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Retired? Here Is A New Retirement Plan For You

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Co-produced with Treading Softly

Introduction

When is the last time you had a truly impactful conversation with someone? One that challenged how you looked at the world, or even a single subject?

I can remember a conversation I had with my parents about retirement planning. They were in the midst of it for themselves, and it made them think about my Grandparent’s retirement plans. My Grandparents, who immigrated from Holland, faced various struggles before immigrating as they survived through World War II as youths and lived out the remainder of their lives in Canada.

They were hard-working, honest folk.

When talking about how they had worked and saved for retirement, my parents relayed how they followed the common advice in Canada at the time. It worked something like this:

  • Work hard
  • Buy a house and pay it off.
  • Sell it in retirement and downsize.
  • Use that money and the interest it earned to supplement their pensions and Canadian Pension Plan money (Canada’s equivalent to Social Security)

This was their plan, it sounded good when they heard it, and they followed it. They lived in an era of jobs providing pensions and low-risk savings paying high-interest rates. Many of us remember CDs earning nearly double digits!

So what happened? Well, the world’s economy faced struggles, and central banks cut rates across the globe. Decades of low inflation and deflationary pressures have led to persistently declining interest rates. When home values fell during the Great Financial Crisis, central banks slashed rates to zero. Many retirees had their long-term plans shattered as strategies like laddering CDs or A grade corporate bonds now fail to have sufficient returns.

We Need to Adjust When the Paradigm Shifts

You can’t play with the same old rules when the game changes. We live in a time when adjustments to how things operate come fast and furiously. Thanks to the Internet, information flows at a breakneck pace. The name of the game becomes adaptation.

I have worked in banking for most of my working years, and I can tell you that the paradigm has shifted even there. Initially, banks were slow to change, stuck in rigid patterns and few banks ever tried “something new”.

When I worked at Regions Financial, I had a supervisor who described their mindset like this:

We won’t be the first to do something, or even the second, but when we do it, we’ll do it right the first time and make a profit.

And while I was there, we did. Regions wasn’t the first to get into Mobile deposits, but they monetized it in ways that competing banks were unable to do – as one example.

Now banks have gone from slow to adapt to rapidly adaptive and fixing issues on the fly. The idea is to get it to consumers and see what catches, then fix issues as they arise or retire what doesn’t catch on. This spaghetti-tossed-on-the-wall method has created banking innovations that previous generations could not enjoy or benefit from. It also keeps consumers tied to their favorite bank more readily.

The issue with retirement planning is that so many of us get into one method or game plan, and we don’t shift when the paradigm changes. My grandparents fell into this issue. They bought the house, worked diligently to pay it off, and even downsized, but the world was different from their plans when it came to living off the interest. Interest rates had fallen considerably. Many retirees were caught off guard.

This is why our Income Method is so important. It’s fluid and growing. Instead of a step-by-step process, it is a set of principles to be applied to the current market situation.

The issue with retirement plans is that they are often structured like “how-to” guides that seldomly get updated. Likely you have been exposed to the “3% withdrawal rule” created to help retirees slowly draw down the principle of their portfolio over 30 years with pre-baked assumptions. It assumes 4% inflation, for example. It was adjusted years later towards 4% withdrawals due to inflation being tame for decades.

If you were to walk into a retirement advisor’s office, you would find many still live and breathe the “safe-max” or 3% withdrawal system. Why? They’ve never adjusted to the paradigm shift, and as such, many retirees are struggling to see good cash flow in their retirements, often having plenty of capital but afraid of taking too much out. They become even more fearful when the market goes through a “correction” like it is doing now.

Too many retirees live with the same fear my Grandfather did: Will I run out of money before I die? What about my spouse?

Flip the Script, Change the Result

Fear can be a massive motivator. It often leads us to do something incredibly stupid without thinking. We react now and ask questions later.

Others have a different fear response. Fear paralyzes them. Like a deer staring blankly into an 18-wheeler’s headlights, they get frozen in place until they’re impacted by harsh reality.

So how can you adjust your game plan?

First, we need a new source for your income. CDs, bank accounts, and Treasury notes simply are not going to cut it anymore.

Bankrate.com

CD rates were north of 8% for years and have collapsed over time. So to get the same income as a CD in the 90s, you need nearly 8x the savings now. Talk about the biggest declining income stream imaginable.

When people retort that dividend investing is “unsafe” or “risky” due to dividend cut risks, they don’t consider how rapidly the “safe” income streams saw their output vanish. The income was continually being “cut” every time an investment matured and was reinvested at lower rates.

Getting Income from Equities

This is why we go to the equity market for income. With equities, we can obtain much higher yields while benefiting from potential price and or dividend growth. Let’s look at how to do this safely and systematically, which we call The Income Method.

The first step is to identify our goal. How much income do you need? At HDO, we target 9-10% yields and often safely meet those goals, we do not compromise safety for income. Our current Model Portfolio has an average yield of 7.9%, slightly below our long-term target; however, we have several holdings from which we expect to see dividend growth over the next year.

Diversify, Diversify, Diversify

Secondly, we need to diversify our income streams. Those who held CDs felt very safe and piled the vast majority of their income into this location. They may have “diversified” by changing their maturity schedule or even having CDs at various financial institutions. However, as we’ve seen above, CD rates fell like rocks dropped in water. Many retirees failed to protect themselves from the risk of low rates.

We use our Rule of 42 – the answer to life the universe and everything! – to keep our portfolios seeing stable income. You should aim to have a minimum of 42 securities. This allows your income to come from varied sources. This way, if one security falls flat or even multiple investments, your income is protected.

No one bats 1000 when it comes to the market. Black swans, unforeseen events, and mismanagement of companies can all come out of the left field. Like a squirrel jumping into the street, sometimes life hits us out of nowhere.

In addition to a recommended minimum number of securities, we also provide High Dividend Opportunities members with suggested allocations for fixed income and other sectors. This is all designed to keep your portfolio on track and performing in the market’s current environment.

Fortunately, many “income alternative” investments have become available in recent years. Today, there are many equities that are biased towards providing high dividends, where a large portion of your total return will be dividends by design. Many corporate structures like CEFs (Closed-End Funds), BDCs (Business Development Company), and REITs (Real Estate Investment Trusts) all have legal requirements to distribute most of their taxable income. You’ll find that the HDO portfolio has a strong bias toward investments with these structures that provide a high-income level.

Stay Adaptable

Thirdly, to keep the script flipped and change the results of your retirement, you need to be adaptable. We talked about how banks changed their methods with changing times. Likewise, we need to be adaptable. This means we don’t marry any particular sector, never to part with it. It can become tempting for investors to become attached to the one sector they know and not touch anything else. One hundred investments, all in the same industry, isn’t good diversification.

For years, HDO refused to touch the CLO sector or even commodities. So why did we change? Those sectors exited their periods of issues and entered into periods of success. We started suggesting commodity exposure before the rest of the market woke up to inflation’s risks. This allowed HDO members to see 30% returns on BlackRock Resources & Commodities Strategy Trust (BCX), for example.

We work diligently to provide weekly “market outlooks” for all of you so you can see what we’re looking out for and what adjustments we are looking to make. These outlooks are simply an expression of the research we are doing to keep our portfolio moving forward and prepared for any coming storms. At HDO, we don’t want to just throw a list of stocks at you and expect you to buy them blindly. We strive to provide the “big picture” as we see it and explain why we buy certain investments at both the macro and micro levels.

The benefit of our portfolio is its active management. We don’t passively sit by, but we adjust as needed to be proactive – not reactive. Long-term members know we avoid making sudden large changes. Instead, we identify the major drivers of the market and seek to gradually shift our portfolio to fit our macro view a few tickers at a time. This allows us to shift our portfolio without disrupting our income.

Now You Have an Income

The big question for all retirees is always, “how much can I take out?” The irony is that most retirees live on much smaller incomes than their portfolios could support.

The inherent problem is that nobody knows the future. The stock market could crash 50% next month. It’s happened before, and it is foolish to assume it could never happen again. So many retirees err on the side of being conservative. After all, nobody wants to outlive their retirement.

This is where The Income Method differs most strongly from other retirement strategies. With other strategies, you have to calculate how much to sell and estimate how much you can sell off without putting your portfolio at risk.

You don’t need to dismantle your portfolio. What is my radical idea?

Most of you have been working since you were in your teens. You’ve earned varying incomes over the years. You’ve gotten raises, dealt with unexpected financial obligations, maybe even dealt with losing it, and still saved some to invest for your retirement. If you are reading this, you know how to manage a budget.

You’re getting an income from your portfolio; treat it like you have every other income you’ve ever earned in your life. Live on a portion of it, set aside an emergency fund to deal with life’s curveballs, and reinvest a portion for the future. The only thing different is the source of the income. Instead of a single job, you have 42+ income-paying investments.

So how much can you take out? You’ve managed to figure out something that worked for you when you were employed. It obviously worked. For me, I like to reinvest a minimum of 25%. This provides a reasonable pace of income growth while providing a healthy cushion to protect from dividend cuts. Just like when you were working, the more you reinvest today, the more income you will have in the future.

The best part is that you know what your income is to ensure you are always spending less. You don’t have to fear outliving your portfolio because you will never be forced to sell, and you won’t be relying on selling shares to fund your income needs. You will always be reinvesting a portion, which means you will always be a net buyer of stocks.

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Conclusion

I will say that thankfully my Grandfather’s worries never came to light. Both he and my grandmother passed away before their money ran out. They enjoyed their retirement immensely. They lived simply and enjoyed their time with family.

I hope we all can have a retirement filled with enjoyment and relaxation. Even more so, I don’t want any retiree to live with fear eating at the back of their minds.

You can achieve this by adapting to the current paradigm we live in. The market is the best source of retirement income ever presented, and yes, it means being watchful and careful. Keep your portfolio diversified and nimble to shift when needed. In the coming decades that we will spend together, more changes are due to occur, and we will be here to help us all navigate them together. Who would’ve thought we’d survive an entire pandemic in the short time we’ve been together.

If you know a friend who is worried or struggling with their retirement, feel free to share a copy of this article with them. We’d love to see them join our community and get their retirement on the right track!