How To Retire At 64 With Only Half A Million

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Includes: AAPL, AGNCN, HD, JNJ, KO, LOW, MA, MCD, MMM, MO, MSFT, NNN, O, PEP, PFF, PG, PM, SCHZ, SPG, T, V, VNQ, VZ, WMT, XOM
by: Colorado Wealth Management Fund
Summary

Seeking Alpha provides help for retirees and other investors working through current issues in the stock market today.

I will be using hypothetical situations many readers may face.

Retirees can use dividend investing to create income.

Consider your personal situation. Is taking Social Security early the right choice for you?

Finding a peaceful way to afford retirement is one of the most pressing issues of the day. Many readers have turned to Seeking Alpha to handle challenges which face retirees today. Retirees need to understand:

  1. How to plan their cash flows
  2. How to build a steady portfolio
  3. What level of expectations are reasonable

It's distressing to hear from retirees who "NEED" a 14% annual rate of return. Even with heightened risk and volatility, 14% is very unlikely. Even if an investor achieved it, it wouldn't be in a steady pattern. That's the nature of high volatility.

Many investors want to spend part of their golden years on a cruise ship. That's entirely possible.

Today, we are using hypothetical situations many readers face.

It would be easy to plan retirement with $10 million. So instead, let's make it less: $568,848. The portfolio we will highlight would've cost $500,000 about 18 months ago, but share prices have risen along with dividend rates. We'll demonstrate how to boost the yield without raising the volatility. If investors want to run a similar plan on $500,000, they can simply scale down the size of positions or utilize a higher allocation to preferred shares.

Market environment

The current interest rates available on bonds are low, but they have increased substantially. Bonds are a difficult way to generate income without a huge portfolio. Perhaps you'd rather go with a portfolio of mostly equity?

The market was seeing all-time record highs earlier this year. The higher valuations make it a more dangerous time to go all in on equity.

Investing today requires caution. The investments I would choose are large companies with a strong track record. A retiree today can still invest in an income portfolio and expect solid dividend yields. Dividend champions are unlikely to cut their dividend - even in harsh times. Short-term volatility of the market may be significant, but the income source should remain almost entirely intact.

Nursing homes

Care in a nursing home is expensive. Staying there for a long time would almost certainly drive most retirees into bankruptcy or an early grave. Skilled care costs are much too high for most retirement portfolios. If you are considering this option, please speak with a financial planner. They can advise you on designing a legal structure to protect your capital in the event of a forced bankruptcy.

Social Security

Waiting to take Social Security has huge benefits. The retiree is investing in their future cash flows and securing a larger payout in each future period. If they expect to enjoy a long retirement, then waiting often makes sense. However, there are some significant exceptions.

Here are several reasons why a retiree might choose to file early:

  1. Paying off high interest-rate debt
  2. Health concerns that make them doubt they will live into their late 80s.
  3. Doubts about the future level of benefits
  4. Expectations for changes in taxation on Social Security benefits

For this scenario, our retiree is taking out SS as soon as possible. When a retiree has no idea whether they will live to be 65 or 105, taking Social Security early can be wise. Often the payback period on taking social security benefits later runs through the early 80s. If we adjust for the ability to accrue interest income on cash balances, it would be a bit later.

For our example, the investor is taking Social Security at 64 and is going to receive a monthly benefit of $1,500. That translates to $18,000 per year.

Challenges in Retirement

Each person entering retirement faces their own unique challenges. To give yourself a better shot in retirement, we recommend the following steps:

  1. Be diligent in your planning. Spend the time to track expenses upfront.
  2. Be frugal. Look to cut back on some of those expenses.
  3. Consider ways to earn additional income. Even a small source of income can help.
  4. Remain committed to the plan. A plan is only useful if you follow it.

Work

Retirees who don't work at all tend to have shorter lifespans:

Correlation and causation are not the same. We can see a very clear correlation, but we can't say what caused it. Were the death rates higher because those who were ill retired earlier? What about those who retire earlier to enjoy their final years? Share your ideas in the comment section.

Portfolio investing

Let's build a sample portfolio with strong dividend investments. Investors should pick a strategy that helps them sleep at night. Some investors like a portfolio built on a very diversified group of ETFs. Others would prefer a few strong dividend growers to create a more stable stream of dividend payments.

We will focus on dividends payers to supplement income. In this scenario - plan simple. Buy and hold 20 of the best dividend stocks on the market. These picks will be in a rapid format, so we aren't going to get into deep dives on fundamental valuation. The focus of this article is on the retirement strategy with the individual shares being used as examples for building a diversified portfolio.

Let's begin!

MO and PM

My first and second picks might scare investors: Altria Group (MO) and Philip Morris (PM). MO and PM are two of the tobacco giants and their performance over the last calendar year has been dreadful. Analysts have become far more concerned over the future of the industry. We disagree. Tobacco revenue growth rates are unlikely to maintain their prior levels. However, shares trade at low valuations. The current dividend yield is 5.74% for MO and 5.24% for PM. They have their dividends thoroughly covered and can choose to invest in new technology or use excess cash flow to repurchase shares.

We consider MO's dividend history as being relevant for PM also. The two were previously parts of the same company.

Altria Group has raised their dividend for nearly 50 years. Each of these companies has massive market share. They sell an addictive market. They are demonstrating their ability to transition into new products. Philip Morris is testing their new technology in international markets: IQOS.

PG, MMM, and JNJ

Picks three through five:

Procter & Gamble (NYSE:PG) has 61 years of dividend increases. 3M (MMM) has 59 years of dividend increases. Johnson & Johnson (JNJ) has 55 years of increases. All of these companies have another factor in common: Product diversity.

The companies are giants within their sectors. All three sell products which are probably in your residence right now. For dividend portfolios, these three companies should be at the top.

PEP and KO

Sixth and seventh:

Coca-Cola (KO) and PepsiCo (PEP) combined have 100 years of dividend raises. Future growth rates are uncertain. That's always the case. Without uncertainty, investing would be very strange. The companies have delivered to grow dividends and share prices. We see a headwind for selling sugary junk food (including soda), but the companies have plenty of time to transition into healthier products. Their greatest strength isn't the brands they own, it is their ability to build brands. The existing brands simply demonstrate their expertise.

LOW and HD

Eighth and ninth:

Lowe's (LOW) and Home Depot (HD) are the kings of home improvement. The home-building stocks have suffered through a very rough year, but we still see prices higher prices on LOW and HD today than we did in late October of 2017.

The two chains have delivered solid growth on a consistent basis. We don't expect a sudden emergence of a third player to challenge this oligopoly.

O and NNN

Tenth and eleventh:

Realty Income (O) and National Retail Properties (NNN) are both favorites for dividend investors. They have decades of dividend growth. Each excels at managing their real estate. One important aspect is choosing the right tenants. By choosing the right tenants they can significantly reduce their risk of tenants going bankrupt. That gives them greater certainty over their future cash flows.

T and VZ

Twelfth and Thirteenth:

AT&T (T) and Verizon (VZ) are the two behemoths of mobile internet access. Banks can be "too big to fail." If that designation goes to telecommunications firms, these would be the first on the list. They trade at high dividend yields and low P/E ratios. Over the last year, we've seen T dip, but VZ is up significantly.

AAPL

Fourteenth:

It's hard not to put Apple (AAPL) into a retirement portfolio. There are limited choices for dividend stocks in the tech space. If investors want a company with an exceptionally strong balance sheet, the list gets dramatically shorter. Some investors might prefer to use Microsoft (MSFT) here instead. Either way, tech stocks are a very large portion of the economy and it makes sense to include at least one of them in a dividend growth portfolio.

XOM

Fifteenth:

Exxon Mobile (XOM) is the definition of big oil. They have political clout and the size necessary for huge economies of scale. For retirees, the large dividend yield is the main appeal. The yield, about 4.16%, is pretty high. It's much smaller than the high-risk players in the oil industry, but a lower yield with less risk is a better fit for this portfolio.

V and MA

Sixteenth and Seventeenth:

Visa (V) and Mastercard (MA) are two stocks we all should've bought long ago. They dominate their sector. When Visa claims to be "everywhere," they aren't joking. It's rare to find a transaction which can't be completed with Visa. Mastercard is their strongest competitor and the two should benefit from an increase in electronic payments on a global scale.

WMT

Eighteenth:

Walmart (WMT) is the king of retail. Despite the retailer bankruptcies in the news, Walmart continues to grow:

Source: Schwab

They've delivered great progress in online sales.

You couldn't count on Wall Street to predict that.

Look back in time a little over three years:

Source: Seeking Alpha News Alert

How do you think the king of retail did following those rating cuts?

Most analysts were guilty of closing the stable door after the horse bolted.

MCD

Nineteenth:

McDonald's (MCD) is the king of artery-clogging fast food. McDonald's also has more than 40 years of dividend raises. The dividend history isn't quite as impressive as some on the list, but it sure isn't bad.

MCD may have weaker future growth with competition from mobile ordering. We see that as a potential challenge because one of MCD's greatest strength is their speed in processing orders. A trend toward mobile order might favor competitors who previously were not considered by the customer because of their longer wait times.

We don't foresee them needing to reduce the dividend though.

SPG

Twentieth:

Simon Property Group (SPG) is the biggest among the mall REITs. It will continue to the biggest for decades to come. SPG has delivered solid growth year after year and the "death of retail" narrative dragged shares down through April of 2018, but since then SPG has been on a solid rally.

Stores will be replaced, but a landlord with great properties and a strong balance sheet should be fine.

Source: Seeking Alpha

Portfolio

Here are all the stocks put into The REIT Forum's portfolio tracker:

This portfolio would produce $17,388.28 in annual income and is valued at $565,848.

We suggested this batch of stocks about a year ago and demonstrated it in the portfolio tracker at that time as well:

About 18 months ago, this portfolio would've cost $500,000 and had an annual dividend yield of $15,455.

Since then, we saw dividend growth of about 12.5% and price growth of about 13.2%.

When investors are concerned about inflation, dividend growth is the answer.

The price performance listed here is without dividend reinvestment. You can see that the share counts remain flat. When we provide investment ideas, we focus on the total return. That's the change in share price plus the value of dividends paid during the period.

Total retirement income

The total portfolio income would be $17,388.21. Social Security benefits add another $18,000 a year. This comes out to $35,388.21 per year for one person.

This is enough to live off of for one person, though comfort levels may differ.

It would be very difficult if the retiree were paying rent and completely unworkable if the retiree were paying rent in San Francisco or New York.

However, if the retiree is living in a city with a low cost of living, this can still work. They need to own their own home and shouldn't be planning on driving a brand new car.

At 64, this retiree has one year left before Medicare kicks in. They might look to buy a separate health insurance plan, which would require keeping more cash on hand. They might decide to go uninsured for those two years. Or they might look for a part-time job with health insurance benefits. These can still be difficult to find, but the health insurance aspect would be more important than the paycheck. The declines in the unemployment rate are forcing employers to compete more for qualified employees, so these positions aren't impossible to find.

How to get more income in retirement

If retirees want a portfolio with a higher yield, one clear way to get there would be to replace Visa and Mastercard with preferred shares. Those two positions offer yields of less than 1%, but there are several high-quality preferred shares offering yields over 7%.

Preferred shares don't offer the same dividend growth, but they do offer high yields and stable values. That combination can make them an ideal addition to a retirement portfolio. It gives the investor the benefit of higher yields and lower volatilities. To handle increases in interest rates, we favor including shares which have a "fixed-to-floating" feature that kicks in during the next decade. That gives investors an automatic hedge against short-term rates moving materially higher at some point in the next decade.

Visa and Mastercard are delivering a combined $450.16 in annual income, despite being worth more than $80,000. If we invested their value in a couple of 7% yielding preferred shares, we would have lower volatility and be getting $5,600 in dividend income instead. That's a difference of more than $5,000. Adding $5,000 to the annual income on this portfolio. The total income (including social security benefits) would increase to more than $40,300 per year.

The combined portfolio would still offer excellent dividend growth due to the other positions in the portfolio. However, the preferred shares would make it dramatically easier for the retiree to handle their expenses.

Never Index For Yield

One of the biggest mistakes we see investors make is grabbing for high yields through high-fee index funds. For instance, many investors might grab the iShares U.S. Preferred Stock ETF (PFF) for the 5.89% yield. They would think that the diversification automatically reduced their risk, but they would be wrong. The ETF still holds individual preferred shares, but they are selected by an index rather than an expert on the sector.

One of the preferred shares we own is AGNCN (AGNCN). To demonstrate the difference in both volatility and total returns over time, we prepared a chart showing how much an investor would've needed to invest in either PFF or AGNCN on any given day since 1/1/2018 to reach $100,000 in total value.

How can AGNCN outperform over long periods? It has a higher yield, lower risk, and doesn't pay a hefty expense ratio (like PFF). That gives AGNCN a big advantage for long-term performance. It offers more upside through the higher yield, but it also performs much better during a decline.

For buy-and-hold investors, this is a great share due to the low risk. For traders, the lower risk is particularly appealing after a huge rally in the markets. When we own a risk-rating one preferred share and see the market dive, we may eat a loss for 2% to buy another share that just plunged by 8%. If the market doesn't dive, we simply continue to collect our solid yield.

Investors who aren't comfortable with this can simply stay in the shares.

Our Portfolio

My portfolio isn't as diversified as I would suggest for retirees. Quite simply, no analyst can specialize in so many sectors. Consequently, we take on more concentrated positions and trade a little more actively to enable us to capitalize on "relative valuations."

The technique has worked very well. It enabled us to dramatically outperform the Vanguard Real Estate ETF (VNQ) and PFF:

Since no analyst can be competent in so many sectors, what is an investor to do? If they want to use ETFs, they could use ETFs to target a core lower-yielding part of their portfolio. That's one very viable way to get diversification into the portfolio. Meanwhile, they could focus their efforts on picking individual shares in some of the higher-yielding investments such as REITs and preferred shares.

Alternatively, the investor could look for a few analysts to follow in different sectors. That could be more expensive since professional analysts always keep their best research for subscribers. All of our top research comes out on The REIT Forum. You'll find articles like Preferred Shares Week 151, where we provide an overview of the mortgage REIT preferred shares and highlight which ones are most attractive at their latest prices.

Bond option

If investors want a small allocation to bonds, I would suggest the Schwab U.S. Aggregate Bond ETF (SCHZ). The portfolio is constructed with mostly high-quality bonds and relatively short duration. It can reduce the total volatility in the portfolio. It won't pay much, but the yield is better than investors will get on their savings account.

Conclusion

There are many strong companies which were excluded. The companies we listed are strong enough to be seen as viable income sources for any investor. We won't be applying ratings in this article, because the emphasis is on planning for retirement and the stocks are highlighted as examples for durable income.

Retirement planning has two major aspects. Neither is glamorous. Planning should rarely be glamorous.

The first aspect is planning for expenses. By reducing expenses the retiree has a lower hurdle to clear for income. Many retirees don't look at this as an option until it's too late. Reducing expenses early on is dramatically more effective than attempting to do so later.

The second aspect is planning for cash flows. Some investors will choose to sell shares on occasion to free up capital and spend a portion of the principal. There's nothing wrong with that strategy, so long as the retiree is comfortable using it. For retirees who prefer to hold onto their investments, it makes sense to focus on establishing an income portfolio.

One way to dramatically improve the expected income without ramping up the risk and volatility is to incorporate some preferred shares. Carefully selected preferred shares can offer a high yield while still reducing the total risk of the portfolio. They don't offer as much upside during a prolonged bull market, but they dramatically reduce the risk while increasing the income. We like to focus on finding defensive investments, so they suit us very well.

Disclosure: I am/we are long AGNCN, MO, PM, SPG, 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.