Invest for total return or for income?

[statsman]

My wife and I will be retiring some time next year. At that point, she'll be nearing 64 and starting social security. I will be 57.5 and starting my pension (non-COLA), required to be able to enroll in my company's retiree medical plan.

Given our expected expenses at the beginning of retirement, we would need about 1% from the total of our tax deferred and taxable accounts. If we sell our house and downsize, which is the plan at the moment, the extra cash from the downsize would drop the needed amount to 0.8%.

It would seem we don't need a high rate of return to be able to meet these requirements. About the time inflation would start eating away at the value of the pension, I would be able to start social security for myself.

Do we still concern ourselves with achieving as much total return as our risk tolerance will allow? Or do we invest in a way that would kick off more than enough dividends/interest/capital gains in order to meet the shortfall?

As mentioned before, my wife and I are very risk averse, but I think that is mostly due to watching the bottom line net worth drop in bad markets. As such, we have no equities investments. But if a combination of equity and bond funds were to produce enough to cover our expected shortfall without the need to touch principal (at least until the RMDs kick in), I imagine we could stomach that.

 

[LOL!]

Total return. Definitely, total return. Read this:
https://personal.vanguard.com/pdf/s557.pdf
and this
https://personal.vanguard.com/pdf/s352.pdf

But your risk aversion says something about the asset allocation you should want to have.

 

[ejman]

Dividends and CG. Definitely, Dividends and CG. A very conservative Wellesley or equivalent Vanguard Retirement income (all Index funds) will place 30-35% of your assets in stocks for inflation protection and the rest in a diversified bond portfolio (Vanguard Retirement income ads a dollop of international index funds) . Both will certainly give you more than the 1 % WR you want and you'll never have to sell shares so you'd be immune to market ups/downs (as long as you don't sell when the pundits go into panic mode).

 

[NW-Bound]

I invest for total return. However, if that means buying frothy stocks with high P/E, then I am out.

I like to go bargain shopping, and if I get more energy stocks, obviously I am counting on getting some capital gain when they recover.

 

[statsman]

Total return. Definitely, total return. Read this:
https://personal.vanguard.com/pdf/s557.pdf
and this
https://personal.vanguard.com/pdf/s352.pdf

But your risk aversion says something about the asset allocation you should want to have.

Thanks. I will read the articles and see if I have further questions.

Dividends and CG. Definitely, Dividends and CG. A very conservative Wellesley or equivalent Vanguard Retirement income (all Index funds) will place 30-35% of your assets in stocks for inflation protection and the rest in a diversified bond portfolio (Vanguard Retirement income ads a dollop of international index funds) . Both will certainly give you more than the 1 % WR you want and you'll never have to sell shares so you'd be immune to market ups/downs (as long as you don't sell when the pundits go into panic mode).

Interesting. I think this is a concept my wife and I would be comfortable with. I have been trying to get us back into equities, and this would be a way for us to do it. Despite being very risk averse, I would prefer investing like this than handing someone a large chunk of money for an annuity. We will already have my non-COLA pension; not a huge one but enough to cover at least 1/3 of our initial retirement costs.

 

[nun]

If al you need is 1% put everything into equites and go for total return. That's my plan.

You are have a Bernstein liability matching portfolio, once you have your income needs covered by safe stuff you can get pretty risky with what's left.

 

[statsman]

If al you need is 1% put everything into equites and go for total return. That's my plan.

You are have a Bernstein liability matching portfolio, once you have your income needs covered by safe stuff you can get pretty risky with what's left.

We would not be able to stomach a 100% equities investment portfolio, but 0% equities is not the answer either. And from what I have read so far from the Vanguard PDFs linked to in an earlier post, value stocks for their dividends plus bond funds is not the answer either. More reading to do, but I am not sure I am going to like Vanguard's recommended solutions.

 

[Ed_The_Gypsy]

Yes.

Next question.

 

[ETFs_Rule]

High dividends are for unsophisticated investors. Don't "chase yield". Keep it simple. Invest in a total stock market index fund or S&P 500 index fund and a total bond market index fund or total US bond market index fund.

 

[statsman]

High dividends are for unsophisticated investors.

Given my wife and I have been 0/80/20 (stocks/bonds/TIPs) in our 401(k)s since early 2008, I would say we easily fall into this category of investors. I will also say we got lucky. We sold out of equities when the Dow was teetering at 13,000 in early May 2008. Since then the balance on my wife's 401(k) at that time has gained 41%, while mine has gained 38%.

While being unsophisticated, I understand enough to know we very likely won't approach that return in the next 7.5 years using the same AA. That plus having almost as much cash in our taxable account as we have investments in our tax deferred accounts. Which is why I am forcing us to re-consider our no-equities portfolio as we prepare for retirement in the middle of 2016.

Don't "chase yield". Keep it simple. Invest in a total stock market index fund or S&P 500 index fund and a total bond market index fund or total US bond market index fund.

That seems to be a common message.

 

[ETFs_Rule]

Given my wife and I have been 0/80/20 (stocks/bonds/TIPs) in our 401(k)s since early 2008, I would say we easily fall into this category of investors. I will also say we got lucky. We sold out of equities when the Dow was teetering at 13,000 in early May 2008. Since then the balance on my wife's 401(k) at that time has gained 41%, while mine has gained 38%.

For clarification, there's nothing wrong with owning for example iShares US Utilities ETF. It pays a "high" dividend of about 3.5%. Anything that pays for example 7% or more right now becomes RISKIER! All too often something that pays 7% or more is a bait to take your eye off the ball, being the share price.

In 2009 you had the opportunity of a lifetime to get into stocks. But maybe you have already reached "critical mass" as Bob Brinker says. No point in taking much risk if you have amassed a fortune. However you might want to take note that owning NO stocks is RISKIER than owning 28% in stocks.

 

[Totoro]

However you might want to take note that owning NO stocks is RISKIER than owning 28% in stocks.

Going to be a bit pedantic here, apologies up front

Is OP talking about volatility or risk of loss?

Owning no stock virtually garantuees a return lower than inflation, so a garantueed loss. Even though in numbers you won't see much movement up or down, this is as risky as it will get (risk in terms of losing).

Moving a portion to equities reduces that risk, but unfortunately increases volatility (both up and down). This is the definition of risk that gets thrown around in most textbooks, and frankly in my view is a useless and even dangerous definition.

Assuming you'll get nervous seeing volatility here are three psychological tricks:

• Buy into a target retirement fund (as others have mentioned) with a 70/30 mix. Since it is grouped you won't see the bumps in the road as much as in solo equity land. A meltdown of 50% in equities is still only a 15% loss.
• Buy a consumer staples/discretionary fund. These are typically lower beta (less volatile) stocks. They tend to underperform in bull markets and outperform in bears. And pay divvies too.
• Buy a broad index tracker, but try to organize your accounts in such a way that you'll only see the dividend payments, not the capital.

That said, I really see no point in worrying too much about this. A withdrawal rate of 1% is as nuclear bomb proof as you can get (assuming you have healthcare covered). Not to mention your part of SS that comes in later in life.


The only effect a large equity share will have on you is best case more money for your heirs, worst case you don't sleep well some nights.

 

[Al18]

I think 80% bonds is pretty risky over the next 35 years. For municipal bonds - consider at least 1/4 of the states have underfunded their pension plans for years/decades - they will default on some of these bonds over time. I'd consider cashing out some of those bonds and moving to a CD ladder.

Also, the Fidelity Retirement Planner and others assume 7%+ medical inflation going forward. I think you'll need some equity exposure to keep up with that inflation rate.

 

[LOL!]

It seems statman's portfolio is large enough that they can do nothing and withdraw 1% for the next 100 years. It really does not matter what they do with their money from the info given.

Since they are so risk averse, I do not even understand the question posed:

Do we still concern ourselves with achieving as much total return as our risk tolerance will allow? Or do we invest in a way that would kick off more than enough dividends/interest/capital gains in order to meet the shortfall?

… because investing for total return is the same as "invest in a way that would kick off more than enough dividends/interest/capital gains" if "kick-off" means selling shares every now and then to realize capital gains. I do not believe one should invest in something that gives one uncontrolled realized capital gains. One should be able to choose for themselves when they need to realize capital gains.

So with the proposed expenses and the proposed withdrawal rate, statman and spouse could have 0% in equities. They could also buy a fund of bonds and equities such as the Vanguard Target Retirement Income fund (30% equities) that would hide the movement of equities from them which may help with risk aversion.

Maybe they would even want to spend more money, too.

 

[pb4uski]

With that low a WR you are in the zone where you have "won the game" and there are two schools of thought.

One extreme is that you don't have to take any risk so you can invest in safe assets. This is especially true if you don't care to leave a legacy to family or charity. A 10 year ladder of CDs would provide much more than 1% albeit with some inflation risk.

The other extreme is that you can go 100% equities since your portfolio is more than large enough to weather any storm with such a low WR.

Or of course, anything in between would be fine as well.

Since you state that you are risk averse you could buy a SPIA that provides the 1% that you need and then invest the rest in equities. According to immediateannuities.com a joint life SPIA for a 58 yo male and 64 yo female would pay about 5.29% (payout rate) so your initial investment would need to be about 19% of your nestegg. However the joint life with cash refund is priced close to the joint life and would use the same 19% so if you go with a SPIA I would look at that. The rest could be invested more aggressively... say 100/0 to 80/20. If you go in this direction and are worried about inflation you could buy a SPIA and a series of deferred payout annuities to provide extra guaranteed benefits to cover inflation that start every 5 years or so.

Another alternative would be to build a ladder of CDs that cover your spending for the next 10 years and then keep adding a 10 year CD from your equity portfolio as CD's mature so you have a rolling DIY 10 year annuity.

You have a nice problem to have in that everything is a good answer. I'm comfortable with risk and would probably go 80/20 if my WR was 1%.

 

[nun]

When you have a WR of 1% you can basically forget about running out of money. With such a low WR you default to an income approach and if you can get 2% dividends from equities you are generating twice what you need. The usual portfolio asset allocations we see are all about balancing the maximum withdrawal rate against risk and if you need less than 4% the criteria for success and asset allocation can change. So you can emphasize the potential growth of your portfolio over the risk that you might run out of money. This means more equites and any excuse to get out of bonds right now looks good to me. I would put a couple of years of spending into cash to give you some flexibility and prime your accounts and then do a 70/30 split between VTSAX and VGTSX.

There's no risk in you taking a lot of risk..........

 

[Mulligan]

High dividends are for unsophisticated investors. Don't "chase yield". Keep it simple. Invest in a total stock market index fund or S&P 500 index fund and a total bond market index fund or total US bond market index fund.

I certainly do not disagree with your advise, and unsophisticated investors can indeed get suckered chasing high dividends and chasing yield. But that is not true for all people. Many people are rewarded for doing it and know what they are doing. I am very pleased with my results in the manner I am doing it. But yes for many including newbies you certainly are 100% correct.


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[Danmar]

With such a low withdrawal rate you can do whatever makes you feel most comfortable. Considerations would be, do you want to leave a legacy (if so more equities), do you want to spend more later in retirement eg health care, (if so more equities). If these are not considerations any thing with equities at 30-50 % would be fine.

 

[W2R]

Given our expected expenses at the beginning of retirement, we would need about 1% from the total of our tax deferred and taxable accounts. If we sell our house and downsize, which is the plan at the moment, the extra cash from the downsize would drop the needed amount to 0.8%.

Given your low WR rate, it seems to me that the question is not so much total return investing vs income investing, as it is this: What do you plan to do with your excess money? What will bring you happiness and satisfaction? You could travel the world, donate to favorite charities, leave a lot for your heirs, buy a new home or car for yourself and/or for relatives, just live on 1% of it happily because your security will be so very high, and so on.
　
It may take you a few years to look within yourself and figure out the very best use for your money. There are worse tasks. But you do owe it to yourself to give this some considerable thought.

I, too, have a low WR (about twice yours, though!). I have invested 30% in Wellesley and the rest in broad index funds like Total Stock Market and Total Bond Market, plus I keep 5.5% in cash. I regard my investing as a total return approach although I spend less than the dividends. I just bought my Dream House and consider the cost of the house and move to be a reduction of portfolio principal rather than a withdrawal since I won't be doing that every year.

 

[RetireAge50]

Yes.

Next question.

This is what I was thinking.

 

[nun]

With a 1% WR the standard portfolios and withdrawal methods that are geared to maximizing SWR can be abandoned and IMHO the OP should look to maximize their wealth and come of with a plan for it; that might be leaving to heirs or charity etc. Now if the OP wants to spend more everything changes.

 

[daylatedollarshort]

Do we still concern ourselves with achieving as much total return as our risk tolerance will allow? Or do we invest in a way that would kick off more than enough dividends/interest/capital gains in order to meet the shortfall?

You could theoretically cover your retirement expenses buying 30 year TIPS and live off your other income and the interest alone (as of this writing 1.2% yield + inflation), and the principal will keep up with CPI pegged inflation. This strategy works better for retirement accounts but can work in taxable if your WR is low enough.

Look at all the liability matching strategy and especially posts by Bobcat2 and Bernstein at Bogleheads, plus Zvi Bodie articles and books for more on this topic. It is not a popular choice here. You'll find more info at BH on "won the game, time to stop playing" strategies.

Whether you need to concern yourself with growth beyond CPI inflation can become a personal decision strategy and not a financial necessity strategy at zero or low required withdrawal rates. Individual TIPS and TIPS ladders (not TIPS mutual funds), SS, I-bonds and inflation adjusted annuities are pegged to CPI inflation, stocks are not and have not always kept up with inflation over 10 - 20 year periods: Investing Error: Don't Use Stocks as an Inflation Hedge - DailyFinance

Though of course many decades stocks have done wildly better than inflation, so you have to decide what your goals are in terms of safety vs risk and what works for you. One book that helped me decide how to choose a strategy was Against the Gods: The Remarkable Story of Risk and a description of the diminishing marginal utility of wealth idea.

 

[ETFs_Rule]

Someone recommended a SPIA. Like all annuities, SPIA's are a raw deal.
The salesmen who sell them NEVER talk about what happens in the later years of retirement with these duds.

 

[nun]

Someone recommended a SPIA. Like all annuities, SPIA's are a raw deal. The salesmen who sell them NEVER talk about what happens in the later years of retirement with these duds.

I like SPIAs in some circumstances, but not for the OP as they already have guaranteed lifetime income from pensions. They don't need more annuities. My income comes from a pension, rent and TIAA-Traditional and the rest gets invested 100% in low cost broad equity index funds. No bonds and no rebalancing, just reinvest dividends. I'd recommend toe OP do something similar; take 1% dividends to live off and reinvest the excess.

 

[NW-Bound]

You could theoretically cover your retirement expenses buying 30 year TIPS and live off your other income and the interest alone (as of this writing 1.2% yield + inflation), and the principal will keep up with CPI pegged inflation. This strategy works better for retirement accounts but can work in taxable if your WR is low enough.

Look at all the liability matching strategy and especially posts by Bobcat2 and Bernstein at Bogleheads, plus Zvi Bodie articles and books for more on this topic. It is not a popular choice here. You'll find more info at BH on "won the game, time to stop playing" strategies...

I could do the above, and along with SS can have the same lifestyle I do now. But I like to take some risks with the market and keep 60% in stock (used to be as high as 80%).

I like a bit of excitement to keep life interesting, and besides, the financial risk is small relative to the health risk that I once thought I did not have.