100 Rules of Success: Investing Part 3

What follows is the continuation of success habits that will become part of a book I’m writing, “100 Rules of Success”. 

RULE:  Special Rule for Retirees (Part 1)- Create an Impenetrable Safety Net.  We’ve already discussed the importance of having cash reserves enough to cover unexpected occurrences (Rule: Avoid the Cardinal Sin of Investing), but for retirees we must expand this rule because there is no longer a paycheck providing financial support.  To address the risk of a ‘generational bear market’ (a stock market decline of 50% or more and takes four years or more to recover), in the early 2000’s, I developed a trademarked strategy Growth Strategy with a Safety Net®.  The objective of this strategy is to protect monthly cash flow required for living expenses long enough for a significant stock market decline to fully recover.

First, you determine how much annual cash flow you need and multiply that number by the number of years that you want to protect your income. Use the following scale as a guide:

Conservative: 10 years or more

Moderate: 5-10 years

Aggressive: 2-5 years

Next, add an amount of money that represents a generous emergency fund. Your total here will be invested as follows:

  1. Emergency fund plus your first year’s income need is invested in a money market account. To find the highest money market yields, go to the Resource Center at www.welchgroup.com; then click on “Helpful Links”; then “Highest money market yields.”
  2. The money that represents your remaining cash flow ‘safety net’ will be invested in high-quality, relatively short-term bond funds such as Vanguard Short-Term Investment Grade (VFSUX).
  3. Implement your Growth Strategy by investing the balance of your money in a diversified portfolio of blue-chip stocks with a long-term history of paying (and raising) dividends. Periodically, you will sell a portion of your appreciated stocks and use the proceeds to replenish your Safety Net basket of investments.

In a year when stocks do poorly, you postpone stock sales and wait for the market to recover. Historically, one to three years is sufficient time for this to occur.

For example, assume you have $2,000,000 available to meet your retirement income needs. You decide that a $20,000 emergency reserve account should be sufficient to cover any unforeseen financial emergencies and that initially you would like to draw $78,000 per year (a 4% withdrawal rate) from your investment portfolio in addition to your other income sources which include Social Security and pension from your employer. You consider yourself a conservative investor and therefore decide to protect this income for 10 years.

Each month you draw $6,500 from your money market account along with Social Security and pension to cover your normal living expenses. If you have a financial emergency, you have an additional $20,000 available in your money market emergency reserve account. Having your Safety Net in place guarantees that your income needs will be met for a total of ten years.

The balance of your portfolio ($1,200,000) is invested in a diversified portfolio of stocks and will provide you with needed long-term growth. In years when the stock market does well, you will sell $78,000 worth of stocks and invest the proceeds into your bond fund to replace the $78,000 that you spent during the previous year. If the stock market does poorly in a given year, you will postpone selling stocks until there is a market recovery. You can take comfort in knowing that your income is totally secure for the next nine years no matter what happens to the stock market.

RULE:  Special Rule for Retirees (Part 2)- For Growth, Focus on Blue Chip Dividend-Paying Stocks.  Unless you have huge amounts of money or a very limited lifestyle, you’re going to need to invest in stocks for growth during your retirement years.  Historically, over long periods of time, stocks have outperformed bonds, CDs and Money Markets by a significant amount with stocks earning on average about 9% and bonds earning about half that amount.  Stocks, by their very nature, are much more volatile than bonds and similar investments so it’s imperative that you create an appropriate ‘Safety Net’ as described above.  There are literally hundreds of strategies for investing in stocks that can produce good long-term results but my preference is to use blue chip dividend-paying stocks.  I like to focus on big companies with strong balance sheets and with a long history of consistent profits so they can commit to sharing a portion of their profits in the form of dividends.  The second thing I look for are companies who have the kind of growing businesses that allow them to raise dividends over time.  Examples would include companies like Procter & Gamble, AT&T and Home Depot.

As a retiree, what’s important is rising cash flow because you should anticipate that your living expenses will rise over time due to inflation.  This rising dividend strategy plays well into that narrative.  It takes more work to research, find and monitor these ‘gems’ of companies but I believe it’s worth the effort.  If you’re unwilling to do the work yourself, consider hiring an investment professional to help you or you can consider using an Exchange Traded Fund (ETF) such as Charles Schwab’s US Dividend Equity ETF™ (SCHD).

With this strategy, it doesn’t matter whether you own stocks, bonds, CDs or money market investments, all of your investments, including your stocks, are focused on producing cash flow…just what you’re looking for during your retirement years.