If you are investing to fund your retirement, “income investing” may sound like just what you need. The financial world has plenty of tips and strategies purporting to accomplish just that. Yet in Fisher Investments’ view, you should press Pause before acting. Otherwise, you could end up with high-risk products or securities that may run counter to your long-term goals.
This largely stems from the financial industry’s penchant for jargon that can confuse everyday folks. People often use income and cash flow synonymously, figuring money they withdraw from their portfolio in retirement and the regular paychecks earned in their working years accomplish the same purpose. But in the financial world, income refers specifically to portfolio income—regular payments you receive from securities you own. That includes bond interest, stock dividends, interest on cash balances and income from more-nuanced securities like real estate investment trusts (REITs) and master limited partnerships (MLPs). Therefore, income investing generally refers to maximizing these payments or your portfolio’s “yield.” Many retirees believe the benefit of this is that spending only yield means you don’t touch your retirement portfolio’s principal, negating depletion risk.
Fisher Investments thinks this quickly confounds many retirement investors—even high net worth folks—because higher yields generally come with higher risk, especially in this era of ultra-low interest rates. Let us consider the case of Jim, an imaginary investor retiring today with $1 million in his 401(k) thanks to decades of diligent saving and wise investing. He determines he needs this account to generate about $50,000 annually to supplement Social Security—5% of his total portfolio value. (For simplicity, we are presuming this $50,000 accounts for the income taxes he will owe on both Social Security benefits and withdrawals from his qualified retirement account.) He doesn’t want to cut into his total account value if he can help it, so he looks for investments that will pay at least 5% interest.
But the choices are slim. As we write, 10-year US Treasury bonds pay only 1.6%. Even 30-year Treasurys pay just 2.0%, less than half of what Jim needs. The S&P 500’s dividend yield is a paltry 1.3%, while global stocks’ yield is scarcely better at 1.5%. The S&P 500’s real estate sector, which consists mostly of REITs, pays out just 2.4%. US corporate bonds pay 2.3%. US high-yield corporate bonds come closest to Jim’s target, with a 4.75% yield, but that comes with stock-like volatility and still won’t meet all his needs.
So Jim looks further afield, and everything he finds makes him quite nervous. At first, MLPs look good, as the Alerian MLP Index boasts a 7.7% yield. But then he sees MLPs are concentrated in the Energy industry, and he worries about staking his financial well-being on pipelines—especially with all the political wrangling over them and fossil fuels in general. He also sees this index is down -63.8% since mid-2014, which would have been a very large hit to his retirement portfolio’s principal. So he tries looking up top income investing strategy on the Internet, scrolls through a lot of suspicious-looking things, and then clicks on something that seems legitimate: special REITs that only a select few own because they aren’t traded on public exchanges.
These private, income investments seem good to Jim at first blush, and some claim to pay over 8%. That is alluring, and Jim knows real estate has been hot lately. But a little alarm bell goes off in his mind, saying this almost sounds too good to be true! A little more research tells him it is. Turns out many nontraded REITs have sky-high fees and would be very difficult to sell if he needs cash in a pinch. He also can’t verify nontraded REITs’ valuations since information is scarce and they don’t have public listings.
Another few hours of research prove fruitless. South American bonds seem to carry much more default risk than he is comfortable with. Russian bonds also appear too risky for him. Variable annuities are so complex they gave him a migraine, especially when he tries to figure out why anyone would want to sell him a tax-sheltered investment in his tax-deferred account.
If you are like Jim, Fisher Investments can help. Fisher Investments believes Income investing isn’t the only way to live off a retirement portfolio. Portfolio income is only one part of stocks’ and bonds’ total return. The other ingredient is price appreciation. If Jim’s hypothetical investments yield only 2% in a year but his hypothetical portfolio value rises 10%, then he can withdraw the 5% he needs—and finish the year with more hypothetical money than he started with. Now, stocks don’t return 10% year-in and year-out—there are good years, bad years, great years and just-ok years. It is also entirely possible investors would want to employ some bonds to mitigate volatility. But over time, the S&P 500’s returns have compounded at about a 10% annualized rate, generating the growth many investors have needed to fund retirement.
If you think in terms of investing for cash flow rather than income investing, it opens a lot of doors. Instead of hunting in risky corners for high yield, you can figure out the long-term rate of return you need to support a given level of annual withdrawals. Then, you can target the mix of stocks, bonds and other securities likeliest to achieve that return and build out a nice diversified portfolio. When you need cash, you can sell securities to generate it. Really, you can! You can even combine that effort with portfolio maintenance, taking the opportunity to trim positions that have grown too large relative to your portfolio, reducing your diversification.
Fisher Investments Founder and Executive Chairman Ken Fisher calls this approach generating “homegrown dividends,” and we think it is likely a better approach for most long-term investors than pure income investing as the industry defines it. It lets you invest in liquid assets that are fully transparent and easy to track. It doesn’t force you into countries with high political or default risks. Finally, it reduces the likelihood that you will get stuck in complex products that are likely better for brokers than for you.
So join the movement, and just say no to income investing!
Investing in stock markets involves the risk of loss and there is no guarantee that all or any capital invested will be repaid. Past performance is no guarantee of future returns. International currency fluctuations may result in a higher or lower investment return. This document constitutes the general views of Fisher Investments and should not be regarded as personalized investment or tax advice or as a representation of its performance or that of its clients. No assurances are made that Fisher Investments will continue to hold these views, which may change at any time based on new information, analysis or reconsideration. In addition, no assurances are made regarding the accuracy of any forecast made herein. Not all past forecasts have been, nor future forecasts will be, as accurate as any contained herein.