Planning, Building & Managing Retirement Income Portfolios

The reason people assume the risks of investing in the first place is the prospect of achieving a higher "realized" return than is attainable in a risk free environment…i.e., an FDIC insured bank account featuring compound interest.

Over the past twelve years, such risk free saving has been unable to compete with riskier mediums because of artificially low interest rates, forcing traditional "savers" into the mutual fund and ETF market place.

Mutual funds and ETFs have become the "new" stock market, a place where individual equity prices have become invisible, questions about company fundamentals meet with blank stares, and where naive individuals think that they aren't really risking their nesteggs "in" the stock market at all.

Risk comes in various forms, but the average income investor’s primary concerns are "financial” and, when investing for income without the proper mindset, "interest rate" and “market” risks.

Financial risk involves the ability of corporations, government entities, and even individuals, to honor their financial commitments... an actual risk of financial loss.

Market and interest rate risks stem from the absolute certainty that all marketable securities will experience fluctuation in market value (i.e., their price)... sometimes more so than others. But this "reality" should be planned for and dealt with rationally... and never feared. These perceived risks can only be turned into a real financial loss by selling

Question: Is it still the demand for individual stocks that push up mutual fund and ETF prices, or is it now just the opposite?

We can minimize financial risk by selecting only higher quality (investment grade) income purpose securities, by diversifying properly, and by understanding that market value change is actually "income harmless". By having a plan of action for dealing with "market risk", we can actually turn it into investment opportunity.

What do banks do to get the amount of interest they guarantee to depositors? They invest in securities that pay a fixed rate of income regardless of changes in market value.

You don’t have to be a professional investment manager to manage your investment portfolio professionally. But, you do need to have a long term plan and know something about asset allocation… an often misused and misunderstood portfolio planning/organization tool.

For example, annual portfolio "re-balancing" is a symptom of dysfunctional asset allocation. Asset allocation needs to control every investment decision throughout the year, every year, regardless of changes in market value.

It is important to recognize, as well, that you do not need hi tech computer programs, economic scenario simulators, inflation estimators, or stock market projections to get yourself lined up properly with your retirement income target.

What you do need is common sense, reasonable expectations, patience, discipline, soft hands, and an over-sized driver. The "KISS principle" should be the foundation of your investment plan; compound earnings is the epoxy that keeps the structure safe and secure over the developmental period.

Additionally, an emphasis on "working capital" (as opposed to market value) will help you through all four basic portfolio management processes. (Business majors, remember PLOC?) Finally, a chance to use something you learned in college!

Planning for Retirement
The retirement income portfolio (nearly all investment portfolios become retirement portfolios eventually) is the financial hero that appears on the scene just in time to fill the income gap between what you need for retirement and the guaranteed payments you will receive from Uncle and/or past employers.

How potent the force of the super hero, however, does not depend on the size of the market value number; from a retirement perspective, it's the income produced inside the costume that shields us from financial villains. Which of these heroes do you want in your wallet?

A million dollar VTINX portfolio that produces about $19,200 per year in spending money... less than 2%

A million dollar, well diversified, income CEF portfolio that generates more than $80,000 annually... even with the same equity allocation as the Vanguard fund (just under 30%), and without including capital gains.

A million dollar portfolio of GOOG, NFLX, and FB that produces no spending money at all.

I've heard said that a 4% draw from a retirement income portfolio is about normal, but what if that's not enough to fill your "income gap" and/or more than the amount produced by the portfolio. If both of these "what ifs" prove true... well, it's not a pretty picture.

And it becomes uglier rather quickly when you look inside your actual 401k, IRA, TIAA CREF account, ROTH IRA, etc. and realize that it is not producing even close to 4% in actual spending money. Total Return, yes; gain in Market Value, sure. But realized, monthly, constantly growing, spendable income, 'fraid not.

Sure your portfolio has been "growing" in market value over most of the past twelve years, but it is likely that no effort has been made to increase the annual income it produces. The financial markets live on market value analytics, and so long as the market goes up every year, we're told that everything is fine.

So what if your "income gap" is more than 4% of your portfolio; what if your portfolio is producing less than 2% like the Vanguard Retirement Income Fund; or what if the market stops growing by more than 4% per year ... while you are still depleting capital at a 5%, 6% or even a 7% clip???

The less popular (available only in individual portfolios) Closed End Income Fund approach has been around for decades, and has all of the "what ifs" covered. They, in combination with high quality equity CEFs (certainly containing a significant number of Investment Grade Value Stocks), have a unique ability to take advantage of market value fluctuations in either direction, increasing portfolio income production with every monthly income reinvestment ritual.

Monthly reinvestment must never become a DRIP (dividend reinvestment plan) approach, please. Monthly income must be pooled for selective reinvestment where the most "bang for the buck" can be achieved. The objective is to reduce cost basis per share and increase position yield... with one click of the mouse.

A retirement income program that is focused only on market value growth is doomed from the get-go, even in Investment Grade Value Stocks. All portfolio plans need an income focused asset allocation of at least 30%, oftentimes more, but never less. All individual security purchase decision-making needs to support the operative "part growth purpose and part income purpose" asset allocation plan.

The "Working Capital Model" is a 40+ years tested auto pilot asset allocation system that pretty much guarantees annual income growth when used properly with a minimum 40% income purpose allocation.

The following bullet points apply to the asset allocation plan running individual taxable and tax deferred portfolios... not 401k plans because they typically can't produce adequate income. Such plans should be allocated to maximum possible safety within six years of retirement, and rolled over to a personally directed IRA as soon as physically possible.

The "income purpose" asset allocation begins at 30% of working capital, regardless of portfolio size, investor age, or amount of liquid assets available for investment.
Start up portfolios (under $30,000), however, should have no equity component, and no more than 50% until six figures are reached. From $100k (until age 45), as little as 30% to income is acceptable, but not particularly income productive.

At age 45, or $250k, move to 40% income purpose; 50% at age 50; 60% at age 55, and 70% income purpose securities (or more, depending on size) from age 65 or retirement, whichever comes first.

The income purpose side of the portfolio should be kept as fully invested as possible, and all asset allocation determinations must be based on working capital (i.e., portfolio cost basis); cash is considered part of the equity, or "growth purpose" allocation

Equity investments are limited to seven year experienced equity CEFs and/or "investment grade value stocks" (as defined in the "Brainwashing" book). The problem with individual equities is the limited availability of reasonably priced (and reasonably "down" investment candidates) in rising markets. The equity CEF universe is stable in all market environments, much easier to "hedge" against corrections, and they pay considerably higher income distributions.

Even if you are young, you need to stop smoking heavily and to develop a growing stream of income. (By the time I was 34, my securities portfolio produced nearly double my salary.) If you keep the income growing, the market value growth (that you are expected to worship) will take care of itself. Remember, higher market value may increase hat size, but it doesn’t pay the bills.

So here's the plan. Determine your retirement income needs; start your investment program with an income focus; add equities as you age and your portfolio becomes more significant; when retirement looms, or portfolio size becomes serious, make your income purpose allocation serious as well.

Don’t worry about inflation, the markets, or the economy... your asset allocation will keep you moving in the right direction while it focuses on growing your income every year.

This is the key point of the whole "retirement income readiness" scenario. Every dollar added to the portfolio (or earned by the portfolio) is reallocated according to the "working capital" asset allocation. When the income allocation is above 40%, you will see the income rising magically every quarter... regardless of what's going on in the financial markets.
Note that all equity security distributions are also divvied up according to the asset allocation.

If you are within ten years of retirement, a growing income stream is precisely what you want to see. Applying the same approach to your IRAs (including the 401k rollover) , will produce enough income to more than pay the RMD (required minimum distribution) and put you in a position to say, without reservation:

Neither a stock market correction nor rising interest rates will have a negative impact on my retirement income; in fact, I'll be able to grow my income even better in either scenario...

Learn How to Fund a Healthier Retirement Income


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