How To Retire: Kill The TV

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Includes: AAPL, AGG, AVB, BND, BSV, DIS, EQR, F, FPE, FRT, GILD, GM, INTC, JNJ, LLY, MCD, MO, MRK, PFF, PGX, PM, QQQ, REG, SCHD, SPY, T, TGT, VDC, VIG, VNQ, VYM, VZ, WHLR, WMT
by: Colorado Wealth Management Fund
Summary

People are waiting at the door of retirement without a clue of how to plan for it.

Thinking about buying an investment property in retirement? You won't.

Do ETFs beat stocks and bonds?

Publicly-traded REITs are materially better than throwing your money away investing in non-traded REITs.

Seeking Alpha offers investors many strategies for both retirees and people planning for retirement today.

100% of our revenue from this article in the first month will be donated to a charity. In February, we will be supporting 2 Blondes All Breed Rescue.

Many people are eagerly awaiting retirement.

Unfortunately, far fewer retirees are actually planning for it. A shocking percentage of people have little idea about how much retirement will cost. One way to learn about retirement planning is to read Seeking Alpha. Our free articles will contain some examples of how to prepare for retirement.

If you frequently read our articles, you'll notice a strong emphasis on investing defensively. We believe that investors should put a much greater emphasis on minimizing risk rather than swinging for the fences. That doesn't mean investors need to hold most of their portfolio in cash or short-term Treasuries. It simply means that they should focus on companies with a stronger financial position. Whether the investor is focused on common shares or preferred shares, a safer balance sheet leads to a safer investment.

Where can an investor find safer shares?

We built a tool called the "Safe Income Portfolio" for subscribers. It can be accessed with just a couple clicks on our service. We fill it with REIT shares that have a risk rating lower than 4. Our risk rating scale runs from 1 to 5 with 1 being the lowest. This portfolio creates an easy way for investors to filter out the lower quality REITs. We don't suggest that investors need to purchase every share in the portfolio. Instead, investors should think of it as a buffet where we've carefully evaluated each item.

For instance, it includes AvalonBay (AVB), Equity Residential (EQR), Regency Centers Corp. (REG), and Federal Realty Investment Trust (FRT). Those examples include two apartment REITs and two strip center REITs, but there are several other REITs that also qualify.

The chart below demonstrates how it works and includes 4 of the shares with a risk rating of 1:

We also own positions in several shares that are included in the portfolio. We believe this is a great time to focus on buying quality REITs and preferred shares.

Where Americans get retirement advice

One of the common sources for information about retirement is friends or relatives:

Source

This is a great idea if you discuss the experiences with friends and relatives who are already retired. It should be insightful. However, it is best to use those friends and relatives for ideas about retirement rather than for tax planning or stock picking. Simply going through retirement is a viable way to learn about the process and how it impacted their expenses.

Making plans for retirement

When you're making plans for retirement, you might think that you will want to buy a second home. That is something many people thought but very few actually do. You can likely toss that plan out.

7% of people in Australia thought they would be buying a property as an investment:

Source

Only 1% actually did.

6 out of 7 people planning to buy an investment property didn't follow through. There are several great reasons not to follow through.

Owning an investment property directly can be a substantial amount of work. You are consistently on call as the landlord. It can be a very effective way for people to make money in retirement. However, it is best suited to people who have some expertise in handyman work and who enjoy dealing with people. If you own the property, you will be dealing with people. If you are paying a property manager, you may be much better off with a REIT.

When investors are picking a REIT, it is much better to pick a publicly-traded REIT. Publicly-traded equity REITs (Listed Equity REITs) have thoroughly outperformed private equity investments in real estate.

Source

REITs have professional property management. They get exceptional scale on their operating expenses, and the management is almost always competent. If the management is incompetent, we expect to discover that for you. While I cannot screen every property manager for readers, I do evaluate the quality of REIT management for subscribers.

Why does the quality of management matter?

If you were hiring a property manager, a poor manager could lead to higher vacancy or lower rental rate collections. A good manager would attempt to avoid renting your property to any tenant with a significant chance of being evicted. Evictions are terrible for the landlord. Evictions are an enormous hassle and a loss of potential revenue.

The ideal tenant would always pay rent on time and stay in the property for several years to prevent any vacant time. When we look at REITs, poor management decisions often lead to dividend cuts. There are instances where a dividend cut is not a sign of poor management, but there is a very high correlation between the two. Often, investors will blame management for a dividend cut. The challenge with that thinking is that they are only blaming management for the eventual symptom rather than for the underlying cause. The cause is often excessive leverage. When a REIT has excessive leverage, any reduction in revenues can create difficulties with their lenders. Much like a retiree owning a rental property, the REIT needs to make payments on any debt it uses.

An example of a company that handled leverage poorly was Wheeler (WHLR). On 6/23/2017, we wrote that WHLR was dramatically overvalued because analysts fail at accounting.

We've included Federal Realty Investment Trust and Regency Centers to demonstrate the performance of the 2 lowest risk shopping center REITs. Wheeler's plunge occurred despite solid performance from the stronger shopping center REITs.

We also had a buy alert for FRT on 6/20/2018:

Source: The REIT Forum

Since then, FRT has performed quite well:

We believe investors can improve their probability of success by focusing on REITs with more conservative balance sheets. That doesn't guarantee that the REIT with a stronger balance sheet will deliver better investment results, but it reduces the likelihood of implosion due to debt-related issues. In our experience, over the long term, the stronger balance sheets lead to better results because it prevents the REIT from needing to liquidate properties when the economy is weaker. This same principle can be applied to other types of companies as well. By maintaining a strong balance sheet, they are in a better position to negotiate with banks and other creditors.

FRT and REG have the excellent balance sheets necessary to have a strong negotiating position with creditors.

Leverage

You can think of leverage within the company in the same manner as leverage within your brokerage account. If you wouldn't feel comfortable using a large amount of margin debt to increase your holdings, you are in the same camp as me. Having a highly leveraged portfolio could force investors to dump positions at the worst possible times. That doesn't mean investors should never use leverage, but they should be very careful in choosing those opportunities.

If an investor is using leverage and the share price tanks, the broker could force them to sell assets. In the same manner, a company's creditors could force them to sell assets after the values have declined. Those assets could be anything from bonds to buildings or manufacturing facilities. Regardless of which asset the company is forced to sell, shareholders would rather see management making the decision about when to sell assets than having the creditors make the decision for them.

Portfolio strategy

There are 3 main portfolio strategies:

  1. The first strategy is using ETFs. Many ETFs have excellent liquidity and significant diversification. There is a great deal of research encouraging investors to simply mix shares of major stock index ETFs with bond ETFs. The result is a portfolio with lower volatility compared to a pure equity portfolio. Here are some examples of ETFs retirees may use for income that comes with a relatively low expense ratio:

High Dividend ETFs

Bond ETFs

Preferred share ETFs

Sector ETFs

Vanguard Dividend Appreciation ETF

(VIG)

1.91%

iShares Core US Aggregate Bond ETF

(AGG)

2.72%

iShares Preferred and Income Securities ETF

(PFF)

6.01%

Vanguard Real Estate ETF

(VNQ)

4.57%

Vanguard High Dividend Yield ETF

(VYM)

3.07%

Vanguard Total Bond Market ETF

(BND)

2.79%

Invesco Preferred ETF

(PGX)

5.74%

Vanguard Consumer Staples ETF

(VDC)

2.61%

Schwab U.S. Dividend Equity ETF

(SCHD)

2.84%

Vanguard Short-Term Bond ETF

(BSV)

1.98%

First Trust Preferred Securities and Income ETF

(FPE)

5.83%

Invesco QQQ ETF

(QQQ)

1.00%

  1. The second strategy is mixing ETFs with individual stocks. This can be a great technique for many investors. It allows them to maintain diversification through the ETFs, but they are also able to pick individual stocks. The individual stocks benefit from having no expense ratio and researching individual stocks can help the investor understand the market better. We suggest that investors look to invest in larger companies with a healthy amount of research available. These are several highly covered companies on Seeking Alpha:

Consumer Staples

Healthcare

Consumer Discretionary

Technology & Others

Target

(TGT)

3.50%

Gilead Sciences

(GILD)

3.74%

General Motors

(GM)

3.90%

Apple

(AAPL)

1.72%

Altria Group

(MO)

6.53%

Merck & Co Inc

(MRK)

2.76%

Ford Motor Company

(F)

7.04%

AT&T Inc.

(T)

6.73%

Walmart

(WMT)

2.09%

Eli Lilly & Co

(LLY)

2.12%

Disney

(DIS)

1.57%

Verizon

(VZ)

4.41%

Philip Morris

(PM)

5.48%

J&J

(JNJ)

2.65%

McDonald's

(MCD)

2.59%

Intel Corporation

(INTC)

2.46%

  1. The third option is to mostly or entirely cut out ETFs and mutual funds. Investors focusing exclusively on individual stocks and bonds will have less diversification, but if they focus on lower risk stocks, they can still keep the total portfolio volatility to a reasonable level.

Actual investor performance

If we consider the actual returns achieved by the average investor over the last 20 years, it is clear that they have significantly underperformed the major indexes.

Source: JPMorgan

The best-performing sector was REITs, but any major sector was a viable way to beat average investor performance. There are a few techniques I believe investors can use to improve their results over time. We implement many of these strategies at The REIT Forum and have continued to beat the major REIT Index ETF, VNQ, and the major preferred share index ETF PFF:

We've also beat the S&P 500 (SPY) over these years. We spend a lot of time looking at the risk of individual companies and their dividend coverage. We assign individual risk ratings for each security we cover.

Risk ratings and dividend coverage

Stocks with lower risk ratings should be less exposed to a dramatic decrease in value.

The risk ratings are driven by our assessments on a few factors:

  1. How much leverage are they using?

  2. How exposed is their real estate to the impacts of recessions?

  3. How sustainable (or growable) is their dividend?

After we ask those 3 questions, we ask one additional question:

Do we see anything in their history, dealings (such as a bad external manager) or accounting that raises red flags?

If we see any red flags, it eliminates the possibility for a low risk rating. If we don't spot any problems, we go with the risk rating we initially calculated. Having zero red flags will not get a company an "improved" score. It simply prevents a severely punished score.

We suggest investors emphasize looking at REITs with modest amounts of leverage and very solid dividend coverage. If we were to hit a recession, revenue would fall for most REITs. Consequently, it is important that they cover the dividend with a margin of safety.

A solidly covered dividend with steady growth is a great sign of a strong company.

For instance, Altria Group (MO) is a dividend champion. Despite regulatory pressure, multiple recessions, dramatic swings in interest rates, and a decline in the number of smokers, Altria Group kept right on producing cash flows and sending them to shareholders. Their latest increase was 14.3% on the quarter. The dividend is up about 21% year over year. We see solid value in Philip Morris (PM) as well.

However, dividend coverage can be difficult to measure. Some investors are looking at GAAP earnings, others want normalized earnings, or they may use cash flow from operations or cash flow to equity.

For equity REITs, one of the most common metrics is FFO.

Another tip - turn off the news

Turn off the news.

I believe watching the news too frequently can cause investors to be caught up in market sentiment. Investors should be wary of buying into the market's emotion. It is important to recognize that investor emotion can have a significant impact on stock prices.

If investors want to invest on market emotion, then they need to be able to have good mathematical and sentiment analysis. For investors who are interesting, one of the best at this is Avi Gilburt who runs 'The Market Pinball Wizard'.

Most of our research focuses on the fundamentals of each company, but we also want to evaluate the impacts we are currently seeing from investor emotion and how we expect those factors to change in the future.

Macroeconomic research

Another thing for investors to do is to find an alternative way to monitor macroeconomic developments. Understanding a little bit about macroeconomics can help investors maintain their senses.

For instance, Eric Basmajian runs a service called EPB Macro Research. In a recent article, he stated:

In year over year growth rate terms, the best way to measure any data series, nonfarm payrolls accelerated from 1.81% to 1.90%. The current growth rate is still below the peak of the economic cycle, registered in February 2015 at 2.25%. Total employment growth is not a leading indicator, but rather a coincident indicator and thus, the current numbers are not confirming a shift into the next phase of the economic cycle yet. It can be frustrating waiting for the data to change but in real-time, the cycle takes years to develop. In hindsight, looking at a chart makes a 12-month period feel like a blink but in real-time, it feels like the transitionary periods can drag on for long periods of time.

Total Employment Growth Year over Year: Source: BLS, EPB Macro Research

The short-term chart shows the bounce in employment growth within the longer term downtrend off the cyclical high in growth in 2015.

Recent developments

While we believe that macroeconomics and fundamentals both play a role in investing, we primarily focus on fundamentals and relative valuations. A few months ago, we were pounding the table telling investors that the December decline was temporary. During that time, the market was severely concerned about the potential for a recession. What happened since then? Sentiment improved significantly, while fundamentals improved a little bit. That was a significant mismatch.

After such a fierce rally, we considered it a wise time to reduce some risk. We're already up substantially on the year. If the year ended today, it would be the best year for VNQ in recent memory.

We believe investors are becoming excited about REITs for a few reasons. One is greater knowledge of the impact from tax reform on reducing the tax rate on REIT dividends. A second factor is investors realizing bond yields are not simply going to shoot to the moon.

While both those factors are reasonable reasons to include REITs in the portfolio, they were both visible in late December. We are not predicting an economic collapse or a recession. We believe the odds for either of those events in the immediate future remains low, much as it did in December. However, we are not expecting the odds to be 0% either. It appears the market valuations today are quite reasonable, but we've seen the market enter significant panics twice within the last 13 months.

We believe investors should strive to be ready for the next panic, whether it happens in 6 months or 16. One way to do that is to reduce exposure to higher risk investments after a major recovery. Instead, we can utilize exposure to a few preferred shares with risk ratings of 1 or 2. We still collect yields around 7% to 8% but do so with far less volatility.

Final thoughts

A large percentage of people do not know how much money they will need to have saved for retirement. Further, many of them could be getting advice from the wrong people. Seeking Alpha offers retirees and future retirees investing wisdom and several different portfolio strategies. We would recommend that each reader decides for themselves about the importance of ETFs versus individual stocks in their portfolio. Either technique can work, but we have found including individual stocks is a great way to take advantage of research on risk levels and valuations.

Diversification

While most of our coverage is on REITs with far less than average risk, The REIT Forum still recommends diversifying. We invest the substantial majority of our portfolio in REITs and preferred shares. We suggest that investors choose a maximum allocation using our risk ratings combined with their risk tolerance. Each of our risk ratings connects with a suggested maximum allocation. The maximum allocations generally range from 1% for higher risk options to 6% for our lowest risk choices. By diversifying among these choices, investors can build a portfolio with a less volatile value and more consistent dividend growth.

Disclosure: I am/we are long EQR, MO, PM, WMT, FRT. 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.