October 2017 Newsletter

The Costly Misconception About Investing for Income

I discovered years ago that there are many aspects of income-based investing that make it a practical choice for investors in or near retirement—including risk reduction. When I’m able to teach this to others, it’s like a light-bulb turns on as they realize: “Increasing my income doesn’t require increasing my investment risk, but just the opposite!” It comes as a revelation because everyday investors are constantly bombarded by misinformation that causes misconceptions, so I’d like to address one of the most common and potentially costly misconceptions.

 

It pertains to the difference between “growth” and “return.” Many people use those words synonymously because they’ve been brainwashed by Wall Street—and advisors with stock-based business models—to believe that investing for growth is the only way to get a reasonable return on their investments. To clear up this misconception, I use a simple formula to illustrate that “return” actually stems from two components: TR = I + G, which stands for “total return equals income plus growth.” To expand on that, it’s important to understand that the “income” portion of total return comes in the form of interest and dividends, while growth is measured in capital appreciation. Many people are led to believe that in order to increase returns, you must increase growth and that the best way to do that is through traditional “buy and hold” investing in the stock market. Thus, many people have the idea that increased retirement income requires increased risk.

 

‘G’ Sometimes Turns to ‘L’

 

That’s wrong for two reasons. The first is that growth can quickly turn to shrinkage or loss when the stock market suffers a major downturn—as it has twice so far since 2000. The second is that when you invest for income instead of growth, you’re typically investing in vehicles designed to significantly reduce volatility. For example, they can be insured or come with contractual guarantees (based upon the issuer’s credit-worthiness) that let you know your money is secure as it generates income. So, while increasing your portfolio growth may require increasing your risk, increasing your income—if that’s your goal, which it should be after age 50—ideally, calls for reducing your risk and focusing on strategies specifically designed for protection and income.

 

This isn’t to say you must sacrifice growth when you shift your focus to income. You can continue to grow your portfolio “organically,” or the old-fashioned way, by strategically reinvesting the income you don’t need into other conservative vehicles. The result is reasonable portfolio growth with far less risk and more reliable retirement income through interest and dividends in the average range of 4-6 percent, even in today’s low-interest-rate environment.

 

This is where advisors with conventional Wall Street-based business models would likely try to argue: “But the stock market has gone up over 20 percent just since the presidential election and up over 60 percent since 2000!”1 That may sound impressive, but what does it actually mean in terms of returns for those who’ve hung on through those two major drops and are still committed to the market? Well, 60 percent equates to a little less than a 3 percent average return since the turn of the century and 4.99 percent with dividends factored in.

 

The point is, income-based investors whose portfolios have been properly managed to earn around 5 percent have achieved comparable returns to investors focused on growth. But, they’ve done it with far less risk of a major loss during those two major market corrections and without the continued risk of a third correction—which, by the way, market history suggests is very likely.

 

Is Now a Good Time to Reduce Risk?

 

I know many of you may be familiar with a lot of these concepts already. But, I like to reiterate them in different ways to help you potentially educate friends and family members you know who might be clinging to some of these common misconceptions. Here is another one you can clear up for them if they should ask: “Wouldn’t I be a fool to get out of the market now while it’s still going up?” The simple answer is no, you wouldn’t. As with the misconception about risk and income, the reality is just the opposite of what many people are led to believe. Now is actually a smart time to get out based on the most basic principle of investing: buy low, sell high.

 

Now, could the markets climb even a bit higher in the coming months? Sure, but is anyone not aware, by now, of just how many potential tipping points are in place for the next major market correction? I’ve been calling attention to these points for months, and rather than any getting resolved, they just keep increasing. For example, the market’s entire growth since the election—which I call the “froth” on top of what was already an overvalued market—is almost dependent on the success of Trump’s tax plan. Its approval was never a given, but approval now seems even more questionable with our national debt having surpassed the $20 trillion milestone and Trump agreeing to temporarily raise the debt ceiling.2

 

I’ve also talked about the potential impact of the Fed’s efforts to “unwind” quantitative easing, which could topple the markets regardless of whether their efforts succeed or fail. Other factors include increasing tensions with North Korea, the Russia investigation—the list goes on and on. Recently, I likened the market to a floating balloon in search of a pin to land on. So, does it make sense to focus on income and reduce your risk now before the balloon lands and pops? I think so!

 

1.     macrotrends.net

 

2.     John Bat, “National Debt Hits Historic $20 Trillion Mark,” CBS News, last modified September 11, 2017, https://www.cbsnews.com/news/national-debt-hits-historic-20-trillion-mark/

 

Copyright © 2017. All Rights Reserved, Pacific Financial Planners, LLC.

 

Pacific Financial Planners, LLC is an Independent Registered Investment Advisor. Securities offered through Western International Securities, Inc., headquartered in Pasadena CA. Pacific Financial Planners, LLC and Western International Securities, Inc. are separate and unaffiliated. The material contained within are the opinions of Jerry Slusiewicz only and are neither an offer or recommendation to buy or sell any securities or strategies mentioned. You should always check with your professional financial advisor and/or tax advisor before taking any action on any of the securities or strategies contained on this site.

 

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