I am rather new to investing where the primary goal is income.While there is no "zero risk" investment, does anyone here feel it's possible to achieve a 5.5% yearly return, with a somewhat low risk portfolio? I'm doing a cursory check of "bond funds" and "income mutual funds" suggested by Money Magazine and it seems that the 10 year annualized return on these things is anywhere from 4% upto 8%.Seems like a no-brainer...just park money in such funds and 5.5% is easy.But, something tells me it's not that easy.With low-risk threshold, is it possible to make 5.5% per year and if so, any suggestions? (I assume conservative bond and income funds would be the primary vehicle, but totally open to stock appreciation, or annuities or any other vehicles)Thanks, Cb
In a nutshell, even a bond mutual fund has risks. Just look at a whole bunch of them that tanked 40% or more in 2008. But putting a black swan or market crash aside, there is also the cyclical risk of interest rates and how they impact the mutual fund price shares. Right now is a great example. Bonds of all credit quality classes have come along way and at some point will pull back.Something to consider might be hand picking your own bond; other than default, you can sail smoothly through any market condition or scenario.A great example of a potential investment grade candidate to consider would be the Sara Lee bonds I pointed out in another thread. 21 years til redemption with a ytm in the 6.6% range if you bought today. But whatever you decide to do, just remember that past performance is no indication of what will happen in the future.
Have you ever considered covered call writing? Purchase shares of say PG at $65 and sell Jan '13 calls at 4.50. The call premium + your dividend would be 7.75, which works out to 9% annualized over that 19 months.
This is obivously only to be done on high quality companies (maybe there's 10 out there that I would do it for), trading at attractive prices.
Since the 10 year treasury yields a bit shy of 3% and well below your target, you have to accept some risk to generate 5.5%. But since there are few (if any) risk free investments, this is more about taking a measured risk to make a reasonable return.The first thing to figure out is what your risk tolerance is to get your target return. You would also want to see if your return hurdle is achievable given your return goals.I manage an account for my father in law that is specifically intended to generate reasonable returns without taking too much risk. I have used a variety of instruments over time, including fixed income, merger arbitrage funds, covered call funds, foreign bonds, REITs, commodities, convertibles and CDs. I have generally been successful, and the drawdown during the recent crash was pretty modest (on the order of 10 to 15%). Key to this strategy is always looking for the "fat pitch" on instruments that don't have too much volatility. So although I see small cap equities that have excellent return potential (AXL, for example), I will not buy them for his account due to excessive volatility. But when the VIX was north of 40 and I could buy covered call CEFs at a double digit discount to NAV, I bought with both hands.At the moment, this account is loaded with fixed income CEFs trading at double digit discounts to NAV (BKT, JQC, ACG), vanguard convertibles fund, a dollop of commodities (PCRDX), and a slug of what amount to low volatility hedge funds that can be bought retail (MERFX, ARBFX, LCMAX). I have been letting cash build up as well, which I do from time to time so that I can grab the next fat pitch when it shows up.Is there risk in this strategy? Sure, especially interest rate risk at the moment. But the risk is a lot lower than an equity or junk heavy portfolio and it is fairly diversified. Plus I meet the middle to high single digit return hurdle. It is not terribly tax efficient, though.YMMV.
Inflation is the killer problem. Subtract 3% inflation from the raw yield and things don't look nearly so good.There's lots of ways to skin that cat, but over the past couple of years I've come to like preferred stocks for my fixed income asset class.Plenty of good info here: http://www.preferredstockinvesting.com . And his book is under $25--well worth it, IMHO.One nice thing about preferreds is that they sell for around 25 and they are much more liquid than bonds, so you can easily get a well-diversified portfolio at much lower cost than bonds. Plus you don't have the costs & disadvantages of a bond fund.
If inflation is the killer problem, I would be very critical of preferreds. With a 7% coupon purchased at par and 5% inflation, you're not doing too well.
Inflation is the problem with *all* fixed income investments. However, the inflation rate isn't different for different vehicles. It's not like inflation is 5% for preferreds and 2% for bonds and 1% for treasuries -- it's the same for everything.If you subtract 5% inflation from 7% for preferreds, you'd also have to subtract 5% inflation from 3% Treasuries. Net 2% gain isn't a barn-burner yield, but it sure beats a net 2% loss.
I agree. In fairness, I'd rather have a 7.5-8% pref than a 3% treasury. But, I'd rather have a 2.8-3.8% yielding KO, PEP, KFT, PG, PM, CL at these prices. Theoretically you can roll short-term treasuries, but it isn't worth it given the paltry yields. I'd rather stay in cash and pounce on an opportunity. The time to buy rock solid preferreds for double digit non-callable returns is when interest rates start going up. Otherwise, you're locked in to something that at some point will be pretty unattractive. PEP and KO won't be unattractive in an inflationary environment. On the contrary.
LONGREITS,You wrote, If inflation is the killer problem, I would be very critical of preferreds. With a 7% coupon purchased at par and 5% inflation, you're not doing too well.I assume that's sarcasm?I think Rayvt was just rambling - talking about two completely separate issues and injecting a vote for one of his favorite investment vehicles. Preferreds hardly solve the inflation issue. Some can help address it by providing variable rate (indexed) coupons, but you can do the same things with bonds or fixed income funds. I think Rayvt is just hooked on the liquidity and to some extent the obfuscation of preferreds.I like preferreds too. But I don't think buying them protects me in any way against inflation, interest rate or any other risk you'd normally find in bonds.- Joel
*Nothing* solves the problem the OP was asking about. investing where the primary goal is income.... does anyone here feel it's possible to achieve a 5.5% yearly return, with a somewhat low risk portfolio? I brought up inflation because that's what kills portfolios that are heavily weighted to "low risk income" investments. The protection from inflation comes from much riskier -- and certainly much higher volatility -- stocks.Neither bond, nor bond funds, nor preferred stocks, nor CDs will solve the inflation issue. CDs and such super-safe investments have trivisl returns, so they are out as a primary vehicle.Ken French (of Fama/Fench) had an interesting video of what he called "Homemade Dividends". http://www.dimensional.com/famafrench/2011/05/homemade-divid...Bond funds are frowned upon by people who appear to be authoritative. Individual bonds seem to be superior, but as far as I can tell come with a huge inherent risk unless you can do a massive amount of DD investigation. And unless you have a very large portfolio, it's hard to be adequately diversified in bonds, since par is typically $1000 and the typical minimum order size is 10 or 20 bonds.For a small investor, referreds, limited to a subset that pass a handful of simple rules, seems to me to avoid most of the negatives of bonds. But I'm always ready & eager to hear about something better.Uh, yeah, I should stop rambling. So.....anybody have more suggestions for the OP?
Why 5.5% exactly?-Ben
Thanks for all the replies so far, keep them coming please.Ben, you asked why 5.5%.Based on what I have saved, I'd need to earn a pre-tax yearly income of 4.0%.At 5.5%, I minus 1.5% for inflation, and there's my 4%.(I know the inflaction number is low, but for all sorts of reasons, I'm going with 1%)So, basically, I'm trying to explore if it's possible to earn 5.5% yearly returns, and keep risk somewhat low.Jedi
At 5.5%, I minus 1.5% for inflation, and there's my 4%.--------------1.5% is actually pretty spot on. Allot of folks will probably scoff at that number at face value. But if you go back the early 1980's, now nearly 30 years ago, and compare what a gallon of milk cost then vs. what it costs now and the compounding inflation rate is around 1.5%.The cost of an average home was somewhere around $77,000 three decades ago. If you factored in a rate of 2% inflation compounded, it would give you a number today in 2011 around $138,000. If you think $138,000 is too high for the average home price and went with $119,000, that would give you an inflation rate of 1.5% also.How about petro or gas. Around $1.25 or so per gallon 1980. Depending on where you live present day, the inflation rate would be in the 3.5% range.
Based on what I have saved, I'd need to earn a pre-tax yearly income of 4.0%.At 5.5%, I minus 1.5% for inflation, and there's my 4%.Ahhhhhhh.Reminds me of when one of our neighbors put their house up for sale. They priced it according to what they needed to buy the new house they wanted, and didn't even bother to ask what similar houses were selling for.Needless to say, that's exactly backwards. You don't start with what you need. You start with what you can get. I think you've kinda started your questions from the middle instead of from the beginning.Why do you "need to earn 4.0%"? How did you arrive at this figure?What does "Based on what I have saved" have to do with anything?Absent further details about your situation, I would make a completely blind guess that 4% comes from what you've heard about the 4% withdrawal rule. If so, then you've completely missed all the important details of how that figure came to be determined.
Agree with rayvt. Is your house paid for? Do you plan on moving? Do you have any debt you can pay down? Many relevant questions. I also wouldn't look at it as all bonds or all stocks. if your timeframe is long enough, you can reach your goal in a lot of different ways.
good fixed income reading - this woman has written several good books on the subject:http://www.envisioncap.com/
To clarify...4% has nothing to do with withdrawal rate.I've tallied up all my expenses. Needs, wants, luxuries, whatever.Anything from housing expenses, to health expenses, to clothes, right down to going out for pizza. I've come up with a monthly and yearly dollar figure.So I take my savings. And I figure out how much money I need to generate, pre-tax...in order to live at the forecasted lifestyle.After inflation, I need to earn 4% return.Thanks, Cb
"So I take my savings. And I figure out how much money I need to generate, pre-tax...in order to live at the forecasted lifestyle." That's what I figured you did, Bonny Roy.......thought it was a little presumptous (sp?) of others to imply that you just pulled that figure out of your butt. Now that I can do so, I find it very hard to cancel my term life policy. I'll be really ticked off if I drop dead within a month of cancellation. It's almost a phobia.
"So I take my savings. And I figure out how much money I need to generate, pre-tax...in order to live at the forecasted lifestyle."Not meaning to be presumptuous, but all this sounds to me like somebody that is cutting it too close to the edge, and leaving themselves no margin of safety.Sadly, our local Walmarts have a waiting list of people applying for a Greeter job, who retired with an inadequate margin of safety.Yes, I know, none of this gets around to answering your original question.Unless you have a generous safety margin, all it takes is for one of your holdings to blow up like WPPPS, or GM bonds, or Lehman, or AIG to put you in a world of hurt.The well-researched studies show that the maximum safe withdrawal rate is about 4%. You are proposing a withdrawal rate that is much higher.
The well-researched studies show that the maximum safe withdrawal rate is about 4%. You are proposing a withdrawal rate that is much higher.I seem to recall the studies show the safe rate is an inflation-adjusted 4%. So the OP is fortunate that their needs are achievable.
I seem to recall the studies show the safe rate is an inflation-adjusted 4%. So the OP is fortunate that their needs are achievable. IIRC, the 4% rate takes inflation into account when adjusting (increasing) the withdrawals in subsequent years. I *think* that's that same as what you said.But, IIRC, they used something like Monte-Carlo, and used the actual historical inflation rates. They didn't use an arbitrary fixed rate like the 1.5% the OP assumed.FWIW, I think that assuming 1.5% is much too low and completely unwarranted. The SSA annual Cola rate, averaged 1975 thru 2010 is 4.2%. 'course that included the Carter years of double-digit inflation (1980/81). The average of 1982-2010 is 2.9%. And that includes two years of zero (2009/10) which will likely never occur again.I recall reading somewhere that the SSA rule-of-thumb is 2.2% inflation rate.I prefer for my finanical surprises to be of the "Wow! We can go to the French Riviera this year." category rather than "We'd better learn to like Alpo."All it takes is one 11.2% year (like 1981) when you are depending on 1.5% and you are well and truly screwed.
Cb,Sorry a bit late to the party.does anyone here feel it's possible to achieve a 5.5% yearly return, with a somewhat low risk portfolio?I'm doing a cursory check of "bond funds" and "income mutual funds" suggested by Money Magazine and it seems that the 10 year annualized return on these things is anywhere from 4% upto 8%.IMHO it is possible to match these returns many ways and none of them are hands off autopilot style investing. Pick your bond vehicle(s) or income stream vehicle(s) of choice and with smart disciplined investing it is possible for us hacks to fall comfortably within the 4%-8% range. Much depends on how active and how disciplined you can be. Much depends on matching your personality with an investing vehicle(s) and style with your personality and skill set. The more you know the better off you are, eventually. When beginning you will make more mistakes than more mature investors; too conservative, too active, not conservative enough, not active enough. When you are at the start of intermediate investing you are likely to make several major mistakes because you think you got this tiger by the tail and it aint got no teeth left. After that its about how you apply your skills wisely. I am of the belief that an intelligent person is capable of learning a new skill like investing or investing in a new class. No on knows how skillful they will eventually be until they walk the road. The higher skilled folks can clear the 8% hurdle that the good pro funds chase, those who top out at a lower skill level should be able to bring home 4%. All of the above is possible to do with greater safety than simply buying X basket of funds and passively managing them using very occasional pruning methods or some annual rotation schedule. The key to success is to learn and then think. The market does unexpected things that can be broadly anticipated and thus planned for. The willingness to accept what is occurring and recognizing that the broad strategic plan is still working but now requires some tactical adjustments is what is needed. Occasionally we stick to our guns and weather the storm. Occasionally we jettison plans A and B and shift to plans A' and B' doing so by the seat of our pants with every intention of knocking the rough edges off when things calm down. Many vehicles and ideas have already been shared. Find the ones that interest you or make sense to you and have a go. The pro's are not magical. Very few are truly gifted. The greatest advantage the pro's have is not access to data and staff, their greatest advantage is they go to work every day. We often don't have time for that kind of commitment and we often do not have to commit that kind of time for our much smaller account of a single client whom we know pretty well. jack
If you're interested in the buy the company/sell the call strategy, which someone mentioned to you earlier in the string, here is a suggestion: Federated Investors (FII) sells for around 23 and a half, and pays 96 cents dividend, for about a 4% plus yield. Do your research and decide if you think its stable enough for you. You can sell a january 2012 call option with a strike of 25 for another 95 cents or so, after commissions, and a total yield north of 8%. One nice part is that if the stock goes up over 25/share, and the buyer of your call option exercises early to steal the dividend(s), you still might make 5.5% return with the capital gain, depending on commish and taxes. If you ever see ODC drop back to a 5.5% yield, I'd reccommend latching on to it. Last time I looked, there are no options available for this equity. But it makes great talk at a social gatherin...while others are talking about gold, t-bonds, ETF's and oil, you can say your heavily invested in kitty litter.
As part of your 5.5% portfolio, I'd recommend a MeadWestVaCo bond, 6.8% of 11/2032. Its selling below par, so the yield must be at least 7%. I think its a good risk/reward ratio. If the stock (MWV) drops below 27 and hasn't changed its dividend, or had any outrageous news, you could also try the buy/write strategy.
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