Welcome to Protect Your Retirement! On this week’s episode, we talked about inflation, fixed income, dividends, and social security. Many soon to be retirees have some plans on how they will retire but the small things are what can ruin your retirement. Enjoy this episode of Decker Talk Radio and be sure to tune in next week for a new episode.
MIKE: Good morning everyone, this is Mike Decker here with Decker Talk Radio’s Protect Your Retirement, and I am here with Brian Decker, who is a licensed fiduciary from Decker Retirement Planning and we’re just so grateful to have him here, and we’re gonna kick this show off with financial news of today. Brian what do you have for us today?
BRIAN: I’ve got some interesting information about how the stable money markets that we take for granted and our 401k’s, how a new rule called SEC 2A-7 went into effect a week ago Friday. KVI listeners, this is a big deal because this is a ruling that was dreamed up after the big 2008 meltdown and the idea is this: when the money market gets really nervous, a lot of people storm the gates, they sell their stocks, they go into the money market.
BRIAN: That gets the managers of the money market funds scrambling for a quick high return investment because they’ve mandated to keep their NAV, the Net Asset Value, at par, which is one dollar per share. If you remember in 2008, they broke par and it was a big deal. It caused a lot of concern among people that hold what’s supposed to be money in a money market fund in 401k’s. Now KVI listener’s I wanna be very specific.
BRIAN: We here at Decker Retirement Planning wanna make sure that you keep your retirement safe. So, specifically to people who are within five years of retirement and have 401k money invested, this is for you. So, when you’ve got all these funds looking for quick high-return assets to fend off too many people just trying to get their money out, it creates an enormous stress on the par value of the Net Asset Value of the money market fund.
BRIAN: The new rules allow the NAV to float. The price per share of your money market, which ultimately means that the money can be invested in a fund that could allow you to lose money on your money market fund. This is not something that we’re excited about. When we found this out, we wanted to immediately alert you, KVI listeners, and give you a way around this. The whole reason people park money in money market accounts is for the safety aspect.
BRIAN: You could get a higher return than a savings account elsewhere, but you want stability. But now there’s a problem with this floating NAV, and there may be times, KVI listeners, when your 401k will not allow you to redeem your funds, where they may say that they have 10 days to do that. Many of the CFO’s, Chief Financial Officers, have looked over the situation and decided to move away from traditional money market funds and to put their money only in government-backed paper such as agencies or treasuries.
BRIAN: Those are not subject to new rules, including the redemption rules that we’re talking about with the new rule SEC 2A-7. So what does that mean for you? Well, you’ve got choices. Most people utilize a money market via a portion of their 401k, and you expect that you’re gonna make some money. Well, with today’s low rates, you just expect that it’s gonna be safe, that’s all.
MIKE: I was gonna say [LAUGHS].
BRIAN: Yeah. With the new rules in place, it’s extremely important that the money market funds the 401k manager is using has tons of liquidity. In other words, let’s say you’re a fund manager for ABC Investments and you run a 401k for 5000 companies. In the past, you’d utilize money market funds just anywhere. They were all safe. Now with the new floating NAV rule, it’ll be easy for money market managers to not have enough liquidity to meet the obligations in the ebbs and flows of money markets, and potentially requiring your redemption rules, where you can’t get your money out for 10 days or so.
BRIAN: So, if you’re in a 401k, KVI listeners, and you have an option to use treasuries or government money markets, we hope that you use them because they don’t fall under this floating NAV rule anymore. So, I just wanna throw that out there. Mike, that’s item number one.
MIKE: [LAUGHS] out of how many? How many more items do we have today on the financial news?
BRIAN: We’re gonna have four items. I’m gonna talk about Chinese banks right now, credit card debt, and I’m gonna finish with the Federal Reserve, and talk about how quantitative easing, how it’s getting so many complaints and the problems of it. I’m gonna jump into Chinese banks. So, we here at again, Decker Retirement Planning in Kirkland, we have a focus on protecting your retirement, and want you, KVI listeners, to look at the “canary in the coalmine”, which one of them, and there’s a few, one of them is the Chinese banks.
BRIAN: China has failed to curb excesses in its credit system and faces mounting risks of a full-blown banking crisis, according to early warning indicators released by the world’s top financial watchdog. A key gauge of credit vulnerability is now three times over the danger threshold, and has continued to deteriorate despite pledges by Chinese Premier Li Keqiang, to wean the economy off the debt-drive grown before it’s too late.
BRIAN: The bank for international settlement, we call it BIS, warned in its quarterly report, that China’s credit-to-GDP gap has reached 30.1. The highest-to-date, and it’s in a different league altogether by the way, from any other major country tracked by the BIS. It’s also significantly higher than the scores of east Asia speculative boom in 1997, or in its U.S. subprime bubble before the Lehmann crisis.
BRIAN: Studies in earlier banking crises around the world over the last 60 years, BIS flashes red alert for a banking crisis in China, suggesting that any score above 10. Now remember, China has 30.1. Any score above 10 requires careful monitoring. The credit-to-GDP gap measures deviations from normal patterns within any one country and therefore strips out cultural differences. This is apples and apples. It’s based on work that the U.S. economist Hyman Minsky and has proved to be the best-single gauge of banking risk, although the final litmus test can often take longer than assumed.
BRIAN: Indicators for what would happen to debt service costs if interest rates rose up 2½ percent, or we call it 250 basis points, are also well over the safety line. China’s total credit reached 255 percent of GDP at the end of last year. So, KVI listeners, if China’s total economy is $10 trillion, they have $25 trillion in GDP. They have 255 percent of GDP at the end of last year, and that’s, by the way, a jump of over 100 percent in the last eight years.
BRIAN: KVI listeners, when the markets crashed in 2008, China, as a country, turned and added over 100 percent, 107 to be exact, in additional debt in the next eight years. Now, by the way, of course, the economy has been growing, but this is an extremely high level for a developing country, and is still rising fast. China’s debt ratio has rocketed. Outstanding loans have reached $28 trillion, as much as the commercial banking system of the U.S. and Japan combined.
BRIAN: I’m almost done with this. The scale is enough to threaten a world-wide shock if China ever loses control. The too-big-to-fail is very pertinent here. Corporate debt alone has reached 171 percent of GDP and it is this that keeps global regulators awake at night. The BIS said that there’s ample reasons to worry about the health of the world’s financial system. Zero interest rates and bond purchases by central banks have left markets acutely sensitive to the slightest shift in money policy or even a hint of a shift.
BRIAN: “There’s been a distinctly mixed feel to the recent rally, more stick than carrot, more push than pull”, said Claudio Borio, who’s the BIS Chief Economist. He went on to say this explains the nagging question of whether market prices fully reflect the risks ahead. Bond yields in the major economies normally track the growth rate of the nominal GDP, but now they are far lower. So, KVI listeners, the first story was making sure that your 401k is in treasury or U.S. government money markets because of the new rule of allowing floating NAV’s on your money market.
BRIAN: We’re looking out for you guys. The second thing is to make sure that you know, and watch, the debt levels over in China. Mike, I’m gonna switch over to credit card debt here in our country, and this’ll just be a few minutes, but it’s important what’s going on.
MIKE: Sounds good.
BRIAN: According to a July survey of consumer expectations by the Federal Reserve Bank of New York, one in seven borrowers expect to miss a debt payment. That’s up from one in nine just six months ago.
BRIAN: The uptick was pronounced for households below the age of 40 and those with a high school degree or less. This is sad. 15 percent of American families have no wealth, no savings, or worse, negative net wealth. In June, consumer credit hit a fresh record high of $3.6 trillion. By the way, consumer credit sounds nice, but that’s debt, that’s consumer debt.
BRIAN: Disposable personal income growth, adjusted by inflation, grew just 2.2 percent over last year. That was a full percentage point below March’s 3.2 percent pace. The savings rate fell in June to 5.3 percent. That’s the lowest since last October. Meanwhile, the revolving credit growth, that’s also known as credit card spending, galloped ahead at a 9.7 percent annual rate. According to the Financial Times, U.S. banks extended $18 trillion in credit card and over-draft loans to consumers in three months through June.
BRIAN: That’s the fastest pace since 2007, triggering concern they’re taking on way too much risk in a slowing economy. Productivity growth fell by a half a percent in the second quarter, way below estimates predicting it would actually rise by .4 percent. Dismal productivity is what you get when you combine a capital investment strike, a labor market plagued by immobility, and a slow-down in new business formation. I’m gonna sum it up with this:
BRIAN: If, rhetorically, you ask, is it possible that the market is a tad bit ahead of itself? The S&P’s reported earnings are expected to fall by 3½ percent, year over year, and this quarter that we just started may make it the seventh quarter in a row of falling or declining earnings per share. KVI listeners, we here at Decker Retirement Planning want you to be aware of the change in the laws for the Net Asset Value, first thing top of the hour that we talked about.
BRIAN: We want you to know about the Chinese debt, and we want you to know about the amazing consumer debt we have in our country. Those last two are two canaries in the coalmine that we want to make sure that you are aware of and know the situation that we have right now. Mike, before we get into the last part of the top-of-the-hour news, I’m gonna go into probably… gosh, this is probably gonna be seven minutes.
BRIAN: That takes us over our 15 minutes that we allocate, Mike, for the news. But this is on a big deal. This is quantitative easing, and these are 10 problems with quantitative easing’s and what they’ve created for Americans and American investors. I’m gonna go through this very quickly, is that all right?
MIKE: Yeah, let’s do this. I mean, the news is important, so we’ve gotta cover this, and then we’ve got a great show after this, so stay tuned.
BRIAN: Okay? 10 drawbacks to quantitative easing’s and low interest rates.
BRIAN: This is what the Federal Reserve Bank and all of the central banks around the world are doing in their countries to try to keep interest rates low because their government debt is so incredibly high, and to try to inflate their way out of this debt cycle. These are 10 problems with low interest rates. Number one, of course, savers find it almost impossible to earn a return, which turns them to riskier assets, thus causing the price of houses and stock market shares to inflate even higher.
BRIAN: That’s number one. Number two, higher asset prices make people who own them much richer, while leaving out many others and seriously exacerbating social and political divides and fueling the anger behind the populace campaigns. But this is Federal Reserve-caused with low interest rates. Number three, pension funds have poorer returns, causing businesses to have to put more money into those, rather than to use it for expansion. Number four, of the 10 problems with what the Federal Reserve has done with low interest rates.
BRIAN: Banks find it hard to run a viable business, contributing to the banking crisis now visibly widespread in Italy and Germany in particular. Number five, those people who are able to save more, they do so, but at such a low interest rate that their savings means that they’re spending less, and the consumer is three quarters of our GDP of our economy. Number six, companies have an incentive to use borrowed funds to buy back shares, which they’re doing on a big scale, rather than spend new money on new and productive investments.
BRIAN: Mike, we talked about this in the earnings quarter when companies for the last six quarters, we’re in the current quarter, have had to do huge repurchasing to show any gains at all. So, that’s a little smoke and mirrors. Number seven, central banks are starting to buy up corporate bonds, not just government bonds, to keep the system inflated. Number eight, zombie companies are created in a low interest rate environment because it’s free money. Money can be borrowed so cheaply. Normally, these dead companies, or zombie companies, would be taken out in a typical economy.
BRIAN: Number nine, pumping up prices of stock markets and houses without an underlying improvement in economic performance ultimately threatens the typical cyclical crash that happens which wipes out businesses and home buyers and really hurts investors in the countries. Number 10, people aren’t stupid. When they see emergency measures going on for nearly a decade, it undermines their confidence in authorities who think they have lost the plot.
BRIAN: So, if you’ve got emergency measures that were employed in 2008, and those emergency measures are continuing, and we have the lowest growth rebound in the economy ever. We’re not getting much for the trillions that we’re spending on quantitative easing. So Mike, that’s the news. We did it under 20 minutes, but those are important things that are happening right now. Wanna make sure that the listeners at KVI are hearing this from Decker Talk Radio, Decker Retirement Planning.
MIKE: Absolutely, and we won’t forget also our podcast listeners that listen to us through iTunes, and if you’re not a listener, subscribe today. But, no Brian that’s great news and it’s important news, and I kind of wanna restate it all the way you just explained it in a very simple analogy. I feel like our economy, our spending habits, our debt ratio, it’s kind of like we’re blowing up this balloon and no one’s stopping. The balloon’s just getting bigger and bigger and eventually it’s just gonna pop because that’s what balloons do when you them up too big. Is that a pretty easy broad-brushed analogy?
BRIAN: Yeah, the balloon’s analogy is a good one, Mike, but the problem is, there’s not one balloon, there’s four. In the market cycle that caused 50 percent drop in the S&P 500 in 2000, ’01 and ’02, that was one balloon, that was the tech bubble that burst. There was one balloon in 2008 that burst. In 2008, that was the mortgage bubble, the mortgage bubble that burst that almost brought the world financial markets to its knees with unsustainably low interest rates that the Fed has rolled out and continued in their plan for quantitative easing.
BRIAN: We now have four bubbles. We have a debt bubble. Debt across the country, actually the debt for countries around the world is at record levels; unprecedented country debt, number one. Number two, the bond market has a bubble right now that is fueled from artificially low interest rates. The bond market bubble will eventually burst. Number three, we have a real estate bubble. Because of low interest rates, assets are incented to go into risk assets like real estate and like the stock market, which is the number four bubble.
BRIAN: How do we know that the stock market and the real estate markets are in a bubble? By measures, price-earning ratios for the S&P 500 is not above 25. It’s only been higher once. That was in the late ‘90’s where it went up to over 30 in the tech boom and then we know that real estate through the affordability index is breaking records right now for residential real estate. So, we have four bubbles this time, Mike, that KIV listeners need to be aware of.
MIKE: So Brian, can you kick us off first? There was a Social Security article that recently came out, not from Social Security itself, but it talked about the bump.
MIKE: I guess the average bump was about three dollars a month per person, and that’s not gonna do a very good job when you’re keeping up with inflation and the cost of living that’s happening in today’s market.
BRIAN: So, let’s talk about that. Inflation or the cost of living is an interesting topic because, based on the regular cost of living CPI measure, we have been in a deflationary environment for quite awhile. We’ve looked at declining energy prices in the last 18 months, but when it comes to… you can’t tell someone that they’re in a deflationary environment if they own real estate, if they’re paying healthcare costs, if they are an investor in the stock market in the last eight years, or if they have a son or daughter in the university.
BRIAN: Those costs are spiraling higher. We are not in a deflationary market when you look at those indexes and measures. Certain foods have also gone up very quickly. By the way, Mike, guess what commodity has dropped quicker than any of the other major food items?
MIKE: Is it soy beans? Corn?
BRIAN: Nope. It’s bacon.
MIKE: Is it bacon? [LAUGHS].
BRIAN: Bacon prices have plummeted in the last four months. There’s been a huge glut of bacon on the market.
BRIAN: So Mike, back to your point, if you’re retired and you live on Social Security, can you pull it off? Well, in certain parts of your spending, if you’re retired, you’re probably not going to university, but you’re probably using the healthcare system, which has spiraled costs much higher, and that three-dollar gain per month is really not gonna cut it.
MIKE: And it probably won’t continue to grow. A Social Security in the political realm is the continuing topic of discussion. So, if your retirement plans depend on Social Security, there’s some other things you…
BRIAN: That’s not a plan.
MIKE: That’s not a plan, that’s the last resort. Would it be fair to say that’s like saying I’ll just use my money until I run out, then I’ll move in with the kids? I mean, is that essentially what we’re saying here?
BRIAN: Yeah, that’s not a plan either. But let’s talk about Social Security for a second. Is that all right, Mike?
MIKE: Yeah, let’s finish this one up.
BRIAN: Okay. Social Security, you’re benefits, the earliest that you can draw typically your benefits is at 62. The latest you can wait is age 70, and your Social Security benefits grow from age 62 to age 66.
BRIAN: They grow at around five percent a year, and then from 66 to 70, they grow at eight percent a year, and your monthly benefits almost double from 62 to age 70. So, you are incented to wait as long as possible, and I’m cynic, so I’ll just say it, you’re incented to wait, die, not collect anything and the government keeps everything. Now, I’m gonna do a five-second rant. It used to be measured in minutes, but it really bothers me, KVI listeners, that the government is calling the money that we paid into the Social Security system, really bothers me that they’re calling that a government benefit.
BRIAN: It’s not a government-it’s getting your own money back. But I digress. So, Social Security has a couple of very important dates to it. One is called your full-retirement age. Your full-retirement age, typically for people who are in their mid-‘60’s right now, about 65, 66-years old, is your full-retirement age for people that are over 48, 50 years old; 66, 67 for some of the younger crowd.
BRIAN: Your full-retirement age is important for two reasons. Number one, that’s the age that, if you are receiving spousal, it doesn’t go any higher after that. Your spousal benefits max out at your full-retirement age, number one. Number two, if you’re drawing Social Security, and you are earning income, you can earn all the income you want after your full-retirement age and draw Social Security, but if you draw Social Security before your full-retirement age, you are limited, and it’s a low limit, it’s around $17,000.
BRIAN: If you draw Social Security and make more than $17,000, you are penalized a dollar for every three on your Social Security benefits. So, we wanna make sure that you’re aware, eyes wide open, that the timing and how you draw Social Security is very, very important. Now Mike, we should do an offer here for our KVI listeners because there’s hundreds and hundreds of ways to draw your Social Security, particularly if you are married, husband and wife, we wanna make sure that our clients maximize their Social Security, so we run a program to see if all the hundreds of ways, number one, what is the worst way to draw your Social Security, and number two, what is the best way?
BRIAN: And we usually kill people off in this study at age 90. I know that sounds morbid, but we usually have you die at age 90 and run the numbers, and typically the difference between the worst way and the best way to draw your Social Security, it’s a lot of money. It’s a couple hundred thousand dollars.
BRIAN: All right, couple more things about Social Security. Mike, let’s say that I’m a guy that just can’t wait to draw it. I draw it at 62. Mike, you wait, wisely, to age 70.
BRIAN: I’m better off than you, dollar-wise, for about 14 years. The lines cross around 14 years. You would have to live beyond age 76 for you to benefit over someone that’s drawing as early as possible. So that’s the break-even, or when the lines cross. The last thing I wanna talk about, when it comes to Social Security, is that when it comes to Social Security in our planning that we do, we have, in a vacuum, the way that our clients can maximize their Social Security.
BRIAN: But when we bring reality into it, there’s two deviations that we make to the optimal numbers, optimal strategy of drawing Social Security. One is health. Why in the world would you wait till age 70 to draw your Social Security if your doctor says that you’re terminal at age 65. You’re not gonna do that. You’re gonna draw right away. So, one is health. And also going with that number one being health is your medical history. That would have you draw sooner if your medical history is kind of sketchy.
BRIAN: Number two, the second reason that we deviate from maximizing your Social Security is if, by maximizing your Social Security, we actually hurt your principal, we draw to heavily on your principal. Let me give you a scenario. Let’s say that you retire at 65, go right into receive Medicare benefits, Medicare supplemental, we have a strategy for that. We optimize your income plan, and we’ve optimized your Social Security.
BRIAN: And we have both husband and wife wait till age 70. So there’s five years where we’re drawing six figures from your million-dollar portfolio. Well, that doesn’t make any sense because your Social Security benefits at age 70, let’s say that they’re $35,000 a year. So, husband and wife have 35 each. That’s $70,000 that is not coming in for the first five years. Social Security is of no help, and these $100,000 draws are hitting your million dollars in principal.
BRIAN: It’s too much, too soon and it hurts your plan. So, what we do at Decker Retirement Planning is, we wanna make sure that what is maximized is your lifetime net of tax income, period. If that includes Social Security optimization, then so be it, and most of the time if does. But we wanna make sure that all the pieces of your income plan are optimized and Social Security optimization is one part of that.
MIKE: Now, Brian, I think that’s something that’s very important here I wanna drive here is these are proprietary software that complement the Social Security Optimization Report. This is not something you can just Google or run a couple scenarios. This is something that you’re gonna get exclusively through us, and so that’s why the benefit of coming and visiting with us is huge. I mean, you owe it to yourself to plan accordingly and to use all the tools that are available to you.
BRIAN: All right. So, that’s Social Security. Mike, next on the list, what…?
MIKE: Yeah, the next one we wanna talk about here is fixed incomes, and this is specifically with bonds, dividend investments, such as Blue Chip stocks or preferred stocks. Basically, if your retirement plan has to do with the state invested, riding the market up and down, and you’re just taking the dividends, we need to address that. Because just this week, the Fed quote/unquote it’s expected that they won’t raise interest rates before the election, but in December, they might. We don’t know. No one has the future or a crystal ball here, but if they raise rates, your quote/unquote retirement plan of taking income from dividends could be devastating, depending on what happens. So, let’s talk about, Brian, what would happen if the Fed raised rates and how would it affect these retirement plans.
BRIAN: Okay. So, why would the Fed wanna raise rates on a tepid economic recovery? The reason is, they wanna use monetary policy and load some bullets back in the gun to use as a strategy to lower interest rates. How can they lower interest rates when we’re already so close to zero? So they want to gain some ground so they have some ground to give back. That’s the monetary strategy of the Federal Reserve and why they wanna raise rates. Raising rates is a slow-down procedure when an economy is going faster than you want.
BRIAN: We don’t have that. We just wanna gain some room to lower if and when the economy stalls and we go into a recession. So, that’s the background on why would wanna lower. As far as bonds go, and bond funds, this opens up a big can of worms. So, KVI listeners, we at Decker Retirement Planning, in Kirkland, Washington, want you to know that if your advisor has your quote/unquote safe money and bond funds, we would tell you that that’s kind of like a math teacher telling you that two plus two is 20.
BRIAN: It’s demonstrably false, it’s misleading, it’s anything… bond funds are not safe when interest rates are low, because of something… well, there’s two problems with it. Number one, there’s something called the Rule of 100, that says that if you’re 60-years old, you should have 60 percent of your money in bonds or bond funds. When interest rates are at all-time record lows, that means that your advisor is telling you to put 60 percent of your money in something that’s earning almost nothing. That is a problem. That’s a major problem.
MIKE: Would you liken it to putting it into a money market?
BRIAN: Yeah in a money market, in a floating NAV money market. The bigger problem has to do with what’s called interest rate risk, and KVI listeners, I wanna paint a picture that when interest rates go up, bond prices go down. You lose money on your bond funds when interest rates go up. So, since 1980, ’82, when interest rates were sky-high, to now, we have had a steady decline, 36 years, of steady declining interest rates.
BRIAN: Now that we are so close to zero, the expectation of much more gain on your bond funds is really small, where the potential principal loss is extremely high. Imagine that you have a stock market like we’ve got right now, where we’re at 18,300 on the Dow Jones. Would you put any money in the stock market if the most you could made was 18,500 and we’re at 18,300? So, you have 200 points of upside and you have all the downside. So, the market can fall as much as possible and you’ll take that hit, but the upside is 200 points.
BRIAN: No thinking person would do that. That’s the situation you have in bonds right now, bond funds. Interest rates are all-time record lows; interest rate risk is at all-time record highs. When you have bond funds… let’s look back in history. The 10-year Treasure yield rose in 1994 from six to eight percent in one year. Boom, went up. According to Morningstar, the average bond fund that year lost 20 percent. In 1999, the 10-year Treasure went from 4.25 to about six, and the average bond fund that year lost 17 percent.
BRIAN: If we go from where we are right now, where the 10-year Treasury is at 1.7, almost 1.8, back to just four percent, to hit the principal on your quote/unquote safe money, is over 25 percent. Your banker and broker telling you that your safe money should be in bond funds is financial malpractice, it’s demonstrably false, and again, I wish there was a better analogy, but it’s like the math teacher telling you that two plus two is 12. It’s ridiculous. So, we wanna warn you that your safe money is not, and should not be invested in bond funds.
BRIAN: Why do we think that interest rates will be going up? Well, historically, there’s a very tight, close relationship between the CPI, the Consumer Price Index, and the monetary base or the money supply, this is what the Fed prints and puts in circulation. Mike, I wish we could show this chart, but it’s where, from 1960 to 1975, the Fed printed what used to be a lot of money. Although not at first, interest rates turned and started to go higher, until they ripped higher into the ‘70’s and ‘80’s high-interest rate environment.
BRIAN: Paul Volcker, the Fed Chairman, got in front of rates and brought them back to parody until 2008, and the hockey stick spike in the monetary base in 2008, where we have added $11 trillion in borrowing in the last eight years, we now have a huge gap between the CPI and the monetary base, so the money supply. And interest rates have not gone up yet, but they will, and when they do, when they do, KVI listeners, the people who have their quote/unquote safe money in bond funds are going to lose double-digit principal.
BRIAN: They will lose a lot of money, making it very difficult for you to stay retired. So, we wanna warn you, KVI listeners, we wanna warn you that your bond funds are not safe. If you have a banker or broker that tells you to put your safe money in bonds or bond funds, it is ridiculous, it’s demonstrably false. Mike, when it comes to seeking yield in retirement, a lot of clients with low interest rates that we have, are going into dividends, dividend-paying investments in the stock market.
BRIAN: I don’t know if I wanna say anything more about bonds right now, but do you have anything else that you wanna cover on bonds before we go into the income-producing investments in the stock market?
MIKE: No, I think you covered it perfectly, but I do wanna say real quick, that there is a solution for safe money. But let’s keep going with different dividend-paying investments.
BRIAN: Okay. So we have REIT’s, R-E-I-T’s, Real Estate Investment Trusts, we have utility stocks, we have energy LP’s, other limited partnerships that pay out dividends and nice interest so that, you know, they pay a good rate. A lot of retirees are, no fault of their own, they’re seeking yield wherever they can find it.
BRIAN: We at Decker Retirement Planning, want to warn you of a couple of checks and balances that you need to have if you’re going into the stock market to receive an income stream. First of all is the cyclicality of the underlying commodity itself. Take for example, REIT’s. Well, if you get a four percent yield on a Real Estate Investment Trust, you gotta know that real estate cycles. So, when real estate got nailed in 2008, what the heck good is it that you’re getting four percent when you’ve lost 60 percent of your principal?
BRIAN: Which, by the way, typically the REIT’s got just hammered in 2008. So, just know that the underlying commodity that you’re invested in, cycles. That’s point number one. And another point on the cyclicality is oil and gas limited partnerships. Oil and gas took a major hit in the last 2½ years. A lot of clients getting their four or five percent, but they’ve lost 30 or 40 percent in your underlying principal for a negative total return.
BRIAN: So, we wanna warn you to check out the cyclicality of the underlying investment, commodity investment, that’s producing your dividend return. That’s number one. Number two is to make sure that your dividend is safe. Your income money’s supposed to be your safe money. So, I just wanna go through this again and, Mike, we’ve covered this, actually, KVI listeners, we’ve covered this before, even recently. But it’s worth talking about.
BRIAN: KVI listeners, if you’ve got a dividend portfolio, I hope that you pay attention.
MIKE: Hey, Brian, can I put in an analogy here really quick about those dividend portfolios? Because you’re talking about safe, your income is supposed to be safe. Your income is supposed to be there; you can count on it. If you can imagine in your working years, if you’re working and you have no idea, for the company you’re working for, if it’s gonna close doors the day after. You could just show up today and just says it’s shut down. You wouldn’t wanna work there very long. You would wanna find employment with a company that was stable or it’s someplace that you knew would give you a paycheck. That just makes sense while you’re working.
MIKE: Well, shouldn’t the same go, and Brian correct me if I’m wrong, that where your income is coming from, those investments are safe, they’re reliable, they’re gonna give you they paycheck that you want and you shouldn’t have to wake up every morning, hoping that the company doesn’t crash, the stock doesn’t crash, or the investment doesn’t just tank, and now you’ve lost your income. I mean, doesn’t that make sense?
BRIAN: Yeah, it makes sense. So, let’s go through that right now. If you’ve got a dividend portfolio, here’s how the typical thinking goes. We wanna add the other half. The typical thinking says, well, 10-year Treasury is the riskless rate, it’s the benchmark we measure against.
BRIAN: 10-year Treasury? Let’s bump it up a little bit, 1.8 percent, that’s the riskless measure. Well, what if I can get four percent? Isn’t four percent better than 1.8? Well, what if I can get six percent? Six percent surely is better than four percent. Well, what if I can get eight percent? Isn’t eight percent better than six? You see where I’m going? And then, when I actually have a conversation with people where they’re in person here, I ask them, sometimes I have to get up to 12 or 15 percent before they’ll say, gosh, sounds kind of risky.
BRIAN: So, let’s add the other half. The first half is the actual rate of return. Now, let’s add your risk of default to this equation. Let’s say that your risk-free rate of 1.8 percent on the 10-year Treasury is zero rate of default, that’s the benchmark. At four percent, are you willing to take four percent and a 10 percent risk of default? Most people would. Are you willing to take six percent with a 30 percent risk of default? A lot of people still would.
BRIAN: Are you willing to take eight percent with a 50-50 chance of default? Sadly, some retirees still would. How about 10 percent with a two-thirds rate of default or 12 percent with an 80 percent rate of default, etcetera? Make sure that you add the default risk in with your dividend income stream. And then number three. Number three is called coverage. How much coverage does the company that’s producing the dividend have on the dividend stream?
BRIAN: So, let’s say for example that the quarterly-dividend payment is 25 cents a share for an annual payout of a dollar. Four times 25 cents is a dollar. But let’s say that your cash flow per share, per year, is only 60 cents. They’re borrowing to pay the dividend, or you are hoping that the company’s cash flow is going to go way up, one of the two. You have risk if you’re investing in a company that’s not earning their dividend on a net basis.
BRIAN: Please go and check this out, plug in your dividend-paying stock ticker symbols, go to Big Charts, bigcharts.com, plug it in and go under Corporate Information, look at the income statement, the balance sheet, look at the per-share data so that you can see if they’re earning that dividend or not. If they are not, I hope you sell. It’s really that simple. If they’re not earning the dividend and they’re borrowing for it, I hope that you know your days are numbered.
BRIAN: When you’re in a dividend-paying portfolio, and they cut that dividend, it doesn’t matter if you’re getting seven or eight percent, you just lost, in 24 hours, you lost 20 percent when a company cuts their dividend. Of course, it depends on how much they cut it, how big the cut was, but you have companies that are cutting their dividend to retain and preserve cash for the company’s survival. So, that’s some background, Mike, that’s important to KVI listeners, to make sure that their dividend portfolio is safe, because what we talk about when it comes to your income portfolio, is keeping that money safe and separate from the stock market.
BRIAN: We have three types of money. One is your cash; your emergency cash, your rainy-day funds, number one. Number two is your safe money. Now, we at Decker Retirement Planning, when we do planning, we wanna make sure that your safe money is principal guaranteed. By the way, that’s a good subject for another show. Mike, we only have seven or eight minutes left, right?
MIKE: That’s right. Five minutes, actually.
BRIAN: Okay. So we gotta get in what we would recommend here, but… actually, let’s just jump into that.
BRIAN: We have three types of money in our planning. One is cash, one is your safe money that’s principal-guaranteed, and then the third area is a risk money, and the risk money is not principal-guaranteed and it’s longer-term money, stock market money. All right, Mike, we ready to make some recommendations?
MIKE: Let’s make some recommendations really quick.
BRIAN: Okay. We are fiduciaries to our clients, and that means that, as an independent company, we are required by state law to do what’s in our client’s best interest, not what’s in our company’s best interest. Bankers and brokers are not, capital N-O-T, are not fiduciaries. They are sales people; salesmen and women that are doing what’s in their best interest, not in what’s your best interest. They are not a fiduciary. So, what we care about when it comes to your safe money is three things:
BRIAN: Number one, that your money is principal-guaranteed. Number two… by the way, the money that’s producing your income, that it’s principal-guaranteed, number one. Number two… and by the way, if part of your portfolio that is producing your income is not principal-guaranteed, then you’re drawing money from a fluctuating account. If you draw money from a fluctuating account, you are compromising the gains when the markets go up, and you’re accentuating the losses when the markets go down, and you’re committing financial suicide by doing a financial roulette of sorts, where you’re drawing your portfolio, the income part of your portfolio down not efficiently.
BRIAN: So we wanna correct that and make sure that our clients draw income from a principal-guaranteed account. So whether the economy is up or down, interest rates are high or low, or the stock market is up or down. The last one’s the biggest one. The stock market crashing every seven or eight years hurts a lot of retirees and we at Decker Retirement Planning in Kirkland, we wanna make sure that the stock market crashes that happen every seven or eight years like clockwork, that it doesn’t send you back out of retirement.
BRIAN: So, number one, you wanna make sure that your income is coming from a principal-guaranteed source. Number two, that it can send out monthly income. That’s a problem because some of the CD’s, utility bonds, government bonds, corporate bonds, municipal bonds, they pay semi-annually. We need these to pay monthly. So, what we’re doing in effect is we’re creating your retirement paycheck. You used to have W-2 income or 1099 income.
BRIAN: Now, we’re using your portfolio, along with your Social Security, pension, rental real estate, to create your paycheck in retirement. That’s what we do. That is the essence of distribution planning. Okay, Mike, KVI listeners, the last point for our principal-guaranteed accounts, and, Mike, I think we only have a minute to go.
MIKE: That’s correct.
BRIAN: So, we’re gonna have to talk about this in the next show. We’ve got to maximize returns. It is not in your best interest to lock in CD’s, treasuries, corporates, agencies, or municipals right now when interest rates are all-time record lows.
BRIAN: There’s options that you have to get a much higher return, and I guess I’ll tease for the next week’s program. If you’re retired, there are ways for you to get, on average, just over six percent in the last 15, 16 years, net to you, on a principal-guaranteed account that pays out on a monthly basis. It meets our needs, and even with interest rates as low as they are now, it’s something that we can use.
MIKE: All of that sounds great. Until next week, thank you so much. This is Mike Decker…
BRIAN: And Brian Decker…
MIKE: Take care. Thank you so much.
