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I love historical dramas. Ever since "Roots" became an international phenomenon in my early teens, I have made a special effort to catch any movie or television show which dramatizes real events in history.

Right now, I am watching "Into the West." It depicts America's westward expansion from both the pioneer and Native American perspectives. Installment Three, called "Dreams and Schemes," chronicles the Gold Rush of the late 1840s and its effect on one family.

Jethro Wheeler, one of two brother pioneers, gets caught up in the "get-rich-quick" mentality of the era while ignoring the cautions of his Native American wife that he is better off working his land. He sets off to prospect, encountering danger, loneliness and alcohol, leaving the older children to provide for the family.

When Jacob finally strikes a giant nugget of gold, aided by his cousin, both men rejoice and dream of the rich life they will soon have. Unfortunately, greed wins out in the end. After a squabble over division of their new wealth, the cousin steals the gold nugget. Jacob discovers he's been had and sets off, gun in hand, to recover the gold nugget.

It does not end well. Both men die trying to do one another in, and the prized gold nugget sinks forever to oblivion at the bottom of a river.

Greed is No Different Today…

I told my husband, who is watching this with me: I bet this character's story of lost dreams and wealth is the primary story of the Gold Rush. Very few hit that gold "10 bagger." As the proverb says, "He who works his land will have abundant food, but the one who chases fantasies will have his fill of poverty."

Investing is not much different. There are tried-and-true ways to build one's wealth… then there's the pursuit of the next "10 bagger." When you are young and have many years to recover any losses, pursuing the next "big thing" with money you can safely lose is not as painful, and is something we all have probably done.

When you hit retirement, life has to change… none of your investments are something you can safely lose!

This was the point of Part One of this article series. Instead of becoming a day trader in retirement to gain the elusive "10 bagger," this was the advice:

Trading dividend stocks with market timing is not a "better" way to invest for senior retirees. The point of a dividend portfolio is to hold dividend stocks for retirement income. Do not trade based on market or stock direction, but on fundamental issues and the ability to increase income.

Within the last statement, you have a hint that I don't advocate that in all circumstances one most hold any investment forever. Today's Part Two addresses a variety of circumstances, reasons and desired outcomes which may indicate that it's time to sell your income holding.

Preamble

This discussion begins with two assumptions about this article's target audience:

1) You have spent your investing life primarily accumulating income investments; and,

2) You are in the "distribution" phase - as opposed to accumulation phase - of your investing life.

"Distribution" just means you are now using your interest or dividend payments to fund - in large or small part - your current living expenses. Distribution doesn't mean you aren't still working or accumulating, it just means you are now withdrawing from your retirement accounts. (I am not making a strong distinction here between phases of investing. Commentors in Part One rightly pointed out it is not always "all-or-nothing" when it comes accumulation vs. distribution).

How and Why to Sell an Income Investment

There are a number of reasons and purposes that indicate selling is prudent or necessary, and we'll explore these one-by-one:

  • To increase income
  • As a part of portfolio rebalancing
  • Changing company fundamentals / dividend or interest payment cut
  • Better inflation management
  • Asset class redistribution

I will also add that the point of the sell is to redeploy into another income-generating holding. Ideally, you will already have researched and have a new holding in mind. If you are depleting the cash from your sell by withdrawing for your living expenses, you will lose the advantage and reason for the sell.

To Increase Income

Regarding this first bullet point, I have to say: Robert Allan Schwartz beat me to the punch with his excellent piece, "How to Raise Portfolio Income By Selling Overvalued Companies." His article addresses the advantage of selling overvalued investments in order to purchase undervalued investments. If we sell an overvalued investment with a significant capital gain and redeploy into an undervalued investment, we can increase our overall income.

I have very little to add here, as both Robert's article and the comments were excellent. I would only add: a retiree should do this at his own comfort level. If you have been trading like this your whole investing life, this will seem second nature. If you have utilized DRIPs or dollar-cost-averaged all your investing life, this will be a scarier prospect. My advice to these investors: instead of selling outright, try portfolio rebalancing first.

Portfolio Rebalancing

Portfolio rebalancing takes the principles of Robert Schwartz' article and puts them in the slow lane. Instead of selling whole hog, you sell only a small portion of your holding for redeployment. This "rebalances" the portfolio that may have become too heavily weighted in one or more particular holdings. This is a discipline that many investors, over a wide spectrum of investing styles, employ.

Why would an income investor in distribution phase rebalance? Only one simple answer: to increase income. Rebalancing can be as easy or complicated as you like. Some folks prefer regular rebalancing on a monthly, quarterly or yearly basis. Regularly-scheduled rebalancing may work better for those who, at this stage of life, don't want to be tied to watching the market so closely.

Other investors enjoy staying on top of the market and regularly checking in on their investments. For these investors, it may work better to "skim a little cream" off the top as market inefficiencies and over-valuations present themselves.

If you are happy with your income and find rebalancing a bother, there's no investing law that says you must rebalance. If, on the other hand, you want to become more involved with your portfolio and are looking for opportunities to increase your income, rebalancing may be a better option for the more conservative than outright buying and selling new portfolio positions.

Changing Fundamentals / Dividend or Interest Cut or Suspension

A primary criticism of income investing is that dividends can get cut, and interest payments can be suspended. Critics love to point out the two poster children of stock dividend cutters: Bank of America (NYSE:BAC) and General Electric (NYSE:GE). For fixed income investors, the suspension of distributions on Fannie Mae investments was a harsh reminder that you can lose income even on bonds and preferred shares.

Are our detractors in their right to criticize? Well, we can't deny the facts regarding Fannie Mae, GE and BAC. But just because income payments can get cut doesn't mean they will get cut, nor do a few examples negate an entire strategy.

The key to reducing risk of income reduction is to remain active in monitoring your investments. Analysts, financial statements, market pricing and the company itself will telegraph if a potential dividend cut is looming. All an investor needs to do is simply stay in tune with the investing world to be fortified with such knowledge.

Here is where the passive income investor is at a distinct disadvantage. If you aren't at all active with your investments, you are more susceptible to a "surprise" dividend cut.

That's the bad news. As much as we all as self-directed investors - especially the retired - want a "set it and forget it" portfolio, no such thing exists.

The good news is: you are never locked into any holding forever. With enough research you can always find another choice to replace a laggard that has better fundamentals and a safer dividend. You need not fear selling if you are simply being prudent in attempting to avert a potential dividend cut or suspension.

Better Inflation Management

For a retiree wishing to maintain his current level of income, making sure his or her retirement portfolio keeps up or beats inflation is paramount.

I addressed this issue in this article, and maintain that dividend growth stocks are an easier path to inflation management than is fixed income. Before we go further, let me state outright that this particular section does not address dividend growth over fixed income. In fact, fixed income is not addressed here at all. Instead, I am dealing here with trading out of one dividend growth stock for another.

Fact is, even the best dividend stock payers can sometimes significantly reduce their rate of dividend growth. When this happens, a retiree has a choice: hang on and not worry, or sell and try to capture a more inflation-busting growth rate.

David Fish's CCC list has a metric that should be considered absolutely essential for monitoring a retirement portfolio, and that is the "5/10 year A/D." This metric measures the acceleration vs. deceleration of the dividend growth as measured from the 10th year to the 5th year. You can't predict the future, buy you can look at how a dividend has already performed:

A stock with a accelerating dividend growth rate will have a
ranking of
>1.0

A stock with a decelerating dividend growth rate will have a
ranking of
<1.0

It is also important to understand inflation trends. You can find this data at InflationData. A wise retiree will plan for the worst case scenario, inflation-wise, for at least the coming year.

Here is a hypothetical example of how this could work. I am assuming trading in an IRA so taxes are not factored in:

  • You have owned SJW Corporation (NYSE:SJW) for over 10 years. When you bought it, the dividend growth rate was 5%, but now the growth rate is 1.5%, and the 5/10 year A/D is now under 1.0.
  • You sort the spreadsheet according to yield and 5/10 year A/D, rendering these choices with a positive A/D (over 1.0) and matching 3% yield: (NYSE:WAG), (NYSE:ABT), (NYSE:GPC), (NYSE:EMR), (NYSE:CVX), (NYSE:AWR). (NYSE:PG). (NYSE:STR), (NYSE:CLX), (NYSE:UGI) and (NYSE:NWN).
  • Conservatively, you trade "like for like." SJW is a water utility, so you settle on another water utility, American States Water Company - AWR - which has an accelerating dividend growth, currently at 5.8%, beating inflation projections for 2013 of, worst case, 3.5%.
  • You sell SJW and use the funds to buy AWR.

The end result? An increase in income of just under $60 per year. This figure does not net out any trading fees, yet it also does not include the "change back" on the sell:

** SJW has not appreciated in 10 years (it was approx. $25.00 10 years ago, and it is approx. $25.00 today). You sell your $10,000 stake and get $10,000 back on 400 shares. The current yield is 2.77% (it was over 3% on the CCC list last publication).

** You buy 228 share of AWR at today's price and have some change left over. The yield for is 3.25%.

** If you had held on to SJW: 400 shares x $0.70 current yearly dividends x 1.5% = Projected 2013 income of $284.20.

** 228 shares of AWR x $1.42 current yearly dividends x 5.8% = Projected 2013 income of $342.59.

Without using any trading acumen whatsoever or any additional funds capital appreciation provides, you can increase your yearly income - even if modestly - by trading out inflation laggards for inflation busters.

Want even more bang-for-buck? Up your standards and apply some trading acumen, if you are comfortable and skilled in trading. Look for even higher yielding issues and better dividend growth acceleration on your "buy" prospect. For better traders, you can look for opportunities to "buy low, sell high." Use the advantage of capital appreciation on your "sell" holding to increase the number of shares of your new holding.

Asset Class Redistribution

We could really get in the weeds on this one, but I will keep it simple.

Some die-hard dividend growth investors swear only by DGI. Others like me mix it up, following loosely some principles of asset allocation by holding "whatever works" amongst fixed income, floating rate income, dividend growth, as well as hard assets such as gold, silver and real estate. Others are die-hard bond fans, and swear that a mix of bonds is the most stable path for the retiree.

Wherever you are in the mix, you can make your own assessment about what asset classes are right for you based on your income goals.

Even if you love bonds, you have to admit - yields on treasuries stink right now. If you love CDs, you have to admit that 1.00% yields hardly make owning a CD worthwhile. So let's all agree that, maybe, right now treasuries and fixed coupon CDs are not optimal investments for the retiree, when considering income to live on.

Let's also hope that if you once held 100% treasuries or CDs, you have long been out of those, and replaced them with higher yielding corporate bonds or preferred shares. You might have even replaced some of your bonds with undervalued dividend growth stocks with a superior yield.

Bottom line, with all investments, there are optimal times to hold them, and like it or not, we may all need to trade out what we love to accomplish the goal of the income we need.

Knowing how and when to trade between asset classes will require you, as the retiree, to remain active and knowledgeable on the market and your own investments. There is no "right" or "wrong" way to do this - there is only the way that is "right" for you.

Conclusion

Being a self-directed investor is both exhilarating and frightening. It is empowering to take over the reins of your investments and find you can do so successfully. It can also be frightening, because your success and failure depends directly on how well you handle the responsibility.

Part and parcel of handling the responsibility is learning when to sell. I will echo again Robert Schwartz' advice in his article: you don't have to sell. However, if you wish to avoid dividend cuts, keep up with inflation and increase your income, learning when to sell may become a necessity. Hopefully this is a skill developed over a lifetime of investing.

Greed and fear are powerful emotions which should be avoided in your sell decisions. This is especially true for retirees, as your income is your very livelihood. Watch out for advisers who proclaim "such and such" stock is the next big "Gold Rush." That "10 bagger" stock may be the proverbial equivalent of the giant nugget of gold from "Into the West" that sinks to the bottom of the river bed, never to be recovered! Instead, look for modest and attainable ways to increase your income. This is the "working the land" that keeps your income intact.

Source: The Real Better Advice For Seniors: Part II