CONVERTING ASSETS TO INCOME
We save and invest today, so we’ll have income to spend tomorrow
The reason we save and invest today is so we’ll have “income” to spend in the future, like when we retire. We don’t save and invest just to admire a bulging account statement, although that’s certainly a psychological benefit of saving and investing successfully over a lifetime. My point is that “assets” and “income” are not the same thing. They’re often construed to be the same because investors assume that if you have a lot of assets, then you must have a lot of income—right? Wrong! A big pile of assets doesn’t necessarily translate into lots of income. The amount of income depends on the assets you own because a lot of asset don’t generate income. One example is gold. To expedite the discussion, I’ll concede that if you’re sitting on a pile of gold, you’re probably rich. Ah, but where’s your income? Since gold doesn’t produce any income, when you retire you’ll have to sell bits and pieces of your gold periodically to pay the bills. That leaves you exposed to the uncertainties of the market price of gold. For now, with gold over $750 (as of October 2007) an ounce you’re probably okay. Excluding the capital gains taxes, and commissions incurred every time you sell. But what happens if the price of gold drops to $300 an ounce. Ouch! So long comfortable retirement. Obviously, a nest egg all in gold is an extreme example, but it helps clarify the distinction between “assets” and “income.” At the same time, the asset-income trade-off is closer to reality than you may think. Today many people consider their house an important part of their retirement savings. Where’s the income from your house? As long as you’re living there, it’s not so much “income” as it is “outgo” for maintenance, insurance, taxes, etc. Let me put it this way, any asset you have to keep dumping money into just to stay even, isn’t so much an asset as it is a liability. And not one you want to vest a significant slice of your retirement assets. Moreover, the only way you’ll get any income off your house is to sell it and invest the proceeds into income producing assets. However, unlike gold, you have to sell your house in one lump, so you better hope your timing’s right, otherwise the transition from “house” to “income” could be very costly indeed. Folks who sold their house a year ago are looking pretty good. Anyone hoping to sell over the next year or two (or longer?) may not be so lucky. Such are the risks inherent in a large, illiquid, a hum, “asset.” Another example is most stock mutual funds. To be sure, a mutual fund is a lot more liquid than either gold or your house and in most cases is even produces some dividend and interest income. The average dividend yield on equity mutual fund is about 1.5%. That’s the good news. The bad news is that at about 3%, you’re paying more in annual management fees and expenses than the fund generates in income. Once again, lots of assets, little, if any, income. The mutual fund example is noteworthy because a growing percentage of retirement assets are in 401(k) plans which are largely invested in mutual funds.
Investing For Income From the Get-go As with many things in life, the answer to the asset—income trade-off is simply, although not easy. Invest with the goal of generating future income. An investment strategy espoused in the pages of VIEWPOINT the last seven years. When I devised the high-yield, dividend growth strategy I now call our EQUITY INCOME Portfolio, (EIP) in the fall of 2000, my objective was to double investment income every five years through dividend growth and reinvestment. Since I don’t need the income, reinvesting the all dividend income was understandable. So how has the EIP done? For the period from December 31, 2000 through September 30, 2007, total dividend income grew 222%, or an annual growth rate of 19.2%. Critical to the strategy’s success was reinvesting the dividends to build future income though compounding, but that’s just part of the story. Most of the income growth came from the stocks raising their dividends. Both Altria (MO) and Bank of America, (BAC) have been holdings in the portfolio from inception. I expect to continue to hold them and watch them increase their dividend at a similar annual rate almost in perpetuity. A strategy like this requires time to allow dividends to grow and the portfolio to benefit from the power of compounding from reinvesting dividends. But in relatively short order, the momentum begins to build from the compounding from the combination of high-yields, dividend growth, dividend reinvestment and by putting new money into your portfolio. The sooner you begin of course, the better. But that’s true for any investment strategy. As the saying goes: “the best time to start investing was 20 years ago. The second best time is now.” If you’re already retired, converting your portfolio to a dividend growth strategy might be difficult because of the transition costs and market risks involved. However, if you have low yielding assets or extra income to reinvest, it makes sense to dedicate some portion of your portfolio to an asset that’s going to grow its income over the next decade to help protect the your retirement income from inflation. In the end, investing is about providing income in retirement. And growing income at that. Is your current investment strategy designed to do that?
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