Paul Winkler: And a big welcome. This is “The Investor Coaching Show.”
For over 20 years, talking about this very … you would think after 20 years, there’s nothing left to say.
Mr. Jonathan Walker, here hanging with me. Jonathan?
Jonathan Walker: Hi, everybody.
PW: Do you think that there’s a possibility that, even after 20 years, I wouldn’t have anything to say?
JW: Not a chance.
PW: Not a chance. No, it’s not going to happen.
JW: Not even close.
PW: No, no, there’s always more. And always research coming out, and always questions that need more clarification.
So that’s what we’re here for. And talking about investing, financial planning, retirement planning.
You know, you go to work for money. Then the second stage of life …
JW: Money needs to work for you.
PW: Your kids spend all your money.
JW: That’s Stage Two, Part A, or whatever.
PW: I’m not going to say my wife spends all my money, because she’s way better with it.
JW: Don’t go there!
PW: No, no, no, no, no, no. She’s—it reminds me of that old John Savage, a financial guy, and he says, “Yep, guy stole my wallet, stole my credit card. Didn’t turn him in. Spending less than me.”
JW: I’ve always heard the “happy wife, happy life” theory, so there you go.
PW: There you go. Okay.
So Jonathan, good to have you hanging out with me, man. That doesn’t happen all that often.
JW: No, it doesn’t. Yeah, we have—most of the time on Saturdays, we’re at basketball games or dance recitals or something of that nature.
PW: Speaking of kids spending all the money.
JW: Yeah! They’re growing up fast.
PW: I’m totally getting that.
How and When to Take an Income From Your Portfolio
Okay, so let’s talk a little bit about … now, there was an interesting question that came in during the course of the week. Client question for Jonathan.
And one of the things that you can do for questions: paulwinkler.com/question is one way to do it. And that’s one way to ask questions.
Or if you happen to be clients of ours, just email and go, “Hey, this is my question!”
JW: That’s the direct route.
PW: Yeah, go the direct route; it’s fine. You’re totally welcome.
So the question: getting down to rebalancing of a portfolio. And actually, taking an income from a portfolio is more it, right? I guess, more, it was taking an income.
JW: Yeah. I mean, that was part of it was: A. How do you do that? and B. I don’t want to take money out of my portfolio when it’s down.
PW: When the market is down.
JW: Yeah, so if the portfolio is negative for the month, I would just choose not to have any income come out at all and then maybe wait until the next month. Can I do that?
PW: Got it.
JW: Yeah.
PW: Okay. The answer is yes, you can do that, but there’s more to the story.
So it would be kind of, because … if you don’t need money. Now, if you need money, that might be a problem.
You’re just saying, “I’m not going to take any income. How are we going to live?”
Those guys on the corner, in Nashville, they’re selling those newspapers.
JW: Are they still doing that?
PW: That’s always an option. Oh yes, they are.
JW: Are they? Okay.
PW: Yes, they are.
JW: I haven’t seen those guys in a while.
PW: You haven’t driven downtown.
JW: No, I haven’t. I don’t go downtown much.
PW: So there you go. There’s an option.
Okay, so all kidding, all seriousness aside. So yeah, you can stop, but let’s get into this a little bit.
How do you take an income? What are the things that you need to know?
Now, you’ve heard me say many times if you’ve listened—now, if this is the first time listening, you’ve never heard me say this.
I have to think about that. That’s a distinct possibility.
Beware of Marketing and Gimmicks
There are rules to taking an income from an investment portfolio. Now, there is a lot of marketing out there on getting an income from an investment portfolio, and I’m just going to call it that.
Jonathan, just throw out some of the marketing.
Some of the stuff that you’ve seen is: this is how you take income from a portfolio. I’m kind of curious what you’ll come up with.
JW: Well, you see that stuff all the time. And it can vary from “The things you need to do with your portfolio now that generate income” or “This is guaranteed income. This is how we do it and …”
PW: Annuities or something like that.
JW: Exactly. You see that stuff all the time.
We get inundated with stuff that—especially from the annuity side of the situation, where people will come in and talk to us. They hear us on the radio, something to that nature, and go, “Hey, I’ve got this—”
PW: Yeah.
JW: “This is my expectation, but this is not what’s happening. Why is this not happening?”
PW: Because they told you something that wasn’t true when they sold it? Could be.
JW: Go figure, right?
PW: Yeah, so some of the gimmicks out there: dividends, dividend-paying stocks for income.
And the problem that you run into is that companies that pay high dividends, that means that their earnings are high compared to their price.
If their earnings—because dividend is a subset of earnings. It’s part of your earnings.
Part of your earnings goes back into retained earnings. So companies hold it back for another day, when they’ve got something better to spend the money on.
They may take the money and buy back their own stock. That may be one way that they return shareholder money is by buying back.
So you’re basically, you’re reducing the number of pieces in the pie, which makes the pie pieces bigger, is the idea behind that. If you can just visualize that.
The other thing that you might have is that you pay out the earnings to the owners of the company, and then we call that a dividend.
Now, if I have a high dividend compared to the earnings, or compared to the price of the company, I might have a problem because the stock price will be low for a good reason. And the reason it’s low is because people think, “Eh, this company isn’t so great.”
So in essence, what I’m doing, I’m telling elderly people to predominantly buy companies that are more distressed.
Are Utilities a Foolproof Investment?
And then you might have somebody who goes, “Just use utilities,” as if utilities don’t have variability. They certainly do; they move with the economic cycle.
Think about it this way: I’ve got a bunch of buildings that are paying for electricity and paying water and all of the other utilities that I use.
And the economy goes down, and they go, “Hey, you know what? We need to shut down this shop for a few months. We need to shut down and go from three shifts to two or to one. You know what?”
Oh, my sister was actually, years ago … I don’t know if I ever told you this, Jonathan, but my—I had two very pretty sisters. And you knew that part.
JW: I knew that part.
PW: But you probably did not know that one of them was actually, she did modeling.
She hated it. It was not her.
But she did modeling. And one of the things that she was in was a campaign for turning down the thermostat in your house to save energy.
So when you go through hard economic times, which is basically what the late seventies was, and this is when this happened, she was actually the poster child for turning down your thermostat, which reduces the amount of income going to a utility.
Think about it, if you’re the utility owner.
So it’s not a foolproof thing, and people think that it is.
The Risks With Municipal Bonds
And another one probably we will talk about at some point during the show: buying municipal bonds.
JW: Oh, yeah.
PW: And going, “Hey, I’m going to buy these municipal bonds, and that’s going to pay me an income that’s tax free.”
And I’ll probably, we may hit that a little bit later. That’s a real problem, real problem.
And the belief that the stock market’s too risky. And it’s actually, when you think about it a little different way, you realize, Oh man, that doesn’t make any sense, my belief that I’m going to buy bonds for income because the stock market’s too risky.
Well, let me just keep it real quick here. Because I can’t stand it.
JW: I wondered when you were just going to go into it.
PW: Yeah, I just can’t stand to—Jonathan’s like, “I worked with you too long, Paul.”
JW: Yeah.
PW: You didn’t know exactly where—you know where I’m going.
JW: Oh, I do.
PW: Well, go ahead. Why don’t you go? No, you go. No? Okay. All right, all right.
JW: You’re doing great, man.
PW: So, in essence what happens, when you go and move all the income-paying investments, you’re assuming that the stock market’s too risky.
And when you’re talking about municipalities, you’re talking about government bonds or something like that, you’re in essence forgetting that what happens when you own a government bond or you own a municipal bond or something like that, that they’ve got to get their money from someplace.
And they’re going to get it from what? Taxes.
Now if, let’s say, we look at a company, and we say that company’s got some problems.
“Oh, the whole economy’s got problems, and the stock market’s just going to crash.”
Well, why does it crash? Because earnings drop. And if earnings drop, then of course another source of revenue drops, called taxes.
And when taxes go down, then governments don’t have any money to pay the interest.
And when you’re talking about, especially, municipal bonds—municipalities, they can go bankrupt. You know, you don’t think about the fact that they can go bankrupt or they can go and default, and then they can’t make any payments.
So it’s just kind of ignoring something that is very obvious when you think through it, but not so obvious when you’re not thinking through it.
JW: I can’t—I’m drawing a blank. There was one; this happened a couple years ago.
PW: Alabama?
JW: Alabama. Yes.
PW: Yes, and you had Detroit. And you had California; there were some that went out in California.
Yeah, so they’ve been all around.
JW: I think the thought process, because we’re conditioned to think this way, if I see “bond” in the name of something, it’s a “bond,” I think safety.
PW: Right.
JW: Automatically. I think safety.
PW: Absolutely.
JW: And the reality is that that’s not the case. There are certain risks in bonds that you have to be aware of.
Just like there’s certain risks in the stock market you have to be aware of.
There’s Always a Risk
And so I constantly talk to clients about what level of risk are you comfortable with?
I’m either going to take it on one side of the portfolio or the other side, or a combination of the two.
PW: It’s a balancing act.
JW: Yeah, and so you have to look at that, that bonds are not always going to be safe and secure. You’ve got to retrain the way you’re thinking about that.
PW: Interest rates go up, your bonds come tumbling down.
JW: That’s right.
So it’s the nature of that one investment. You have to look at it and say, “Okay, just because it—”
I have people that’ll come in with their 401(k) and say, “Well, I used the bond inside of my portfolio because it’s safe. I know it’s safe.”
And then we look at it, we dive into it, and we talk about it. And they’re like, “I had no idea that that was the case.”
PW: So when we talk about income, there are all kinds of gimmicks.
And that would be another one of the gimmicks: take interest off the bonds.
Buy an annuity. In essence, when you annuitize, you’re paying down the principle and whatever interest is earned over a life expectancy.
So it’s really fallacious to actually say that your rate of return, let’s say, is 5% or 6%. And a lot of times you’ll see that kind of stuff.
There are different ways that particular number might be used, like an income rider, and that’s phantom of money. And that’s a whole different deal.
That’s sleight of hand in a whole different way, and I’m not going to get into that right now. I’ve done that many times.
But the other thing is they say: “This is your rate of return.” Well, no, it’s not, because you’re paying me my own principle back, what I gave you.
You can’t count that towards my return. That’s dishonest, just to cut to the chase.
Start With Diversification
So then you go and say, “Well, how?” When we talk about taking income, what do you do?
So you’ll have different asset categories. You’ll have large companies, and you’ll have stocks in big companies, and stocks in small companies, and stocks in value companies, and dividend-paying companies.
And then you got international and U.S., and you’ve got the same asset categories in international. You got your fixed income, your bonds, and all of that stuff.
One of the things that we talk about when you take an income is you think about all of these different things, and it’s just like wells. You know, you got wells in the backyard of your house.
Let’s say you just have 10 things, just to keep it nice and simple. And you had 10% of your money in 10 wells.
So large, small, large-value, small-value, international, large international, small. Let’s just keep it really simple and say, like, emerging markets and then a couple of bond asset categories.
And then you go and you take your income. We say, well, what causes a portfolio to run out of money?
Using Probability Analysis
If we look back through history and say, well, what would cause me problems when we do probability analysis? And say, hey, is this portfolio likely to sustain the income that you need for life?
And you can actually do this. You do probability analysis, and what you’re doing is looking, “Hey, what are the odds? You know, do I have 80% odds of being successful? 90% odds?”
And by the way, typically when we do probability analysis, about 83% and above, we’re cool. We’re good.
And you say, “Well, wait a minute. You’re okay with the 17% odds of failure?”
Yeah, because probability analysis isn’t perfect. It uses standard deviation.
It uses how much the portfolio might deviate from the expected return.
And if you look at all of history, it’s going to spit out numbers. And it may spit out that the Great Depression is the first year of your retirement.
And 1929 is the first year; 1974, the oil-crisis year, was the next year.
And 2008 was the next year of your retirement. And then you were unlucky enough, we went back in a time machine and we jumped to 1930.
And then—so you look at it and go—and then we jumped to 2002 after 9/11. That’s what happened next.
And you look at it and go, well, that’s not how history plays out.
You don’t have a horrible downturn …
Because the reality of it is, for me to lose everything in stocks like that would’ve caused to happen—if you had all of those events right in a row, you would’ve lost everything—every company on the face of the planet would have to go bankrupt with no residual value.
The land would have to be worth nothing. Their buildings would have to be worth nothing.
The inventories would have to be worth nothing. We got bigger problems.
JW: Yeah.
PW: If that happens.
JW: For sure.
PW: So in effect, probability analysis is great, but it’s not perfect for that particular reason. But if I have 83% odds of success, that tells me that, hey, historically speaking, this is pretty good.
So that’s basically what we’re looking at. We’re looking at that type of level of success.
Now what the software is doing is it’s randomizing the returns of these portfolios, such that: “Well, what if we have this portfolio, and you’re taking income from it, and this portfolio design … what happened in ‘29, ‘30, ‘31, ‘32, ‘33, ‘34, ‘35, ‘36 …”
You might do that.
Then it may go, “Well, what if what happened in 1929 is followed by what happened in 1956, which is followed by what happened in 1978, which is followed by what happened in 2005, which is followed by …”
And you have this randomness of the returns occurring in a little bit different order within the range that you might expect, within the percentage of historical returns that fall between those two numbers.
So that’s it. So that’s what probability analysis is, and that’s how you’re judging whether the portfolio’s okay.
When Emotions Influence Our Decisions
Now, what causes the problem is the negative sequence of returns risk, where you have lots of bad stuff in the very, very beginning. Now, you could have depression-like conditions at the very beginning of your retirement.
JW: Yeah.
PW: It could happen, because we’ve had a depression before. We’ve had a 1973–74 before, which was kind of nasty.
JW: Sure.
PW: 2008 was just one year, but it was pretty nasty.
JW: It was pretty nasty that one year. That was the year my dad retired.
So there you go.
PW: Yeah, there you go.
JW: Yeah.
PW: Yeah, way to go, Dad!
JW: That’s right.
PW: But he understood what was going on. So he was good with it.
JW: Yeah, and I think that’s a great example. I look at it a couple different ways.
I look at the behavioral side of it, and I look at the math side of it. Both are extremely important, and it’s trying to manage both of those effectively.
I like to say the math of it is what it is. That’s not going to lie to us.
We can look, and we’ve got a hard number of what we have in retirement assets. We can calculate with a certain probability what that’s going to spit off in income, given some assumptions.
The harder part, in my opinion, is managing how I feel about it.
You know, my contentedness of what that income’s going to be and—
PW: Behavior.
JW: The behavior aspect of it.
PW: That’s why a lot of people don’t ever pull the trigger and retire totally, because they are so scared about that.
JW: Funny thing about it. I know you have, and I know I have, we’ve coached a ton of clients through retirement, and it’s just part of the process.
PW: Yep.
JW: There is such hesitancy going through that process for a variety of reasons. One, you’re voluntarily giving up, for most people, the best asset they have in their income.
PW: Yeah. Their ability to work, right?
JW: Exactly.
PW: Yeah.
JW: And, okay, so if I’m going to do that, what’s my plan? How do I attack that?
And then once you work through that situation with them, inevitably, they’ll come back. And it may be six months, eight months, a year, two years, whatever.
But inevitably they come back and go, you know what? I wish I had done this sooner.
PW: Yeah. And it’s interesting.
Trust Companies to Work in Their Own Self-Interests
So how do I actually get people to that point? And one of the things that I do is that I’ll typically say, okay, so for an entire career, you have gotten up in the morning.
You’ve gone to work. You’ve figured out what you had to do to earn an income.
If, let’s say, your income ceased at any point in time because of a disability, a layoff, or a slow down, you said, “Oh, my income has reduced because of a layoff, a disability or”—so you reduced expenses during those periods of time.
JW: Sure you did.
PW: And so what happens is the way you act as a human is self-preservation.
And I like to compare it to when I own stocks in companies. They are run by what?
Humans just like you, who have the same drive in their belly to survive.
So when things get a little bit soft, sales go down, and they’re running into a rough patch, the economy gets soft, that’s exactly what they do. They will go and reduce expenses.
They will figure out other ways to get income, just like you would’ve. If you’ve got a slow down, you may go find a paper route.
Do something, anything to make some income, deliver pizzas or whatever, as you often hear people come up with.
So what’ll happen is they will figure out a way to get back to solvency and doing okay.
Now, instead of it just being a corporation of “You, Incorporated”—just one person going and making sure that this comes out okay—think of it when you’re investing that you’ve got thousands and thousands of companies.
And you’ve got all run by tens of thousands, millions of people are actually working in those companies with one goal in mind: make sure the company survives, and make sure that it’s profitable.
And you own those companies now. So that should take a little bit of the pressure and the anxiety away from saying, “You know what? Maybe I can retire.”
JW: Yeah.
PW: So let’s talk a little bit more about this income thing. And the question in general was, again, Jonathan?
JW: Can I take an income, or is it possible when the market is down to not take an income from my portfolio?
PW: So as to preserve it more.
JW: Yeah. So I don’t sell things when they’re essentially at a lower value.
Should I Rebalance When the Market Fluctuates?
PW: Okay. So when we have all of these different asset categories, there is … when we look at stock markets, there is a low correlation with stock asset categories.
Not negative correlation. Negative correlation, one zigs and the other one zags.
Now, sometimes that does happen in stock markets. You’ll have, like in the year 2000: large growth went down, large value went up.
2001: growth went down, and small value went up.
2002: almost everything went down, except for small international; that was the only thing that went up. And then you got bonds that went up during that particular year.
Now, can I go and, say, forgo it? “I got a bad month in the market,” and just not take anything in that particular month? Yeah, you can.
But recognize that the way … when you’re managing an investment portfolio, the way we do things is we use investment vehicles that rebalance on a daily basis. U.S.
So, you’ve got the U.S. section of the portfolio, and I would have more of the money in large-value companies. The second greatest amount would be in small-value companies.
A little bit in large, a little bit in micro-cap, a little bit in small-cap. And when they get out of balance, well, one thing I can do is sell the thing that has done better.
So let’s say that I have four asset categories. Let’s just keep it simple.
And I got 25% of my money in each.
And one category, it’s rocked it. It just had a good month.
Now it’s up 27%. And the other one’s down at 23%.
I could sell the 27%, sell 2% of it, and bring that back down to 25%. And then buy 2% of the 23%, and bring it back up.
And then I’ve rebalanced. But you know, I’ve incurred an expense when I do that.
So what we like to do is, since we all own the same funds in common, we eat our own cooking. In essence, we all use—my money is where my client’s money is.
So in essence, when I’m making a deposit to my account, I might be rebalancing a client’s account. Just to oversimplify a little bit, but that’s the idea.
So you’re redirecting money into whatever’s underrepresented.
Now, the other thing that happens is this, because you’ll proportionately have different amounts of money, depending on how aggressive your portfolio is and how much in stocks that you have.
Now, if you’re 20 years old and you got almost everything in stocks, you’re going to have maybe 95% in stocks and 5% in fixed income. And your proportion of U.S. to international would be fairly more even in how much international you have.
But as you get older, you might be actually sliding a little bit more to U.S. simply because, well, partially because of standard deviation. But another reason, level of volatility risk.
But the issue is also that when I’m older, I tend to buy more services, and I need to have something that is more driven by the value of the dollar than international currencies.
Way, way too complicated for this conversation. But it just suffices to say that my proportion of U.S. to international may change as I age.
So therefore, what happens is, I have to think about this in terms of how do I rebalance this thing.
What Triggers a Rebalance?
Now I can’t go and do the daily rebalancing because everybody’s in different types of portfolios based on their age. So you can’t go and do it that way.
So you have to physically rebalance: sell something and buy something else.
Now, like I said, you’re triggering transaction costs when you do that. So hence, what we do is we look at how much did the portfolio deviate from the targets?
So let’s say I’m supposed to have 50% in U.S., and I’m supposed to have 45% in international, and it deviates by 2%. May not actually trigger any kind of rebalance.
It’s not enough of a deviation. If it goes to 52%, if it goes to 48%, maybe not enough.
If it goes to 55%, it goes to 45%. Oh, that could be enough.
And that could actually … and I say “could be.” Why? “Paul, why can’t you just nail it down?”
Because sometimes it’s taxable portfolios, and you don’t necessarily go and do that because you’re triggering taxation. You got to think about more than “Does it deviate enough?”
JW: So what you’re saying, just to clarify, is that every time it deviated from the target that would not necessarily trigger a rebalance.
PW: You got it.
JW: And so, why is that the case?
PW: Well, because of the expense of rebalancing.
The problem with the investment industry is they are just awesome at showing you visible expenses and ignoring the invisible expenses.
Because visible expenses, hey, that’s marketing.
JW: Yeah, right? So if that doesn’t trigger the rebalance from … and the other thing too is the market may naturally recover.
If you’ve got a quick downturn, a lot of times you’ll have a quick upturn. And if you’ve rebalanced on that front end, you’ve got to rebalance on the back end, and all you’ve really done is generated expenses.
PW: Yeah. More expenses. Yeah.
JW: That’s right.
PW: Exactly.
JW: So if it’s not—and to use a terminology—guard-railed, so to speak, so if we’ve gone outside the guardrails and that may be above our percentage deviation, but we choose not to rebalance for a variety of reasons, what’s the timeframe that you think is appropriate to look at doing that within?
PW: Studies have varied. There have been some studies that show annual, looking at it annually.
But more of them have been quarterly. I’ve looked at monthly, didn’t seem to work as well.
JW: And that still goes back to the expenses argument, correct?
PW: Yes! Yeah, so typically it’s that.
And then just setting a time that this is when it’s going to be looked at, period, and that gets the emotion out of it.
Because you can have a situation where you go, “The market’s down! I got to rebalance!” And it goes down further.
JW: Right. That’s the other thing, right? You don’t know what the …
We think, as we like to tell folks, we complete that downturn in our mind.
PW: That’s right.
JW: You know?
PW: Yeah. We tend to complete patterns in our mind. If it’s going down, it’s going to continue to go down.
JW: Continue to go down.
PW: Maybe, maybe not.
JW: I talk to people a lot. And not to kind of go to a different direction a little bit, but think going back to 2020, when coronavirus first came into the States, so to speak.
You get to the end of the first quarter, when the market’s down 35%, or round to that figure. If you had asked anybody at the end of that quarter, “Hey, by the end of the year, are we going to be back to even, or even be up?”
PW: Yeah.
JW: Nine or 10 out of 10 people would’ve said, “You’re crazy!”
PW: That’s right. “You’re nuts. You lost your mind.”
JW: So going back to your emotional side of it, that’s why you can’t do it emotionally.
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