How To Retire At 62 With $1.25 Million

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Includes: AGNCN, ANH.PC, BKH, CHMI.PA, CIM.PB, CINF, CMO.PE, CVX, CWT, DX.PB, ED, EMR, ESS, HP, JNJ, KMB, KO, LOW, MCD, MFA.PB, MMM, MO, NLY.PF, NNN, NWN, O, PEP, PFF, PG, PM, SCHO, SWK, SYY, TGT, THE, TROW, TWO.PE, UVV, VGSH, VNQ, VZ, WMT, XOM
by: Colorado Wealth Management Fund
Summary

Seeking Alpha helps investors and retirees facing current issues. One major issue is producing enough income without excess risk.

The stock market today is painfully expensive, but the lower-risk positions are less expensive compared to the high-risk stocks.

Dividend investing is a great source of income for a retiree.

Taking social security early might be the right choice or you. If you want to delay, you can utilize short-term Treasury ETFs to protect capital.

One of the most effective ways to increase income without raising volatility is to include preferred shares as part of the portfolio.

This research report was produced with assistance from Big Dog Investments.

Well, lads, it’s time for this couple to retire.

When you’re ready for retirement, you need to be able to balance yield with safety. Too many investors focus on only one aspect. One way to improve yield, as we will demonstrate, is to include preferred shares. Several of the preferred shares we are discussing in this article were covered more extensively in Preferred Shares Week 154.

Investing for Retirement

Retirees need to know how to build a steady portfolio, plan their cash flows, and have reasonable expectations. Having a volatile portfolio is something younger investors can do when they have decades to not worry about market panics which can drastically eat into a portfolio in the short term. During retirement, retirees usually can’t afford to take a significant loss in their portfolio. We will use the story of Ted and Mary to demonstrate these concepts. Ted and Mary have a good understanding of this and know they are going to need to come up with a good plan. This time around, Ted and Mary need a lot more income from their portfolio. They will need to find some way to do it without carrying a significant amount of risk.

Retirement Savings

Ted and Mary were able to save up $1,250,000 for retirement. They are 60 years old and have decided to retire so they can spend time with family and eventually travel the world.

Social Security

Ted and Mary decided together that they would wait on filing for Social Security until they could get the max benefit. They are both fairly healthy and plan on having a great insurance plan in case either of them has health issues. Once Social Security kicks in, Ted and Mary plan on using it to travel to places throughout the world they’ve always wanted to see.

The plan

Ted and Mary saved up $1.25 million for retirement but want to live off a portfolio’s income. Ted and Mary have spent a couple of years reading investment strategy on Seeking Alpha. Mary believes that they should have part of their portfolio in dividend champions and short-term Treasuries. With an equal-weighted strategy, they will be able to have some of their portfolio in investments which have good potential to go up in value. They also have the benefit of being invested in companies which have a long-standing record of raising their dividends. Mary believes that the history of raising dividends, even during market panics, will give them a solid foundation of companies. Mary also believes that they should put some of their portfolio into short-term Treasuries in case of an emergency. Ted and Mary decide to put 20% of their portfolio into dividend champions and 30% into short-term Treasuries.

Ted knows they need to be getting a lot of income from their portfolio, and he wants to do it with a low amount of volatility. On Seeking Alpha, Ted found an author who covered preferred shares. After reading many articles on preferred shares, Ted told Mary that they should have a large portion of their portfolio invested in them. It will give them the income they are looking for and also be an investment which is in line with their risk levels. Ted and Mary agree that the remaining 50% of their portfolio will go into preferred shares or baby bonds.

What do preferred shares offer investors?

Preferred shares offer investors a higher yield than the common stock will normally carry. Further, preferred shares generally carry less volatility and less risk. Preferred share owners usually do not have voting rights. However, preferred stock does have a higher priority on assets and earnings relative to common stock. Keep in mind that the preferred share dividend cannot be cut unless the common stock dividend is cut to zero. If that were to happen, for the common stock to start paying a dividend again the preferred shareholders are paid all unpaid dividends if the preferred shares are “cumulative”.

We only cover cumulative preferred shares.

What about risk-averse investors?

Many investors may be searching for investments that carry less risk than common stocks. Preferred shares not only carry relatively less risk than the common stock, but the income tends to be significantly more consistent. Preferred shares carry a consistent yield that is normally higher than the yield on corporate bonds. Investors worried about risk can also hunt for preferred shares with more call protection on the calendar, a discount to call value or an FTF (fixed-to-floating) rate as a hedge against rising interest rates.

Buy-and-hold investors should stick to high quality. We suggest that buy-and-hold investors avoid anything with a risk rating of 4 or higher since it implies we are not comfortable enough in the long-term health of the company/security. It's far from suggesting "this stock might go under next year". We're simply eliminating anything from consideration for buy-and-hold where we would be concerned that the fundamentals might deteriorate. With those higher risk positions, it's better to just avoid going in rather than trying to figure out when to salvage a loss.

What about aggressive traders?

Aggressive investors or traders may be opposed to preferred shares because of their defensive nature. However, we believe there are opportunities for aggressive investors in the preferred share space. Higher yield preferred shares may be a great fit for an investor who is willing to take on more risk. Further, for investors who are willing to trade, we’ve had excellent success when trading in and out of preferred shares. That includes dividend captures.

How much should investors allocate to preferred shares?

We believe the amount that investors should invest in preferred shares is not a specific %. While writing this guide, our allocation to preferred shares was 29%. Our allocation in preferred shares can swing in either direction for a few reasons. When investors are confident in their common stock investments, they are less likely to invest a significant amount into preferred shares. When investors are worried about common stocks, they may allocate more to preferred shares. We believe that it’s important to look at:

  • The current economic environment
  • Personal investment style
  • Risk tolerance
  • Current valuations

What do we offer investors?

There is no perfectly safe investment. Even cash can be stolen (often not covered by insurance) or the value can be inflated away. We mainly focus on low-risk investments and have done quite well at it.

We've had rough periods. Since the start of 2016, our maximum drawdown was about 10% and it was in early 2018 (slightly larger drawdown than in early 2016 with the recession fears). In a nutshell, even though we can't guarantee safety, our downside risk is usually much lower than other methods targeting the 7% to 8% return.

Our system has also consistently outperformed the major indexes for stocks we cover. Those are the Vanguard Real Estate ETF (VNQ) and the iShares U.S. Preferred Stock ETF (PFF):

Why should investors choose individual stocks

Many investors turned to preferred share ETFs like the iShares U.S. Preferred Stock ETF. That technique has delivered some yield for the investors, but it delivered much weaker returns than picking individual shares. We explained this concept at great length in Preferred Shares Week 147.

Within that article, we charted total returns for PFF and included MFA-B (MFA.PB), DX-B (DX.PB), and CMO-E (CMO.PE). We use a unique charting technique for this purpose. Instead of calculating returns from one singular date, we chart based on current values. We want to answer the question:

"To have $100,000 in these shares today, how much would I have needed to invest (with dividend reinvestment) on any prior day?"

By phrasing our question that way, we can view thousands of potential starting dates and prices at once. Here is the chart:

The chart is designed so that all the final points must line up at precisely $100,000. Most charts show returns only from one starting date, but our chart shows returns based off any starting date. That means we don’t need to draw a new chart every time we want to look at a different date.

You can tell at a glance that an investor who bought DX-B, CMO-E, or MFA-B on any day between 7/1/2016 and 1/1/2018 was significantly outperforming PFF. You know that because throughout that period the highest line (worst performance going forward) came from PFF’s green line.

You also can see that these preferred shares usually correlate very well together. Small breaks in the valuation can appear for a few months, but the longer-term correlation is extremely strong. This is why we monitor prices so closely. We’re watching for those opportunities as they occur.

The next thing you may notice is the volatility. The preferred share lines (blue, gold, and red) are not showing materially more volatility than the ETF. They are climbing much faster, but the change from one period to another is not more volatile. This is important because it reflects the difference in risk. Since the ETF is diversified, it “should” be far less volatile than the preferred shares.

Why isn’t the diversification working?

Diversifying between several mediocre investments doesn’t create a great investment. PFF’s holdings include too many shares with excessive credit risk (terrible balance sheets) or excessive interest rate risk (yields are too low).

The concept of diversification is excellent

We encourage investors to diversify among several good investments. However, diversification by itself does not protect investors from including poor investments in their portfolio. PFF’s long-term performance is hampered by the inclusion of several poor investments. Diversification reduces the impact of a single bad investment but it doesn’t replace doing due diligence.

Mary’s strategy

Mary has chosen her 30 dividend champions:

Ticker

Name

Income

Yield

(NWN)

Northwest Natural Gas Company

$232.87

2.79%

(PG)

Procter & Gamble Company (THE)

$231.16

2.77%

(EMR)

Emerson Electric Company

$260.32

3.12%

(MMM)

3M Company

$291.40

3.50%

(ESS)

Essex Property Trust

$219.42

2.63%

(CINF)

Cincinnati Financial Corporation

$182.94

2.20%

(KO)

Coca-Cola Company (THE)

$259.02

3.11%

(JNJ)

Johnson & Johnson

$230.67

2.77%

(CWT)

California Water Service Group

$130.20

1.56%

(TGT)

Target Corporation

$248.60

2.98%

(SWK)

Stanley Black & Decker, Inc.

$161.62

1.94%

(MO)

Altria Group, Inc.

$524.76

6.30%

(SYY)

Sysco Corporation

$182.90

2.19%

(BKH)

Black Hills Corporation

$216.15

2.59%

(UVV)

Universal Corporation

$424.40

5.09%

(WMT)

Wal-Mart Stores, Inc.

$168.04

2.02%

(PEP)

Pepsico, Inc.

$240.99

2.89%

(XOM)

Exxon Mobil Corporation

$389.35

4.67%

(MCD)

McDonald's Corporation

$190.32

2.28%

(NNN)

National Retail Properties

$306.61

3.68%

(O)

Realty Income Corporation

$310.94

3.73%

(LOW)

Lowe's Companies, Inc.

$189.88

2.28%

(KMB)

Kimberly-Clark Corporation

$256.13

3.07%

(ED)

Consolidated Edison, Inc.

$274.89

3.30%

(TGT)

Target Corporation

$248.60

2.98%

(TROW)

T. Rowe Price Group, Inc.

$244.03

2.93%

(CVX)

Chevron Corporation

$328.03

3.94%

(PM)

Philip Morris International Inc.

$490.56

5.89%

(VZ)

Verizon Communications Inc.

$347.87

4.17%

(HP)

Helmerich & Payne, Inc.

$461.59

5.54%

Here are the reasons Mary wanted to go with dividend champions:

Dividend champions will have a high probability to continue to raise their dividends. The income should continue to go up for this portion of Ted and Mary’s portfolio. The companies have growth potential. Though the yields may not be as high as they need, the equity they own in the companies should go up. In the event of a market panic, these companies should do better than the overall market for a few reasons. One, the dividends will still be coming in when the stock falls. Two, these companies overall have a history of raising dividends, even through multiple recessions. Three, large companies that have been around for a while have a better shot at withstanding a significant drawdown.

This portion of the portfolio only has a yield of 3.3%. If Ted and Mary had this as their entire portfolio, they’d be making around $41,250 from the yield. That wouldn’t be enough for their current lifestyle and health insurance.

Treasuries

Here are Mary’s two choices for short-term Treasury ETFs:

Ticker

Name

Income

Yield

(VGSH)

Vanguard Short-Term Government Bond ETF

$4,044.90

2.16%

(SCHO)

Schwab Short-Term U.S. Treasury ETF

$3,989.47

2.13%

Here are a few reasons Ted and Mary decided to go with short-term Treasuries:

  1. They want treasury ETFs because they are a highly liquid substitute for cash.
  2. They provide superior income compared to checking or savings accounts.
  3. They want liquid funds in the event of a healthcare emergency.
  4. The S&P 500 is richly valued. They didn’t want to go all in at these prices.

This 20% portion of the portfolio only gave them an annual income of $8,034.75. However, this gave them an option for cash if anything came up.

Ted’s strategy

Here are the preferred shares Ted chose:

Ticker

Name

Income

Yield

(AGNCN)

AGNCN from AGNC

$4,222.97

6.76%

(ANH.PC)

ANH-C from Anworth

$4,706.44

7.53%

(CHMI.PA)

CHMI-A from Cherry Hill Mortgage

$4,998.63

8.00%

(CIM.PB)

CIM-B from Chimera Investment Corp.

$4,863.81

7.78%

(CMO.PE)

CMO-E from Capstead Mortgage

$4,608.24

7.37%

(DX.PB)

DX-B from Dynex Capital

$4,840.39

7.74%

(MFA.PB)

MFA-B from MFA Financial

$4,659.17

7.45%

(NLY.PF)

NLY-F from Annaly Capital Management

$4,244.10

6.79%

(TWO.PE)

TWO-E from Two Harbors

$4,719.59

7.55%

(GBLIL)

Baby bond from Global Indemnity Limited

$4,755.80

7.61%

Here are some reasons for why they chose these high yielders:

  1. Preferred shares in the mortgage REIT sector can frequently be purchased near their call value or slightly lower.
  2. The stability in the share prices is a huge advantage for investors who want a portfolio with lower volatility.
  3. Getting shares with yields of 6.7% to 8% from common shares would involve dramatically more risk.
  4. Preferred shares will continue to pay out their dividends unless the common stock dividend goes to zero. This is very unlikely to happen unless a liquidation happens.
  5. In the event of a liquidation, preferred shares holders get paid before any money goes to common shareholders. This is where the ratio of common equity to preferred equity comes into play.
  6. The high yields from the preferred shares make up for what they couldn’t get out of dividend champions.

Big dividends

Ted was able to invest 50% of their portfolio into high dividend yields. This part of the portfolio will be able to give them an annual income of $46,619.15.

Combining that with their dividend champions and their short-term Treasury ETFs, they are looking for $62,900.76 in income from their total portfolio.

Total portfolio income

Income from the dividend champions should increase every year, which will help the total portfolio income. The Treasury ETFs also help, but Ted and Mary may decide to sell off a portion of those positions to help cover their expenses. If they wanted to file for social security earlier, they would have additional income in the current periods. However, if they want to delay social security for a larger paycheck when it comes, then the Treasury ETFs are an excellent place to store the cash until they need it.

The main purpose of including these short-term investments was in case they needed extra money. Couples can live in some cities with an income in the $40,000 range, but that would be much more difficult without health insurance provided by an employer or access to Medicare. The higher income will help Ted and Mary cover their health insurance plan, living expense, and their activities throughout the year.

Where to live

Ted and Mary sold their home in Portland, OR for $350,000. They wanted to move somewhere with a much lower cost of living. They wanted at least four bedrooms for visitors and wanted to be in a nice neighborhood. $350,000 was enough to get them the house they wanted.

Here’s home price information from the Zillow website:

In addition, they wanted:

More days where the sun was out closer to the mountains, not dealing with the Portland DMV.

Ted and Mary decided to move to Colorado Springs.

Climate

Here’s a climate history from U.S Climate Data:

Ted and Mary were happy to move to this climate. It gives them enough of a range in temperatures to experience all the seasons. They also liked how during the winter months they were able to get snow, but the majority of the time, it melted the same day. This was nice for a couple of reasons. One, it meant the roads were usually clear the day of or after a storm. Two, it meant they would be getting a lot of sun. Ted and Mary love the sunshine.

Cost of living

Here is the cost of living from the Colorado Springs CHAMBER & EDC website:

Ted and Mary liked the area in Colorado Springs, but they also liked the idea of living by Denver. The couple enjoy eating out frequently. They also love to go watch shows, and there’s a lot more in Denver than there is in Colorado Springs.

Costs

Even though the cost of living was a benefit in moving to Colorado Springs, Ted and Mary enjoy going out several nights a week. They intend to go out to eat and catch a show in Denver or Colorado Springs at least a couple of times a week.

End of the story

Ted and Mary get through retirement despite the occasional market panic, unexpected medical bills, and periodically helping their relatives through hard times. They were able to get through it all because they were disciplined and created an intelligent portfolio in advance. They also had medical bills that their insurance didn’t cover and cost them $150,000. However, they were able to sell their positions in their short-term Treasuries and cover all the additional costs.

They credit their success to remaining disciplined. They avoid taking on excessive risks in search of the highest possible yields. They know that grasping for yields leaves permanent damage to the portfolio. It’s an important lesson for all investors to recognize. Yet it helps them avoid painful recommendations for cutting expenses:

Disclosure: I am/we are long AGNCN, MFA-B, NLY-F, CIM-B, WMT, MO, PM,ESS. 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.