Why Do We Put Ourselves Through This? The market is often a brutal place where we watch the value of our assets go up and down for reasons that we could never adequately understand, much less anticipate. Why not stay out of it and let the hedge funds and institutional investors knock themselves out? While this is an option for some of us, most of us need more income than we can squeeze out of a bond portfolio or government insured bank deposits. Herein lies the retiree paradox. We hate the market volatility but we can't derive enough income from so-called "safe investments." Consider the plight of a small businessman who sells a company for a half million in after-tax cash. Assume there is another half million in investment assets outside the company. A million dollars worth of investment assets puts him/her in the top 1% of retirees. Assume employment opportunities for a 60 year old former entrepreneur are limited and that the retiree wishes to stop working and live off social security and investment income. Further, assume that he/she has little tolerance for the ups and downs of the stock market. A "safe" investment will produce income at 5%, yielding $50,000 in before/tax income. When social security income becomes available, the retiree and spouse can get another $20,000-30,000 annual income for a total of $70,000-80,000 per year. It has been my experience that, although retirees in this category often tell me they need $5,000 per month in income, very few actually end up getting by on that amount. "Extras" like travel, home improvements, and helping out the kids often increase that amount by an additional $20,000-30,000 per year. In addition, declining purchasing power from inflation will sooner or later have a negative effect (although not as much as many financial professionals project). So what do we do?
Most of Us are Forced to Take Additional Risk to Obtain Higher Yields. This forces us into real estate or the stock market. The average annual return from the stock market is in the 10% range; however, we have been warned that 8-9% may be more realistic for the future. This would be satisfactory if we received this average return each year; however, a more likely scenario is a 15% return for one year and 3% the next. If the market is up when we need to make a withdrawal, we do well but if it is down we drain our capital so we have a lower investment base to produce income for next year. Studies have shown that retirees who need to withdraw from a down market for the first two years after retirement will have a substantial risk of running out of money during their life span. The main reason I established this blog is to offer people a solution.
Buy Cash Flow, Not Assets. Hence the title of this blog. If you are retired or planning to retire, your best bet is to start planting your "Cash Flow Garden." It doesn't matter how much money you have if you can't convert it to cash flow to fund your living expenses. The name of the game is to have cash flow from a variety of investments. This adds considerable flexibility since you can use the income in both up and down markets. You no longer have to worry about whether you will have to sell assets into a down market or whether your nest egg will last as long as you do. If you leave your nest egg intact and spend only the income, your risk of running out of money is much reduced. The market price of your portfolio can advance or decline but you can stay secure if your income continues.
The Recent Correction Brings us an Opportunity. The hardest hit stocks in this correction are those in the financial sector. We have sold some of our investments in this sector because we thought their income stream was in jeopardy. Others have been hit hard because they have had to reduce the value of their assets because of a rule that forces them to "mark to market" the value of some of their illiquid assets. While their book value has been reduced, their cash flow remains strong. If dividends continue at current levels, the market value will eventually return to previous levels. By searching a data base of these companies and selecting those with a high probability of dividend continuation, you can not only buy a strong dividend income stream that is likely to increase over the years, you will have a high probability of increasing market value in the future. In my end of October post, I listed five stocks that I believe have a high probability of producing a 9% dividend yield in the future. I did this not to recommend these stocks but to give you an example of some of the opportunities out there. My philosophy is similar to that of Dan Reeves, former Denver Bronco head coach. He said "Your offense has to take advantage of the opportunities the defense gives you. Similarly, your investment strategy has to be one of taking advantage of the opportunities the markets give you. This philosophy has served me well in the past and I will continue to use it.
Tuesday, November 20, 2007
Tuesday, November 13, 2007
AIN'T NOTHIN' YOU CAN DO ABOUT IT.
The Market is Not Treating Us Well. This reminds me of a story I heard recently about a man who was in the process of being tested for a position in the New York City police department. The final step involved an oral interview to get an idea of his overall knowledge of some of the situations he might encounter as a policeman. One question was what are rabies and what can you do about it. His answer was, "Rabies is Jewish priests and there ain't nothin' you can do about it. You might apply that answer to your participation in the stock market. While there is nothing you can do about the overall direction of the market, there are a lot of things you can do about your own investment portfolio. The problem is that many, if not most, of these are wrong. In a study of mutual fund participants, it was determined that very few of the shareholders did as well as the overall performance of the fund over a long period. The problem is that there are powerful forces that prompt us to do the wrong thing at the wrong time. Buying low and selling high is an objective that few investors achieve. Let's face it. Warren Buffet we ain't.
Beware of What You Read in the Newspapers. Even if what we read in the newspapers is mostly true, the papers are reporting history. Making your investment decisions with only his in mind, is like trying to drive your car with the rear view mirror. In the 90's we had a technological revolution in this country as the computer chip and the internet drove huge gains in productivity. It changed the way information is disseminated. Those changes are still taking place. If that is the case why did investors that lost money outnumber those who made money? Instead of the dot com era, why do most people call it the dot bomb era? You may recall that start-up companies with practically no sales and negative earnings became worth as much as Ford or General Motors. You couldn't pick up a newspaper without reading about a bunch of new dot com billionaires. Everyone wanted in on the act and they drove prices of those companies into the stratosphere. If you got in early and got out in time you made money but few people did. Now days you can't read the business section without reading of China, India, and some emerging market countries growing their economies at 8-9%. That was last quarter. What is going to happen next quarter? It isn't so obvious and those of us who think we know, don't know what we don't know.
Oil is Nearing $100 a Barrel. Let's sell our depressed financial stocks like Citicorp and Bank America and run out and buy an oil royalty trust like Prudhoe Bay Trust or San Juan Basin Trust. Before we do that, we might consider that, in addition to supply demand factors, the energy markets are heavily influenced by speculators who buy futures in these markets. Is oil really worth $100 a barrel or is the true value closer to the $60 a barrel level as reported by industry insiders? The point I'm trying to make is that the more publicity an industry segment gets, the more people want to devote capital to it. The result is that more and more investors flock to that segment until they drive prices to unrealistic levels. A sure fire method for sub-standard returns is to sell what is currently unpopular and put the proceeds into one that is currently popular. You might get away with it now and then, but you will make more mistakes than home runs. Remember Warren Buffet's adage. When the majority becomes aggressive, I get fearful but when the majority becomes fearful, I get aggressive.
Playing With the House Money. There is an old saying among Las Vegas gamblers that you are in good shape when you've won enough money to put your own money back in your pocket and play with your winnings (house money). That's what most of our clients are doing. If you've made a good return for several years, you have to expect that you may need to give some of it back when the market corrects. Of course, you can take your money out and wait until the correction is over but it is extremely difficult to know when to put it back in. Studies have shown that if you were out of the market for only a short time during a recovery, you would have lost more than 33% of the gain. The problem is, we don't know when that short time is.
What are We Doing to Manage Risk in Our Portfolios? When we buy stocks, we buy into a business. Part of what we do is look at the underlying business in the companies we own. If the market price is up and we think the business value is down, we sell the asset. If the market price is down and the business is even or better, we try to find reasons for the price to be down. Is it do to an overall correction in the industry? Is the price following that of an industry leader? Are there some expectations of a future reduction in earnings? Does the price reflect a good earnings report that doesn't meet the expectations of analysts? If we can find no reason for the price to be down, we retain the investment but watch closely for reasons to sell at a later date. If, like most investments in our portfolios, cash flow from the investment is satisfactory, we try to place less emphasis on the market price and concentrate on whether or not the cash flow will continue. Sometimes we may sell a part of the investment and hold more cash than normal because we hope to buy some bargains in the future. You may recall that in March of this year, I wrote a post entitled : Awash In Liquidity. I postulated that this might mean "Awash in Stupidity." In other words, the markets are getting overvalued because there is too much liquidity. Since that time, we have been slowly raising the cash allocation in our portfolios. This has protected us somewhat, but not entirely, from major losses. We will continue to watch your money and ours in these turbulent times.
An Interesting Quote on the Aging Process. This one comes from Larry, the Cable Guy. "Inside every old person, is a young person wondering, "What the hell happened." It seems like only a short time ago, I heard better, saw better, and laughed more. What the hell happened?
Beware of What You Read in the Newspapers. Even if what we read in the newspapers is mostly true, the papers are reporting history. Making your investment decisions with only his in mind, is like trying to drive your car with the rear view mirror. In the 90's we had a technological revolution in this country as the computer chip and the internet drove huge gains in productivity. It changed the way information is disseminated. Those changes are still taking place. If that is the case why did investors that lost money outnumber those who made money? Instead of the dot com era, why do most people call it the dot bomb era? You may recall that start-up companies with practically no sales and negative earnings became worth as much as Ford or General Motors. You couldn't pick up a newspaper without reading about a bunch of new dot com billionaires. Everyone wanted in on the act and they drove prices of those companies into the stratosphere. If you got in early and got out in time you made money but few people did. Now days you can't read the business section without reading of China, India, and some emerging market countries growing their economies at 8-9%. That was last quarter. What is going to happen next quarter? It isn't so obvious and those of us who think we know, don't know what we don't know.
Oil is Nearing $100 a Barrel. Let's sell our depressed financial stocks like Citicorp and Bank America and run out and buy an oil royalty trust like Prudhoe Bay Trust or San Juan Basin Trust. Before we do that, we might consider that, in addition to supply demand factors, the energy markets are heavily influenced by speculators who buy futures in these markets. Is oil really worth $100 a barrel or is the true value closer to the $60 a barrel level as reported by industry insiders? The point I'm trying to make is that the more publicity an industry segment gets, the more people want to devote capital to it. The result is that more and more investors flock to that segment until they drive prices to unrealistic levels. A sure fire method for sub-standard returns is to sell what is currently unpopular and put the proceeds into one that is currently popular. You might get away with it now and then, but you will make more mistakes than home runs. Remember Warren Buffet's adage. When the majority becomes aggressive, I get fearful but when the majority becomes fearful, I get aggressive.
Playing With the House Money. There is an old saying among Las Vegas gamblers that you are in good shape when you've won enough money to put your own money back in your pocket and play with your winnings (house money). That's what most of our clients are doing. If you've made a good return for several years, you have to expect that you may need to give some of it back when the market corrects. Of course, you can take your money out and wait until the correction is over but it is extremely difficult to know when to put it back in. Studies have shown that if you were out of the market for only a short time during a recovery, you would have lost more than 33% of the gain. The problem is, we don't know when that short time is.
What are We Doing to Manage Risk in Our Portfolios? When we buy stocks, we buy into a business. Part of what we do is look at the underlying business in the companies we own. If the market price is up and we think the business value is down, we sell the asset. If the market price is down and the business is even or better, we try to find reasons for the price to be down. Is it do to an overall correction in the industry? Is the price following that of an industry leader? Are there some expectations of a future reduction in earnings? Does the price reflect a good earnings report that doesn't meet the expectations of analysts? If we can find no reason for the price to be down, we retain the investment but watch closely for reasons to sell at a later date. If, like most investments in our portfolios, cash flow from the investment is satisfactory, we try to place less emphasis on the market price and concentrate on whether or not the cash flow will continue. Sometimes we may sell a part of the investment and hold more cash than normal because we hope to buy some bargains in the future. You may recall that in March of this year, I wrote a post entitled : Awash In Liquidity. I postulated that this might mean "Awash in Stupidity." In other words, the markets are getting overvalued because there is too much liquidity. Since that time, we have been slowly raising the cash allocation in our portfolios. This has protected us somewhat, but not entirely, from major losses. We will continue to watch your money and ours in these turbulent times.
An Interesting Quote on the Aging Process. This one comes from Larry, the Cable Guy. "Inside every old person, is a young person wondering, "What the hell happened." It seems like only a short time ago, I heard better, saw better, and laughed more. What the hell happened?
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