3 Reasons Most People Can't Retire

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Includes: ANH.PC, BKH, CINF, CVX, CWT, DX.PB, ED, EMR, ESS, FB, IVR.PC, JNJ, KMB, KO, LOW, MCD, MMM, MO, NNN, O, PEP, PG, PM, SKT, SWK, SYY, T, TGT, TMUS, TROW, UVV, VVC, VZ, WMT, XOM
by: Colorado Wealth Management Fund

Summary

Retirees have 3 key areas where they don’t want to budge.

We will give retirees some techniques to solve these problems.

It is better for investors to invest in strong dividends instead of hunting for 14% to 20% yields.

This research report was produced by The REIT Forum with assistance from Big Dog Investments.

Frequently, investors contact me to ask about retirement strategies. Some of them have relatively simple goals to articulate and build a plan around. However, it is all too common to see potential retirees grappling with a 3-headed beast.

Retirees have 3 key areas where they don't want to budge.

Retirement challenge 1

Many potential retirees have very little in their retirement accounts.

They have relatively little in other savings.

Often, they were hoping to retire within the next two years and don't expect to contribute a substantial amount to their retirement accounts during that time period. A lack of savings makes it more difficult to build a solid portfolio to provide income throughout a long retirement.

Some of these investors decide that the optimal solution is to look for dividend yields between 14% and 20%. They often see that the price is plunging on these securities, but believe if they simply purchase it and ignore the share price everything will be okay. Since the dividend is income, they figure that they can spend the dividend and over time the share price should flatten out.

Unfortunately, these investors rarely understand much of the accounting for the companies. The theory that stocks with a 14% to 20% dividend yield will simply have their share price flatten out would suggest that Wall Street is stupid.

If every analyst was missing this opportunity, there would be no reasonable conclusion except that Wall Street as a whole was downright stupid.

The market is not perfectly efficient. However, it is not absurdly stupid either. Investors should expect over the long term that most shares they purchase with a yield in the 14% to 20% range will most likely decline in price over time. However, many investors do not recognize that. By refusing to recognize the decline in share price, they can cling to the hope that the problems will all go away.

Retirement challenge 2

Grasping for a very high dividend yield rather than focusing on dividend safety reflects the desire for additional income. The next challenge that many of these investors face is that they want to maintain their current level of income. If they are willing to work sometimes that isn't hard to do. In some cases, retirees find maintaining their prior salary would be very difficult even if they were willing to continue working full time. It is worth noting here that a person who continues to work full time should not be referred to as a retiree.

However, some people become retired involuntarily. They were perfectly willing to continue working, but the job they were accustomed to doing no longer exists.

Retirement challenge 3

The third challenge for retirees is expenses. Often, the retirees struggling with this situation don't want to reduce expenses. Perhaps, I should be more precise. They don't want to reduce their standard of living. It would be perfectly acceptable to reduce expenses if it meant they were paying less and receiving the same amount. For instance, they might be perfectly willing to reduce their restaurant expense by $200 per month so long as they could still visit the same restaurants and eat the same food. Unfortunately, the restaurants are not agreeable to those terms.

So what can a retiree do in this situation?

The first situation retirees can remove is buying ultra-high dividend yield stocks and closing their eyes. The ostrich defense is not effective. We can build a portfolio with a high dividend yield, but it won't be in the teens. Instead, we will provide an example for building a portfolio with a very respectable yield and consistent dividend growth to help investors keep pace with inflation.

For investors to accept the idea of a reliable dividend yield, rather than gambling on high yields, they need to see a way for income and expenses to be balanced without the income being inflated by garbage yields.

In this article, we are going to focus on an area many readers have asked about. We are going to discuss some of the techniques they can use to reduce their expenses without a similar decrease in their standard of living. These ideas usually involve some decrease in the standard of living, but the objective is to target areas where the retiree was getting the least return for each dollar spent.

Technique 1

You probably know that paying interest on credit cards is one of the worst financial mistakes an investor can make. The interest on their credit card will regularly exceed the long-term returns on their stock portfolio. Credit cards should be paid off immediately and always. However, there is another useful technique here. Since the retiree should be keeping their cards paid off entirely, the interest rate on those cards does not matter. The retiree can focus on cards with the best rewards package. That could be a high amount of cash back or it could be frequent flier miles. Either way, when the retiree is opening the accounts, they should be focusing on the rewards package and willing to accept a much higher interest rate since they don't intend to pay any interest.

Technique 2

The next area to reduce expenses is on vehicles. Driving an older vehicle is much cheaper in terms of depreciation and insurance. However, buying a lemon is a poor strategy. The best deal on buying a used car comes from purchasing on Craigslist and having a capable mechanic checking out the vehicle. I have used this technique several times and saved a substantial amount of money in the process. It does take more time, but retirees tend to have more time. It is important to emphasize that a mechanic needs to be involved.

There is one caveat.

If you have disassembled the engine for a car and entirely rebuilt it yourself, you are probably capable of inspecting the cars. If that job seems extremely challenging, it is best to involve a professional. On two different occasions, I went to see a vehicle and learned from the mechanic that someone who was pretty good with cars had attempted to hide enormous flaws with the vehicle's engine. In each case, the mechanic indicated that the car was not even worth $1000 below Blue Book value.

Technique 3

Retirees can cut their expenses on several services that are less important. Landlines are no longer important if the retiree has a cell phone. The landline mostly serves as a way for telemarketers to create an annoying ringing sound inside your house.

Just get rid of it.

Many retirees may find that T-Mobile (TMUS) offers a much cheaper plan than AT&T (T) or Verizon (VZ). It could depend on the individual consumer's needs, but in my experience, T-Mobile has offered a materially lower price and I have not noticed any weakness in the service.

It is rare to see retirees talking about their cost for phones. However, it is worth recognizing. Phones are not free. Upgrades to the phone are not free. If an upgrade is included in the contract price, then the cost of subscription simply had the phone rolled into it. That does not make it a free phone.

Cable TV is another great area for cutting. Some of the cable providers offer their channels online at a reasonable cost. If the retiree wants to follow shows from several different networks, they can alternate which service they subscribe to and watch the entire seasons before canceling and subscribing to the next service.

Internet service is another area where retirees can save. Often, a slower internet package is perfectly viable. If the retiree is not streaming videos in ultra-high definition or playing games at a very competitive level, they are unlikely to notice the difference in speeds. Since the actual cost of providing internet service is very low compared to subscription prices, the retiree can also negotiate for a better deal on their internet. I still do this regularly. I save several hundred dollars a year in exchange for one annoying and occasionally awkward call that takes about 15 minutes. That is still worth my time.

Technique 4

It is rarely retirees who make this mistake, but it is worth highlighting for them anyway. Furniture is extremely expensive. However, if you shop on Craigslist, you can find great furniture at very attractive prices. It is important to check the condition of the furniture before purchasing. This technique does take some time, but it is something retirees can do to lower the expense.

I often find retirees complain about the expense of buying a new computer. They can find that expense to be over $1000. Somehow, they were guided to the idea that they should purchase a gaming computer when they intended to check email and Facebook (FB). The Chromebook 3 is generally around $200 or a little less and is perfectly viable for those tasks.

Putting together a portfolio

We've created a good starting point for retirees looking for an income portfolio:

Company Name

Ticker

Current Yield

Company Name

Ticker

Current Yield

Company Name

Ticker

Current Yield

Company Name

Ticker

Current Yield

Procter & Gamble

(PG)

3.77%

Target

(TGT)

3.36%

McDonald's

(MCD)

2.53%

Chevron

(CVX)

3.70%

Emerson Electric

(EMR)

2.81%

Stanley Black & Decker

(SWK)

1.98%

National Retail Properties

(NNN)

4.65%

Philip Morris

(PM)

5.77%

3M

(MMM)

2.72%

Altria Group

(MO)

5.71%

Realty Income

(O)

4.98%

Verizon

VZ

5.48%

Vectren

(VVC)

2.54%

Sysco

(SYY)

2.12%

Lowe's

(LOW)

1.94%

Invesco Mortgage

(IVR.PC)

7.98%

Cincinnati Financial

(CINF)

3.16%

Black Hills Corporation

(BKH)

3.17%

Kimberly-Clark

(KMB)

4.00%

Dynex Capital

(DX.PB)

8.20%

Coke

(KO)

3.63%

Universal

(UVV)

4.55%

Consolidated Edison

(ED)

3.81%

Anworth Mortgage

(ANH.PC)

7.79%

Johnson & Johnson

(JNJ)

2.98%

Walmart

(WMT)

2.48%

AT&T

T

6.45%

Capstead Mortgage

(CMO.PC)

7.58%

California Water Service

(CWT)

1.90%

Pepsi

(PEP)

3.47%

T. Rowe Price

(TROW)

2.30%

Essex Property Trust

(ESS)

3.19%

Exxon Mobil

(XOM)

4.15%

Tanger Factory Outlet

(SKT)

6.83%

Here are the selected tickers put into a portfolio tracker:

Source: The REIT Forum

This portfolio would give investors around a 4% yield. While it may not be the 14%+ some retirees are getting suckered into, it does offer stable income. Further, most of these dividends will continue to be raised.

Why did we select some REITs for a retirement portfolio?

Do you like real estate?

Most investors do:

Real estate is the most popular investment for long-term wealth creation. It has won each year since 2013. That makes sense. Many investors have earned a fortune off real estate. Investing in real estate can be a very simple method to build wealth and many investors are familiar with the concept if they've purchased their own home.

The biggest difference between buying a home and purchasing real estate for investment is the rental income. Buying a home is useful because it allows the investor to avoid paying rent. Owning rental property is great because it allows the investor to receive rent. When investors are looking for consistent cash flow to give them greater financial freedom, real estate is a natural choice.

There are a few key challenges to buying real estate directly. These barriers can prevent many potential landlords from achieving their dreams of financial freedom through real estate.

The 3 biggest barriers to investing in real estate are:

  1. Enormous minimum amount to invest.

  2. The high transaction costs in both time and money.

  3. Difficulty of having enough time to manage your properties properly.

Now, let's consider how investing in REITs allows an investor to get around those 3 major barriers.

1. Enormous minimum amount to invest

An investor planning to buy real estate directly would often have their smallest transactions around a few hundred thousand. Properties with a lower price tag are usually in need of massive renovations. For simplicity sake, let's consider a condo in a coastal market. The price tag could easily exceed $300,000. The investor could get a mortgage to help with the upfront cost, but they would still need $60,000 to $90,000.

In several coastal markets, the prices are even higher. An investor who wants to buy a slice of a hotel, a shopping center, or an office building may be asked to come up with substantially more even if they only intend to have a very small position in it.

Let's compare the two:

  • Investing in real estate directly often has a minimum value in excess of $60,000. An investment at that level usually carries extreme debt leverage.

  • Investing in a REIT will require a minimum of around $20 to $300.

The REIT easily wins on being more accessible to investors.

2. The high transaction costs in both time and money

Here is the scenario for an investor buying physical real estate:

  • The investor evaluates their credit rating and checks to see how much financing the property will cost.

  • The investor hires a realtor to help them hunt for the appropriate property.

  • The investor tours properties with their realtor until they find one that fits their criteria.

  • The negotiations can easily take several weeks.

  • The property will usually need to be inspected and any problems will need to be worked out or they could blow up the deal.

  • The bank has to sign off on the deal and the investor gets to see how much rates have changed since they initially planned to take out a loan.

  • The investor must deal with the banks and insurance companies on their own.

  • The investor jumps through any local red tape.

  • Between the buyer and the seller, they must pay the banks, the realtors, and several other fees. The total transaction cost can run as high as 10% of the value of the real estate.

  • The time investment for the buyer may easily run between 50 hours and 150 hours. If they ever intend to sell the property, they will spend even more time preparing for the sale.

Here is the scenario for an investor buying a REIT:

  • The investor searches for a REIT that meets their qualifications and settles on one.

  • They do further research on that specific REIT to ensure they are comfortable with their decision.

  • The time investment when buying is usually part of an evening. With access to good sources, that can easily be sufficient. When the investor is on their own, it may take longer. Having a REIT analyst in your corner is like having an experienced property broker helping you find the property. They won't work for free, but their expertise can assist in finding quality properties (or REITs) at attractive prices.

  • They purchase shares in the REIT.

  • Transaction costs often run around $5 on the purchase. If the investor chooses to sell at some point, they may need to pay $5 again, for a total of $10. That compares favorably to 10%.

The REIT easily wins. It shrinks the time costs from a few weeks of full-time labor to an evening. It shrinks the transaction cost down from 10% to around $5 for a buy or $10 for both the purchase and sale.

3. Difficulty of having enough time to manage your properties properly

There are several major expenses to be paid in either time or money after the investor buys real estate directly. These factors don't make direct investments in real estate bad, but they do highlight several of the skills needed successfully manage the property. When an investor buys a REIT, the management handles all of these things for them.

The investor buying property directly has the option of hiring a property manager to handle several of these events for them. That is a viable route. However, property managers aren't free. They regularly cost a much larger percentage of rental revenues than the total overhead expenses for a REIT. If you want someone else to handle these problems without devouring a huge chunk of your rental revenues, the REIT comes out far ahead.

Here is the scenario for an investor buying real estate directly:

  • When the air conditioner breaks, they either fix it themselves or pay a hefty markup for someone else to perform the service.

  • When the toilet gets clogged, the investor either goes to handle it or pays a hefty markup.

  • When the hot-water heater goes out…

  • When the garbage disposal fails…

  • When the house needs to be repainted…

  • When the landscaping needs to be improved…

  • When the carpets need to be replaced…

  • When a tenant moves out and a new tenant needs to be located…

  • When a tenant fails to pay rent…

  • Even when the taxes are due, the investor either needs to learn enough to get through TurboTax or needs to hire a CPA.

  • The CPA may charge extra for filing these forms. If you were already receiving dividend income from other stocks, it isn't much work to add in REIT dividends. The REIT dividends are taxed at a different rate than other stocks, but otherwise, the process is the same. If you can handle dividends from another company, you can handle REIT dividends.

  • When the property is damaged by hail, fire, or flood, the investor is stuck dealing with the insurance company. Hope they didn't have any other plans for their free time.

  • If the investor didn't carry "Business Interruption Insurance", they may be without rental income for several months. Even with the insurance, the cash flow may be delayed for months. The bank won't stop collections on the mortgage though.

Here is the scenario for an investor buying a REIT:

  • When the air conditioner breaks, it is promptly fixed by an experienced mechanic at fraction of the cost the individual investor would pay.

  • When the toilet gets clogged, maintenance fixes it. The wages aren't too expensive, nowhere near what you would pay a plumber. Don't believe? Apply for their job.

  • When the hot-water heater goes out maintenance fixes it.

  • When the garbage disposal fails maintenance fixes it.

  • When the house (or apartment building) needs to be repainted the REIT has excellent economies of scale in negotiating a lower price. They also know what paint will last best in the local market and what colors work for appealing to a broad tenant base.

  • When the landscaping needs to be improved they already have contracts with landscaping companies.

  • When the carpets need to be replaced maintenance does it.

  • When a tenant moves out and a new tenant needs to be located their leasing department is running ads and responding to potential tenants 6 or 7 days per week.

  • When a tenant fails to pay rent they already have a collection process in place, know all the local laws, and don't feel remorse about getting the job done.

  • The REIT handles all the property taxes. They send you a form 1099 reflecting your dividends.

  • The investor can easily enter this as another dividend from a stock, simply identifying that it is an "unqualified dividend". If they have a CPA, the CPA won't need to file additional paperwork.

  • When the property is damaged by hail, fire, or flood, the management files all the proper forms using their own in-house experts on dealing with the insurance companies.

  • The REITs regularly carry business interruption insurance, so they aren't losing revenue. The cash flow might be delayed, but this is standard cash flow management for a company. It won't impact their ability to pay the dividend or pay the bank.

The REIT wins in a landslide. It takes huge burdens off the shoulders of the individual investor. It saves them from what could otherwise resemble a second job. Some investors simply love dealing with all those hands-on problems and celebrate the "savings" from spending their night off working on the property. Those investors can achieve outstanding returns by counting their time as if it cost nothing. For those of us who don't have enough free time to take on a second job, the REIT's excellent scale on operating expenses is wonderful.

Do REITs really operate like an investment in real estate?

Many investors don't realize that investing in equity REITs is very similar to buying physical rental properties. REITs are generally lumped in with other stocks, but over the long-term, their performance will more closely match the performance of the real estate they own. That makes sense when we think about it.

If a large investor wanted to create a publicly traded REIT, how much would it cost? There are some expenses with creating a company, but the largest expense would be buying the properties. The cost to build a REIT is very similar to the cost of acquiring those properties. At the inception, the cost of making a REIT is the value of the properties.

If a large investor were to acquire all the shares of a REIT, they would simply own the properties. It would be a portfolio of real estate acquired in one quick move. The value of the portfolio would be measured based on what investors would bid for the individual assets. Whether real estate is held directly or held through a REIT, the value of the real estate isn't impacted by the wrapper.

Over the short-term, REIT share prices can fluctuate quite a bit. Often they fluctuate more than appraised real estate values. That leads many investors to believe that the REITs are more dangerous. If you owned a condo worth $300,000 and someone offered to pay you $275,000 for it, does that mean your condo value suddenly plunged? No. You could reject their offer and continue to own the condo. Over the next year, the condo value might increase to $350,000 or it might even fall to $250,000. Whether the investor accepts the offer is up to them.

If investors take that long-term view when buying REITs, they stand to be rewarded. They will see days, even months or quarters, when REITs trade at much lower prices. When REITs trade at low prices, many investors are scared to purchase them. That precise situation was present in February 2018 as the REIT indexes bottomed out. Over the next few months, the fear declined and share prices climbed right back up. There are still some great deals available on REITs. The REIT Forum continues to find great dividend growth in undervalued companies.

High-quality REITs continue to pay solid dividends even as their share prices fluctuate. This is a very important aspect of investing. A long-term real estate investor is not merely speculating on the real estate value appreciating. They are earning income from the portfolio every quarter (or more). The income can come through net operating income if they own property directly or through dividends if they purchase a REIT.

Final thoughts

Retirees need to face future problems and use techniques to plan cash flows. Without proper due diligence or budgeting, retirement can go downhill quickly. What are some techniques you have used to get through retirement? Please leave a comment with your advice towards retirees and future retirees.

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Disclosure: I am/we are long ANH-C, ESS, MO, PM, SKT, WMT.

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.