Why Average Investors Get Average Results In Retirement

by: George Schneider


No one wants to be considered average.

Everyone wants to excel at something.

In Lake Wobegon, “all the women are strong, all the men are good looking, and all the children are above average.” - Garrison Keillor.

What can investors do to actually achieve above average performance?

Why Do Average Investors Get Average Results?

All investors think they are better in their investing than the average investor. Sadly, by virtue of the definition, we cannot all be above the average. Half the people must be below average.

Whether we are talking about driving skill, scores on intelligence tests, or playing a specific sport, we all think we're better than average. The tendency to think we're better than we are is called the Lake Wobegon effect, after the fictional town Garrison Keillor speaks about, where "all the men are strong, all the women are good looking, and all the children are above average."

Behavioral scientists refer to this as the self-enhancement bias and it appears to exist in every aspect of our lives.

Stan Clark, in Perspectives, writes:

"Overconfidence can get you into trouble with your finances. It can cause you to take risks you shouldn't, and to ignore information that disagrees with pre-existing biases. It's tough to combat, because most overconfident people are also convinced they are not overconfident!"

Overconfidence In Some Approaches Can Get You Into Trouble

For years, bond ladders were suggested by the financial industry for retirees. The idea was to build a money generator that would allow the retiree to unhitch himself from the daily prices of the stock market and bond pricing itself by simply providing a smooth income stream from bond interest coupon payments to pay the bills.

The other component was aimed at dealing with the ever-present threat of inflation. The thinking goes like this:

When inflation rises, interest rates normally follow. Each time a bond matures, the investor can buy a new bond and receive a higher interest rate and higher income to combat inflation.

Well how did that work out for bond ladder investors the last 7 years? While the Fed has been engaged in massive monetary easing, pumping huge amounts of money into the monetary system via purchases of Treasury bonds and notes, those inflation-beating higher interest coupons have taken a rather long vacation.

Since inflation has been so well behaved (at least, according to government figures), bond traders and investors have lacked a reason to demand higher returns on the funds they lend to Uncle Sam or corporations. This lack of demand for inflation parity has kept rates in the basement for seven long years.

How did this affect the bond ladder strategy, so revered by the financial community? The outcome has not been pretty, to say the least.

The investor class, long accustomed to this inflation construct, thought they had created the next best thing since white bread was invented. The answer to their prayers would be an ever-increasing income stream in retirement. Whenever inflation ticked higher, the next bond roll-over would yield higher interest and higher income to defeat inflation.

Well, that was how it was supposed to work. The end result has been quite different, with somewhat opposite results.

10-year rates for last 7 years

Anyone buying 10-year treasury notes at the bottom of the last market crash, on 3/9/09, fleeing the market and seeking the safest, government guaranteed paper on the planet, obtained about a 2.75% yield on that investment. At the beginning of the next year, he was able to get a substantially higher yield on the next rung of his bond ladder, at 3.75%.

Making his next ladder investment at the beginning of 2011 the investor was accepting less, just 3.25%. With his next investment at the beginning of 2012 he was settling for much less, around 2%. Now, with his next tranche at the beginning of 2013, he was only getting 1.75%. The next year, rates ticked up, giving him about 2.9% and by the beginning of 2015 he was now accepting about 1.68%. Finally, at the beginning of this year, 2016 he was getting a bit more on his investment at 2.20%. Today, we find ourselves sliding right back down the curve, at 1.75%. It's pretty clear from the slope of the red line that the bond laddering strategy has failed to achieve the goals set for it by the financial community and all of the investors who counted on this concept as their Holy Grail.

Anyone who started buying into this ladder strategy when rates were even higher are in more of a fix today. While they counted on higher coupon rates to help them deal with inflation and preserve their purchasing power, today, as their earlier bonds and notes mature, they are faced with the prospect of accepting 1.75% interest for the following 10 years if they buy today's Treasury notes.

When a presumed 2% inflation rate is subtracted from a nominal 1.75% rate on the 10-year Treasury bond, the investor is left with:

1.75% - 2% = -.25%

That's minus ¼ of one percent. Simply put, at the end of one year, the investor has just $99.75 of purchasing power of his original $100.00 invested. Pretty much a mug's game, don't you think?

The labors of the Federal Reserve to pump up the economy after the financial crisis have worked at cross-purposes to the aim of a bond ladder. Each time the Fed released yet another surge of quantitative easing into the economy, rates ratcheted downwards.

Instead of stepping up each year to higher rates and higher income, bond ladder adherents have been stepping down on that ladder, one rung at a time, to lower and lower interest rates along with increasingly lower income.

That's no way to thrive in retirement, let alone survive. Instead of keeping up with inflation, our bond ladder retiree has been falling further and further behind the inflation curve. Each time Sisyphus almost reached the top of the hill, trying to push a huge boulder to the top, it came crashing down upon him. The punishment visited upon him was the epitome of futile and hopeless labor.

Bond ladders have been acting in a somewhat similar fashion. Each time the investor has tried to stay ahead of inflation buying bonds laddered out to future years of maturity, rates have kept tumbling down and crushing him. It too has felt like futile and hopeless labor.

Each time he believed the next purchase would give a higher return. Next year will be better. The next purchase I make when the next crop of bonds matures next year will give me a higher rate. But that higher rate never comes. For seven long years those rates just kept coming down and the investor's income followed the same path downward.

Be Willing And Ready To Change Course As The Times Demand

One days' wisdom sometimes evolves into yesterday's folly. In an economy where inflation expectations are always for higher prices and higher interest rates, this type of strategy seemed like the Holy Grail for millions of investors and the financial industry sold this concept hard. After all, inflation was a known entity, acknowledged by all.

The Late '70s, Early '80s Told A Different Story

During the period encompassing the late 1970s to the early 1980s, the country went through a convulsion of hyperinflation not seen in modern times in the U.S. Forty years earlier, in the Weimar Republic, the German economy went completely haywire and taught the world a thing or two about hyperinflation. A loaf of bread required a wheelbarrow or carriage in order to load up all your cash and wheel it to the baker to purchase bread for the evening meal.

When we lived through a similar, though not as catastrophic, period of hyperinflation, folks didn't know what a load of bread would cost from one day to the next. Prices of gas at the pump shot up several cents a day (starting from a base of around 25 cents a gallon) as OPEC put an embargo on exports of oil to our country. While prices were unrecognizable on a daily basis, investors began to demand higher interest coupons on corporate and Treasury bonds to compensate them for the risk that future interest payments would buy less goods in an inflated economy.

At the beginning of this inflationary period, I was no longer interested in the free toasters and electric blankets banks disbursed to customers for opening new accounts. I was more interested in the 16% to 18% yields being paid on U.S. Treasury bills (maturing in one year or less).

As things heated up and outrageous interest coupons were being paid on longer maturities, I loaded up on 30-year Treasuries paying 12% to 15% for the duration. For 30 long and prosperous years, I visited the bank every six months to cash and deposit those hefty interest coupons. Over the intervening years, inflation soon came back down to earth and those interest coupons were gaining purchasing power by the day. For many years, this represented a strong and very substantial additional, guaranteed income stream for our household.

Take What The Market Gives You

There are always doubters on the other side of the trade. That's what makes for a vigorous market. Our accountant at tax time would say, "Okay, you've got a good interest rate for the next 30 years. What are you going to do when the 30 years is up?"

This sentiment always gave me a good laugh. It was as if he was saying, OK, but now what? It fell into the category of "what have you done for me lately?"

He was already worried about how I would adapt to changing conditions 30 years hence, while I was ecstatic to have 15% interest payments from the most trusted payer on earth, available, at my beck and call, to invest in equities and build our stock portfolio from those proceeds paid to me every six months.

Be Adaptable To Current Conditions

In the psychological community, it is a given that a patient must first be able to acknowledge a problem before he can be helped and guided toward solving that problem. A psychologist (I'm a retired clinical psychologist) cannot simply diagnose the problem, inform the patient of his diagnosis and cure the patient ipso facto. If the patient denies he has a problem, then there's nothing to talk about. No matter how many hours a therapist might spend trying to have a patient see the light, no daylight can ever shine until the patient is ready to accept and acknowledge he in fact has a problem that needs resolution.

While inflation had remained a given for so many decades, investors thought they had found solutions to deal with it and were satisfied with the results of bond ladders. To a point, this approach worked. But when the music stopped, and inflation stopped doing its "magic" for bond laddering, the house of cards came tumbling down, ever so slowly.

The slow speed of this crash has made the wreckage so much more damaging. When someone slaps you in the face, it is quick, definitive and you react just as quickly to the bodily insult. You either fight, or you flee. Either way, you do it quickly.

In contrast, when a train wreck piles up slowly as we've experienced with molasses-like cascading interest rates, like a slow-motion water fall, no one takes much notice. Nobody sees the problem. Nobody thinks we have a problem so nobody deals with it - until it's too late.

A Picture In Contrast

10-year rate/Omega price

When we overlay a price chart of a commonly held REIT in many retirees' portfolios today, we see a fairly inverse relationship. While bond laddering average retirees accepted the common wisdom of Wall Street, they were suffering consistently lower rates of interest and lower income on their new bonds bought most years. Investors willing to adapt to the new regime and take on a small amount of risk were benefiting handsomely as they watched the value of their shares rise and triple over the course of the last seven years (orange line).

10-year rate/Omega yield

The above graph allows us to compare the 10-year Treasury rate with a representative REIT yield over the comparable seven-year period. Again, the orange line tells the story. Instead of accepting 2.7% on Treasuries at the market bottom in March 2009, an investor having some confidence that the economy and markets would eventually recover, and willing to take on some small amount of risk, could have availed himself of an accidentally high yield of some 9.7% at that time.

The following year, while the bond ladderer was accepting just 3.75% for his next bond investment, the REIT buyer was able to get a yield near 6%. By 2011, when the bond ladderer was receiving a smaller 3.25% for this next investment, the REIT buyer was able to buy more stock if he chose and receive a yield of 6.15%. Throughout this whole seven-year period, it is clear that with all the ups and downs of the rate cycle, an investment in REITs rewarded the investor who was willing to adapt to changing times. He was able to obtain a yield on his investment that was anywhere from double to five times that available on Treasuries at each point in the cycle.

Main Drivers Of Average Returns

1. Over-reliance on Wall Street "wisdom."

2. Gullibility leading to an acceptance of whatever the talking heads on T.V. are saying

3. Lack of confidence in one's own ability to do research and analyze a situation.

4. Overconfidence in one's position and unwillingness to examine a situation from another perspective.

5. Sticking to a long-held belief or strategy, even when the situation has changed and demands re-examination.

6. Unwillingness to adapt to changing economic circumstances.

7. Staying with the status quo, even when the market is handing you an opportunity.

8. Failing to recognize you must pay yourself first, transferring a set amount from a paycheck to savings or to an investment account to build a nice retirement nest egg.

9. Wasting too much time and energy trying to time the market. Building wealth is accomplished from buying and holding and monitoring investments, investing on a regular basis. Sitting on the sidelines too long yields nothing.

10. Dramatically underperforming the market averages by buying high, when excited by the market's move higher, then selling low in fear, when the market sells off due to behavioral biases.

11. Living above your means, thereby depriving yourself of the firepower necessary to invest and grow your retirement account.

12. Failure to begin saving early, with a first job, in your early 20s, Failure to take advantage of a 401k savings plan at work, an employer match of free funds, or establishing an IRA account and making early deposits at the beginning of each and every year to take advantage of compounding from the first day of the year, onward.

13. Buying index funds at market highs, paying exorbitant amounts of management fees that eat into returns, then selling in fear at low market points.

Do you recognize yourself in any of these highlights, characteristic of investors who receive average or smaller returns? Please let us know in the comment section below. If you think of any others, please let us know that too.

Wait For A Pullback Or Commit, Now?

Readers constantly ask me if they should wait for a pullback to buy stock in this market that is close to a top. Nobody could argue that it might be good to time the market correctly. However, it might be better to avoid the risk of missing the market entirely, since no one can consistently time the market correctly. I wrote a piece on this recently, entitled, "You Don't Always Need To Be Right To Retire: Here's Why".

OHI To 10-Year Bond Comparisons

Several days ago, we sent an email alert to subscribers notifying them we had purchased more shares of OHI for the subscriber portfolio. The company increased the dividend on April 26, 2016 to $.58 per quarter. This was a penny increase from last quarter, and a 4 cent increase from the corresponding quarter last year.

A company that is continuing to increase their dividend payouts at the rate of 4/54 = 7.4% annually does not paint a picture of a company in trouble. To the contrary, this is a company that is signaling confidence in future growth.

OHI's 4-year dividend yield average is only 6.2%. So, at the current 7.03%, it is now selling at a price point that rewards a new investor with a 15% greater yield and income compared to its average yield.

Robert Allan Schwartz's website informs us that this strong healthcare REIT has a CAGR (compound annual growth rate) of 9.7% going back to 1992. In recent years, they have been increasing the dividend at a rate of 8% to 10%.

For the benefit of our many new subscribers and followers, let me remind you that my investing philosophy takes these knocks on a stock's price as welcome gifts to buy at cheaper, more value-oriented prices to grow our portfolio income and yield. Rather than wait on the sidelines waiting for the perfect moment and possibly missing out entirely we make our move. As of Monday's close, we're 24 cents in the hole on this position. I'm being paid to wait at the rate of a 7.03% yield, so I'm in no hurry. As long as company fundamentals are intact, as I believe they are, these situations of temporary investor panic give us the opportunities we lay in wait for.

When stocks fall to better-timed entry points, we buy shares in order to grow portfolio income. To gain some of these better-timed entry prices that enable me to receive higher yield and income, I used the Watch List Real Time Tracker to alert me when OHI approached the $33.00 level. This price would represent an 11.4% discount from its 52-week high indicated in column Q. When that target prices comes within 3% of the current price (this distance percentage is customizable by the user), the target price turned bright green to alert me to prepare to enter my limit order. The tracker indicates the 52-week high at $37.24, so as our order executed at the price I wanted to pay, it was a solid 11.4% discount from the high. The tracker tells me at that $33.00 target price I'll receive the 7.03% yield I was seeking.

If a similar amount as we invested to buy 200 shares of OHI for our subscriber account was invested instead in the 10-year treasury, you can easily note that the current yield, at 1.75% would give us annual income of only $115.63. By comparison, the $6600 that was invested in OHI at $33 per share, giving us a 7.03% yield is producing $464.00 in annual income. Because we were willing to take on a small amount of risk by investing in OHI with a long track record of paying and growing dividends in reliable fashion, we have quadrupled our annual income, in comparison.

If we were of a more conservative stripe and wished to reduce our portfolio risk by buying both securities, the tracker lets us know that if we invested essentially equal amounts in each, the average yield of these positions at the targeted price we received would be 4.39% and our total income would be $579.63 annually from these two positions. Note, in column N, even though equal amounts were invested in each position, column O makes it crystal clear that the majority of our yield, the percent of portfolio income, is coming from our position in OHI, 80% as compared to 20% of income coming from the Treasury position.

The tracker allows me to scroll to the right to retrieve additional metrics while locking cells to the left.

Here I can see information on 52-week high and low prices, what percent OHI is currently from these markers, the P/E ratio of OHI and other equities in its sector, like HCN if I wish to make peer group comparisons, and dividend pay dates and ex-dividend dates if I'd like to attempt to capture the dividend.

Watch List Real Time Tracker

Data regarding each component's yield, 52-week high and low, percent away from those highs and lows are also provided to me. If I am interested in timing my purchases to capture the next, upcoming dividend, the ex-dividend date shown tells me I must buy before that date, and I'll know when I get paid as well. Regarding OHI, it recently went ex-dividend so I will have to wait several months to receive my first dividend from this equity.

The Real Time Portfolio Tracker, helps highlight that OHI needed to be bulked up in share count in order to bring its annual income closer to parity with the other positions in the portfolio. Column O on the extreme right of the sheet clearly indicates what percent of portfolio income each component contributes, so a quick glance delineates the positions that need fattening.

Real Time Portfolio Tracker

Discipline To Wait, But Not Forever

I recently authored a piece called, "Patience Pays Retirees Bigger Dividends." Bigger dividends than what, you may ask? Bigger dividends than if you simply allowed the market to dictate prices to you.

I store a running list of candidates I'd like to add to my portfolio, or to those I manage here on Seeking Alpha or for subscribers, in digital tools that help guide me to better-timed entry prices. Instead of trying to keep track of all possible candidates in my head, these tools allow me to name my price and not have the markets dictate to me.

As we exert control over those investing aspects that we can in fact control, these concepts guide us toward the higher yields and higher income that we all seek for our retirements.

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 18 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), and The RMR Group (NASDAQ:RMR).

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 6.59%.

Monitoring Portfolio Positions and Growth Of Income

In an effort to stay connected to our portfolio dividend income and the 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

FTG Portfolio close, May 16, 2016

FTG Recap

Currently, the FTG is producing $27,140 in annual income. When added to the average couple's Social Security benefit of $28,800, we have, in only 16 months' time, significantly exceeded our goal of filling the gap between Social Security income and a comfortable $50,000 retirement. In fact, our total income, between these two sources, is now $55,940, which is $450.00 more than last month's income. This is due to the dividend increases we received this month and our reinvestment of dividends into more GOV shares and the new dividend income attendant to this purchase. It may be only a few more months till our dividend income exceeds Social Security benefit income.

We have experienced no cuts, and no elimination of dividends in 16 months of portfolio management. On the contrary, we have enjoyed a regular stream of dividend increases, more than enough to keep us comfortably ahead of inflation.

With its beginning value of $411,600 and the addition of a $6500 IRA contribution for 2015 and a $6500 IRA contribution for 2016, total asset contributions come to $424,600. The portfolio has grown to a value of $495,874. This represents capital appreciation of 17.23%.

$495,874-$424,600 = $71,274 capital appreciation

$71,274 /$424,600 = 16.79% percentage gain

This year alone, the FTG has grown $45,210 in value, or 10.03%, while the Dow is up only 1.64% and the S&P 500 is up just 1.11%. Accordingly, the Fill-The-Gap Portfolio has effectively trounced the return on the Dow Jones Industrial Average by more than 6 times, and has grown more than 9 times greater than the return of the S&P 500 Index.

MY FTG Mirror Calculator

After doing their own due diligence, readers wishing to proportionately emulate FTG Portfolio trades for their own portfolios use the "My FTG Mirror Calculator" or the "My RODAT Mirror Calculator" to simplify their task.

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.

We are currently offering a FREE two-week trial of my subscription service. To learn more about this premium service and receive early action alerts like the strategies illustrated here, please click this link:

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.

Disclosure: I am/we are long ALL FTG PORTFOLIO STOCKS.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.