12 percent for U.S. trusts and three percent for Canadian trusts).
Business Development Companies - A BDC is a company created to help small companies in the initial stages of their development. Most BDCs distribute 98 percent of their taxable income as dividends in order to avoid all corporate taxes.
BDCs have yields ranging from the mid-single digits to the low double digits. Their dividends are directly tied to earnings.
At present I have an allocation of 10 percent for BDCs.
Currencies/Commodities - I think that currency investments definitely have a place in our portfolios in order to profit on any decline of the U.S. dollar, or foreign currencies. Commodity investments also have a place, as anyone who has followed the price of gold over the past decade well knows. I consider gold and silver to be inflation hedges - nothing more, and my current five percent allocation to this investment category is in CEFs.
Foreign Stocks - In addition to the above I think that everyone should allocate a portion of their portfolio to foreign stocks, particularly those that pay dividends in their own currencies. In that manner if our dollar declines we will wind up with additional dollars or shares.
The allocation can be accomplished in a number of ways; by buying the stock on a foreign exchange, by purchasing the ADRs, or by buying CEFs which would afford greater diversification.
I presently reserve 15 percent of my portfolio for foreign investments (10 percent for equity/income stocks and five percent for emerging markets).
Those are the current allocation levels. As I mentioned earlier in this article, I wish this series to be interactive - I know many of you have excellent ideas for retirement investing for us middle income folks and I hope you will share them in your comments.
Future articles will focus on each of the aforementioned investment categories, and I will discuss individual stocks for possible portfolio inclusion, dividend/distribution amounts, and expected portfolio yields by segment in order to attain our goals.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.