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My husband and I (he's 56, I'm 50) have contributed regularly to tax-deferred plans most of our working lives. We have also saved and invested in stocks during that period. We have about equal assets in tax-deferred and non-deferred accounts. Most of our assets in both are in stocks, a little bit (15%) in cash. As we move toward retirement I know that we need to shift our allocation toward more cash/bonds so as to have a dependable source of income.

Would it make sense to accomplish the shift within our tax-deferred plans as much as possible (so as to minimize cap. gains consequences), and leave the non-deferred account in stocks as long as we can? It makes sense to me but perhaps I am missing something.

Also, on the subject of bonds, what is the advantage of holding bonds now as opposed to cash? If bonds are now returning in the 5-6% range (the gov't kind that one would want to hold for safety's sake) and money market funds are returning in that range as well, it seems to me that we may as well enjoy the liquidity of the money market account and not tie up our money in bonds. The only reason I can figure to buy bonds is that if interest rates were to skyrocket, we could then try to lock in a great long term rate. In that case, the cash we are holding (or will be holding as we convert our tax-deferred accounts to more cash) could be used to buy such bonds.

Anyone's comment would be welcome.

Thanks - Minna
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Greetings, Minnat, and welcome.

<<My husband and I (he's 56, I'm 50) have contributed regularly to tax-deferred plans most of our working lives. We have also saved and invested in stocks during that period. We have about equal assets in tax-deferred and non-deferred accounts. Most of our assets in both are in stocks, a little bit (15%) in cash. As we move toward retirement I know that we need to shift our allocation toward more cash/bonds so as to have a dependable source of income.>>

That's really a matter of how much risk you're willing to assume instead of income production. In theory, fixed income vehicles are less volatile than stocks, so a shift in their direction in retirement in conventional wisdom means a reduction in risk to your overall portfolio. How much gets moved in that direction, though, is a matter of personal preference. Too much moved could ultimately cause a reduction in the purchasing power of both the income and the capital. Conventional wisdom is slowly shifting to saying that better than 50% must still remain in equities for the capital growth.

<<Would it make sense to accomplish the shift within our tax-deferred plans as much as possible (so as to minimize cap. gains consequences), and leave the non-deferred account in stocks as long as we can? It makes sense to me but perhaps I am missing something.>>

Nope, you're not missing a thing. Under current capital gains taxation it makes more sense to keep that in taxable accounts so you can choose when and, to a certain extent, how much gets taxed. Taxed deferred accounts will always get hit with ordinary income tax rates, so those should be used for income producing vehicles in lieu of taxable accounts.

<<Also, on the subject of bonds, what is the advantage of holding bonds now as opposed to cash? If bonds are now returning in the 5-6% range (the gov't kind that one would want to hold for safety's sake) and money market funds are returning in that range as well, it seems to me that we may as well enjoy the liquidity of the money market account and not tie up our money in bonds. The only reason I can figure to buy bonds is that if interest rates were to skyrocket, we could then try to lock in a great long term rate. In that case, the cash we are holding (or will be holding as we convert our tax-deferred accounts to more cash) could be used to buy such bonds.>>

If the rates are about the same, then I would agree. However, my Ibbotson database shows the total return for 1997 to be 15.85% for long-term and 8.38% for intermediate term government bonds. T-Bills, a reasonable proxy for the money market, got 5.26% That spread seems sufficient enough for me to opt for the bonds were that my inclination. I admit, though, I haven't tracked the rates as of today. You may want to verify the data yourself before you decide.

Regards….Pixy


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Pixy:

Thanks for your prompt reply. I guess my ignorance about bonds is really showing. When I look the daily published rates for bonds I don't see anything higher than 5.96% for a 30-year T-bond (this from my daily newspaper 3/28/98.) I do know that people who trade bonds, as opposed to those who would just buy and hold them and take whatever income they produce, which is about my level of expertise, can expect a higher result. Where does the 15+% total market return you refer to come from?

My interest in bonds would be confined to gov't bonds. I figure if I take risk I would rather take it in stocks, where I sort of understand the risk, rather than in bonds, where I'm kind of befuddled.

Thanks - Minna
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Minna,
I would highly recommend two books. Jim O'Shaughnessey -- Retire Rich, and Ric Edelman -- The New Rules of Money.

Both recommend not placing your money in bonds, largely because it won't grow with inflation. What is a nice annual sum now will not be in 20-30 years.

O'Sh recommends a "Utility Portfolio", which gives you annual dividends approaching bond interest returns, but with enough capital growth to match inflation.

Edelman recommends a putting your money into a balanced growth/income mutual fund, and taking an automatic monthly withdrawal.

You probably will live another 30-40 years. If you put the bulk of your money in bonds, you will probably be eating Alpo long before then--unless you have LOTS of money. Look at what has happened to prices in the past 30-40 years, and project that into the future.

Good luck,
Ray
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Ray - thanks so much for your reply. Please know that I would never park the bulk of the money in bonds. Dividend income supported my parents and grandparents in their retirement and I do know that that's where the growth potential is.

I'm just trying to follow the guideline, which I agree with, that you shouldn't have money you need within the next 3-5 years in the stock market. So I'm thinking that we should peel off a little as we age and put it somewhere else. My problem is deciding whether to keep a cash pot, and just depend on whatever the prevailing interest rate is, or whether I can do better than cash with bonds. This pot, whatever it consists of, would be providing us with a steady cash flow. It seems to ne that prevailing money market interest rates are likely to keep track with prevailing T-bond or bill rates, at least with the short term ones, so I'm trying to see if there is any advantage to choosing bonds for this pot. Why not just stick with cash?

I have O'Shaughnessy's book "How to Retire Rich" and I
'll re-read the chapter on utility investing. Thanks for the tip.

Minna

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Minna,

<<Where does the 15+% total market return you refer to come from?>>

The data is compliled by Ibbotson Associates of Chicago, IL, a noted consulting firm whose return statistics for stocks, bonds, bills and inflation are widely used throughout the investment community and academia. They are total return figures which include price appreciation and reinvested dividends.

Regards….Pixy
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Minna,
I too, have been puzzling over the same question for some time- even though my retirement is still about 13 yrs. away. My "tentative" plan is to convert the money in the tax-deferred accounts into a life time annuity with monthly payout. Then, re-allocate a portion of the taxable accounts to a diversified portfolio of utilities(water, elec, gas), and REITs, and oils with scattered payouts, so as to receive checks every month. The rest of the taxable accounts will be skimmed off at the end of each year according to the percentage of their growth. All these incomes are to replenishing an "escrow" account wich will contain enough cash to be withdrawn in a monthly lump sum. Hope this has been food for thought.
Regards,
Eddie
p.s. I'll be interested to see any modifications to this plan.
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<<My "tentative" plan is to convert the money in the tax-deferred accounts into a life time annuity with monthly payout.>>

Is the conversion a taxable event?
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<<My problem is deciding whether to keep a cash pot, and just depend on whatever the prevailing interest rate is, or whether I can do better than cash with bonds...>>

Well, it seems to me that if you want to keep some "good sleeping" money in cash , then you should keep it in CASH. Money market funds or other near-cash with a very short maturity--six months or less. And forget about the opportunity cost of not having it in bonds. This is insurance money, not investing/risk money. You don't expect to make a profit on your insurance; it's job it to protect you against a loss.

Ray
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My understanding is that the payouts are taxable- not the conversion itself.
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Eddie:

That sounds interesting. I guess I am set to follow the first part of your plan, because my retirement plan is annuitizable (if that's a word) and that seems to me to be a great convenience when I get to the age where I don't want to fool with it - I just want the check. This is the place where I will have to make the cash and bonds decisions.

I had also been thinking that I would want high dividend stocks in my taxable portfolio during retirement years. I enherited the basis of my portfolio from my dad who was already thinking along those lines, so it has some stuff like pharmaceuticals and financials in it, which have a fairly high yield. The trick for me is going to be to look at that portfolio and decide what to hang on to, what to add, and what to let go. I guess I'll have to bone up on utility investing after what you and Ray have to say about it.

Ray - thanks, you helped me clarify what I want that money for. It really is "sleeping money."

Regards - Minna
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Pixy - thanks for the info about Ibbotson. I guess they are covering a wider range of bond types than I was considering.

Regards - Minna
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Minna,
Whenever you get around to considering the utilities, it'll be a good idea to make sure they're not still fighting any ancient battles with their nuclear power plants, or any regulatory decisions to compensate for bad construction plans. I don't know if anyone has suggested "preferred stocks" yet, or not. But, sometimes those can be a little more predictable than bonds, in sofar that their payouts do not fluctuate like bonds do. Hope this is of help.
Regards,
Eddie
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Eddie:

I had a little wrangle with preferred stock this year. I had been left about 10 shares of McKesson preferred by my grandmother, which were never delivered to me. Then they were called in. It was my first experience with preferred, and I had no idea what they were talking about. After much filing of notarized affidavits I did get a check, for which I certainly bless my grandmother. However, I will certainly hope not to have to cope with called-in preferreds in my grandmotherhood!

Do utilities continue to be the high yielders they have in the past? I seem to have read something recently about utilities cutting back their dividends. Some of the financials I hold, SOR (a closed-end fund), AC and PNC bank, yield from 4 - 8%. I enjoy the income, which supplements my part-time salary, but my husband gripes about the taxes. The most productive and least taxable way to switch from low-yielding growth stocks to high-yielding stocks for retirement income is what I'm trying to get a grip on.

Thanks for your comments.

Minna
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Minna,
It is true that preferreds DO get called in, and that's their drawback. Another idea is to look into what are known as "tranches." These are mortgage backed securities that one can buy through brokers. One can scatter their maturities, so as to have regular income at specific intervals.

>Do utilities continue to be the high yielders they have in the past? I seem to have read something
recently about utilities cutting back their dividends.<

Utilities, in all probability, will continue to pay higher dividends than the average stock. And, yes, some of them did cut back their dividends- but claimed that it was a one-time recup of their losses over the years due to power plant over-expenditures.

>The most productive and least taxable way to switch
from low-yielding growth stocks to high-yielding stocks for retirement income is what I'm trying to
get a grip on.<

The only way that I can think of would be to cash them in after the beginning of the year in which you retire.
All said, even in retirement, portfolios DO need to be actively managed.
Regards,
Eddie
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<<Whenever you get around to considering the utilities, it'll be a good idea to make sure they're not still fighting any ancient battles with their nuclear power plants, or any regulatory decisions to compensate for bad construction plans>>

Take note that O'Shaughnessey's "Utility Strategy" selects from the stocks that Value Line has rated #1 (Highest) for Relative Safety. This is about 100 out of 1700 stocks. I think that you can safely assume that Value Line has already factored all this stuff in.

When I ran this screen on 4/10/98, I got:
5 electric utilities
2 gas distributors
3 investment companies

The median yield was 5.8%

Ray
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<<The most productive and least taxable way to switch from low-yielding growth stocks to high-yielding stocks for retirement income is what I'm trying to get a grip on.>>

Then you _definitely_ should read Edelman's "The New Rules of Money", because he discusses this very thing.

IMHO, you are probably best off if you just pay the taxes and move on. Remember, the goal is not to stiff the taxman, but to maximize the money in your possession. You can't stiff the taxman forever, anyway--when you finally die, they are Johhny-on-the-spot.

It took me forever to convince my mother to dump the gold funds that her broker foisted upon her, at a loss of near 50%. She didn't want to take the loss. But since January, the Dell and AT&T that she bought with the remains have gone straight up. And the gold funds have continued to lie on the floor.

Ray
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Ray and Eddie:

Thanks so much for these interesting ideas. I'll add Edelman to my reading list.

I guess my tax antipathy was really showing. I don't mean to be that way. I agree with Warren Buffet that those of us who are blessed with education and means to invest wisely should be willing to share and not fuss about capital gains taxes. And certainly the cap. gains situation for the long term holder has improved and may improve more by the time we reach retirement. I just like to be able to say where that sharing goes instead of depending on that quarreling DC crowd to decide for me.

Eddie, I've never heard of "tranches." Do you have any personal experience with them?

Regards - Minna
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Minnat,

<<Do utilities continue to be the high yielders they have in the past? I seem to have read something recently about utilities cutting back their dividends. Some of the financials I hold, SOR (a closed-end fund), AC and PNC bank, yield from 4 - 8%.>>

It might have already been mentioned, but have you considered REITs? Many of the equity based REITs that have been around for a while have very little volatility and a nice 6%-8% yield.
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Minnat,

>>Do utilities continue to be the high yielders they have in the past? I seem to have read something
recently about utilities cutting back their dividends. Some of the financials I hold, SOR (a
closed-end fund), AC and PNC bank, yield from 4 - 8%.<<


There is one other important consideration for utilities, that is deregulation. The natural gas and telephone industries have been going through deregulation for about 10 years. But deregulation is just starting to reach the electric industry and the local distribution companies in the gas industry. Deregulation will force these companies to change the way they do business. Those that adapt are likely to be great investments for the future, those that fail to adapt are likely to be out of business. Utilities can still be a great investment, but they aren't the investment of 20 years ago with return on investment virtually guaranteed by the State Public Utility Commissions.
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Thanks for the suggestion, dodgeem. I do have a little bit in a real estate mutual fund (LLREX) which owns some REITs, but it did not seem to me to be a high-yielder. I guess those folks are keeping an eye on the tax consequences, since they are owner-managers. I would rather let a manager guide me here, since I don't know much about real estate or REITs.
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The rates you see published for bonds are the yields. The total return depends on if rates go up or down. I see little use for bonds before or after retirement. The Dow strategies are especially good for retirement. Proven safty and great returns. The shifting should be from more risky stuff (UG etc.) to the high yield ones. At least thats my humble opinion.
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Take note that O'Shaughnessey's "Utility Strategy" selects from the stocks that Value Line has rated
#1 (Highest) for Relative Safety. This is about 100 out of 1700 stocks. I think that you can safely
assume that Value Line has already factored all this stuff in.

When I ran this screen on 4/10/98, I got:
5 electric utilities
2 gas distributors
3 investment companies
What screening tool do you use? cost? etc. I've been using AAII for the past year.
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<<What screening tool do you use? cost? etc. I've been using AAII for the
past year.>>

The screening tool I used for the Utility Strategy was "eyeball, pencil, & paper". ;-)

For more complex screens, I use StockQuest. This is free (as in FREE!!!) if you have an Ameritrade account. Ordinarily $10 per download or $20 per month, so this is a pretty good benefit. I understand that MSInvestor has a good one, too--but it costs $10 per month. Being stingy, I haven't tried it yet.

Ray
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The hype midyear '97 was "real estate is coming on strong" so I ran out and bot LLREX in Sept '97.
Today it sits exactly where it was when I bot it!
the rest of my portfolio is up 29.7%
I would say LLREX IS A DOG.
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I bought most of my LLREX in Oct. '96 and am up about 43% from basis over that time. I bought it because I wanted some diversification from my large cap stocks and I did not expect it to move in lockstep with S&P returns. The managers are from Memphis, which is where I am from, they have a lot of their own assets in the fund and they have a reputation as careful value investors. I looked at the chart and can see that you probably had the bad luck to buy just before the recent dip. That happens. The dip has not changed my reasons for owning it.

I hope you have better luck with it.

Regards - Minna
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