Fixed Income – Parrott Wealth Management, LLC.

Five Percent, guaranteed!

October 7, 2023Posted in InvestmentsTagged Bonds, Fixed Income, Investment Management, T-BillsLeave a comment

The United States Treasury Bill is enjoying its fifteen minutes of fame as interest rates soar. The T-Bill currently pays more than 5.5%, so should you T-Bill and chill?

Growing up, I often went to First Interstate Bank with my mom to cash checks, make deposits, or withdraw money. Our visits were pre-everything, so we had to enter the lobby, and I remember signs and posters touting T-Bills. The rates were attractive because this was during the inflation-fueled days of the 1970s, but I was too young to realize that inflation was destroying their actual return.

The T-Bill is outperforming most stocks in the S&P 500 this year. There are 315 companies, or 63%, in the index earning less than 5.50%. The T-Bill is also beating the Dow Jones Industrial Average.

The full faith and credit of the United States Government back the T-Bill. It’s guaranteed, and they have zero default risk if you hold it to maturity. It is considered the safest investment in the world and has never lost money since 1926. If it is paying 5.50%, guaranteed, why wouldn’t you put all your money in this vital asset class? A $1 million investment can pay you $55,000, not bad.

However, interest rates fluctuate, and from 2008 to 2016, the one-month T-Bill paid less than 0.25% and earned 0.00% on several occasions. During COVID, it yielded less than 0.07%, and 0.00% was the norm. T-bills can also offer double-digit rates as they did in the 1970s and early 1980s. In 1981, earning more than 14% was possible.

Treasury Bills track inflation. Since 1926, they averaged 3.25% annually, but inflation averaged 2.95%, so your net return was 0.30% before taxes. Over the past decade, T-Bills returned 1% annually, and inflation averaged 2.76%, so you lost 1.76% every year. The S&P 500 averaged 12.81% this past decade and 10.24% for the past 97 years.[1]

A T-Bill is a valuable short-term investment if you need money in one year or less or it’s required to meet an obligation like buying a new car or paying tuition, but it’s a poor choice for the long haul. Buy stocks if your time frame is three to five years or more.

I understand the craving for a safe, secure investment paying more than 5%, especially after the volatility of stocks over the past five years. Despite the periodic losses in 2018, 2020, and 2022, the S&P 500 averaged 10.34% annually, compared to the T-Bill return of 1.58% per year.

Safety is in the eye of the beholder.

A 10% decline in the market is fairly common—it happens about once a year. Investors who realize this are less likely to sell in a panic and more likely to remain invested, benefitting from the wealth building power of stocks. ~ Christopher Davis

October 7, 2023

Bill Parrott, CFP®, is the President and CEO of Parrott Wealth Management in Austin, Texas. Parrott Wealth Management is a fee-only, fiduciary, registered investment advisor firm. Our goal is to remove complexity, confusion, and worry from the investment and financial planning process so our clients can pursue a life of purpose. Our firm does not have an asset or fee minimum, and we work with anybody who needs financial help regardless of age, income, or asset level.

Note: Investments are not guaranteed and do involve risk. Your returns may differ from those posted in this blog. PWM is not a tax advisor, nor do we give tax advice. Please consult your tax advisor for items that are specific to your situation. Options involve risk and aren’t suitable for every investor. Prices and yields are for today only and are subject to change without notice. Past performance is not a guarantee of future performance.

[1] DFA Returns Web 1926 – September, 2023

Are Bonds Safe?

August 29, 2023Posted in InvestmentsTagged Bonds, Fixed Income, Stock Market, Stock Market Crash, Stock TradingLeave a comment

I like bonds, but I’m struggling with their long-term performance. Bonds are inversely related to the direction of interest rates; when rates rise, prices fall like a see-saw in a park, and since the Federal Reserve started raising interest rates in 2022, the one-month US Treasury Bill rate has soared by more than 2,600%. As a result, the prices of bonds have fallen since 2022, wiping out decades of gains.

The one-month US Treasury Bill is considered the safest investment in the world and has never lost money if held to maturity, and since 1926, it has produced an average annual return of 3.25%. A $1 investment is now worth $22.63. If you want a safe investment, look no further than the T-Bill. However, inflation averaged 2.95% during the same period, so your net gain was 0.30% before taxes.

Over the past decade, stocks have been on a wild ride, dealing with four significant corrections, including the COVID crash in 2020 and last year’s down draft, where the S&P 500 fell by more than 18%. Despite the headwinds of COVID, war, inflation, rising interest rates, and multiple corrections, the index soared 171%, averaging 10.50% per year and outperforming bonds by 182%.

The outperformance of stocks this past decade is not an anomaly. As I mentioned, a $1 investment in T-Bills in 1926 grew to $22. Investing that same dollar in the S&P 500 would be worth $13,474, or 612 times more than the safe investment. Stocks appear risky, but I believe they are safer than bonds over time.

Our clients with significant stock exposure have outperformed our conservative clients by a wide margin and recovered losses quickly. It has not been easy for our stock-oriented clients to remain invested, especially after last year’s market performance, but they have stayed the course and are reaping the benefits of a rising stock market.

To maintain your lifestyle and protect your wealth, you must own stocks. There is no alternative.

What would life be if we had no courage to attempt anything? ~ Vincent Van Gogh

August 29, 2023

Four Bond Strategies

May 2, 2023Posted in UncategorizedTagged Bonds, Fixed Income, Investing, Investment ManagementLeave a comment

Bonds don’t get much love, especially after last year’s rout, but they are vital to your investment success. Here are four investment strategies.

Retirement

Bill Bernstein, author and investment professional, has said, “If you’ve won the game, stop playing.” Mr. Bernstein allocates twenty years’ worth of expenses to bonds to remove equity risk from his portfolio. Reducing risk in retirement is paramount, and bonds can help you achieve this goal. Suppose you spend $100,000 annually, then twenty years’ worth of expenses is $2 million before inflation and $2.7 million after. If twenty years is too long, consider fifteen, ten, or five years for your bond exposure. Also, this strategy determines your asset allocation. For example, if you own a $5 million portfolio and allocate $2 million to bonds, you can invest the remainder in equities.

Pre-Retirement

Allocate a portion of your assets to bonds if you are three to five years from retirement. If your annual expenses are $100,000, transfer $300,000 to $500,000 to bonds. Your bond portfolio can provide safety and income if you retire during a bear market. If you retire in a down market like 2000 or 2008, your fixed-income portfolio allows you to cover your expenses without selling your stocks at significant losses. It also gives your equities time to recover.

Major Purchase

Are you buying a new home, car, boat, or plane? Do you need to make a tuition payment? If so, buy bonds to match the liability. For example, if you need $200,000 for a down payment on a new home next year, buy $200,000 worth of bonds that mature simultaneously. The bonds remove uncertainty and equity risk ensuring that your funds will be available when you need them most.

Peace of Mind

Equities are volatile, especially last year. The stock market regularly corrects 10% or more and crashes 30% or 40% every few years, and they are not for the faint of heart. If you don’t want extreme volatility, allocate a larger portion of your assets to bonds. Buying bonds can reduce your long-term returns, but knowing your assets can give you peace and security.

Bonds are a valuable tool if used correctly, and they can enhance your portfolio in certain situations.

Bye, bye, and buy bonds!

An investment in knowledge pays the best interest. ~ Benjamin Franklin

May 2, 2023

What Is A Preferred Stock?

March 3, 2023Posted in InvestmentsTagged Fixed Income, Interest Rates, Preferred StocksLeave a comment

Preferred stocks can generate significant income and are hybrid investments, similar to stocks and bonds. The dividend income is usually higher than owning shares of common stock, and you may get some price appreciation. The preferred label comes from the pecking order on the balance sheet because shareholders receive their dividends before common-stock owners. In a corporate liquidation, bondholders receive their money first, followed by preferred holders, and common-stock shareholders receive whatever is leftover.

Preferred shares are typically issued at $25 per share and can’t be called or redeemed by the issuer before five years. If a preferred does get called, it’s at $25 per share.

The price of preferred stocks hovers around $25, and they may trade to $28 or $30 per share if rates are falling. When rates rise, the price may fall to $20 or $21 per share. They’re sensitive to interest rates, like bonds, and the prices adjust up or down based on the level of interest rates. Earning an income of six percent or more from preferred stocks is possible.

Preferred stocks are rated like bonds, so invest in ones with quality ratings. Standard & Poor’s and Moody’s apply ratings from AAA to D, depending on the quality of the issue. It’s rare to find AAA-rated preferred stocks; most ratings fall between BB and B . Ratings don’t tell the whole story, as we discovered in 2008, so pay attention to corporate balance sheets. During the Great Recession, several preferred stocks fell in price to single digits. Preferred stocks are sold with a prospectus, so you can read about all the features before purchasing your shares.

On the surface, a preferred stock sounds like a solid investment; however, the devil is in the details. As I mentioned, most preferred stocks get called after five years. If you purchased one intending to get your money back after five years, and it is not redeemed, you may hold your shares for thirty, forty, or fifty years or more!

Of course, you can sell your investment anytime, but you may get more or less than your purchase price. It is a risk for investors when interest rates rise because the value of your shares can fall. You can likely sell your holdings for a gain when interest rates drop.

Barron’s has a tremendous section of preferred stocks. In the stock tables, you can look for companies by name, price, yield, etc. Once you have identified a few, you can do further research online.

I recommend allocating approximately five percent of your fixed-income portfolio to preferred stocks if you want to give it a boost,

What do you prefer? ~ 1 Corinthians 4:21

March 3, 2023

What is a Municipal Bond?

March 3, 2023Posted in InvestmentsTagged Bonds, Fixed Income, Municipal Bonds, Tax Free InvestmentsLeave a comment

We built this city; we built this city on rock’ n’ roll, built this city on rock’ n’ roll.” You undoubtedly have heard this song by Jefferson Starship, and now you are singing it out loud and can’t get it out of your head—sorry!

However, with all due respect to Jefferson Starship, tax-free municipal bonds help fund the building of most cities. Local or state agencies issue bonds to help build roads, dams, bridges, schools, and other public works, and you probably voted on a bond referendum or two over the years.

When you vote on bond issues, you’re allowing the local government to issue bonds to finance a project in your city or county. The bonds are funded by your taxes or the services you use, like a toll road.

General obligation bonds can tax you and your neighbors to pay the interest and are some of the safest tax-free bonds to own.

Revenue bonds generate income from a project, and the project’s revenue will fund the bond payment. Typical revenue bond projects include airports, public works, hospitals, and toll roads, and a portion of the money collected from the projects will go to the bond debt service.

Because municipal bonds benefit the public good, the interest you receive is tax-free. The tax-free income incentivizes investors to buy bonds to help local authorities raise money for their projects—schools, roads, etc. The interest is free from local, state, and federal taxes, called triple tax-free.

Municipal bonds are an excellent choice for high-income earners, especially if you live in a state like California or New York. The higher your taxable income, the higher the after-tax return on your investment.

The taxable equivalent yield can help you find competitive rates relative to taxable bonds. For example, a San Diego general-obligation bond paying four percent tax-free interest equates to a six percent taxable bond. To find the taxable equivalent yield, multiply the coupon rate on the tax-free bond by 1.5. In this example, a four percent coupon times 1.5 equals six percent. I use 1.5 as a quick way to find the taxable equivalent rate. The actual formula is the coupon divided by one minus your tax bracket, which looks like this: coupon divided by (1 ˗ your tax bracket). If you’re in the 35 percent tax bracket, the formula is four percent/ (1 ˗ 0.35) = 6.15 percent. If you find a taxable bond paying six percent or more for the same time frame, purchasing the taxable bond makes sense.

If you live in a state with an income tax, buy bonds issued by that state where you live because you’ll pay an income tax if you buy one from another state. For example, if you live in California and buy a Florida bond, your income is taxable at the state level. If you live in a state with no state income tax, like Texas, you can buy bonds issued by any state.

Tax-free municipal bonds may increase your after-tax income, especially compared to CDs, corporate bonds, and US Treasuries.

The hardest thing in the world to understand is the income tax. ~ Albert Einstein

March 3, 2023

What Is A Bond Ladder?

March 2, 2023Posted in InvestmentsTagged Bond Ladder, Bonds, Fixed Income, Interest RatesLeave a comment

An excellent strategy to protect your assets from rising or falling interest rates is to build a bond ladder—a portfolio of bonds with different maturities.

Bond maturities are similar to rungs on a ladder, and each one you climb gets you closer to your goal. Your ladder can consist of bonds maturing in thirty days or thirty years, and yours should fit your situation and time frame. You can also build multiple ladders designed to achieve several goals.

How can you create a bond ladder? Let’s look at an example. Start with five bonds with maturities ranging from one to five years with corresponding rates of 1, 2, 3, 4, and 5 percent. The average yield for this hypothetical ladder is three percent, with an average maturity of three years. At the end of year one, your first bond matures, and you’ll receive a portion of your principal. With the proceeds, you purchase a five-year bond paying five percent. The remaining bonds have now moved up by one year, and your bond ladder currently consists of bonds with original maturities of two, three, four, five, and five years, paying 2, 3, 4, 5, and 5 percent. Your average yield is now 3.8 percent, and the average maturity stays the same because you still own a portfolio of bonds maturing each year for five years.

At the end of the second year, bond two matures. With the proceeds from bond two, you buy a five-year bond paying five percent. The remaining bonds are one year closer to maturing, and your ladder consists of bonds with original maturities of three, four, five, five, and five years and paying 3, 4, 5, 5, and 5 percent, with an average rate of 4.4 percent. You can repeat this process indefinitely.

A bond ladder always has bonds maturing to provide liquidity, while longer-term bonds generate above-average income. The income from the original ladder was 3 percent; by the last example, it jumped to 4.4 percent—an increase of 46 percent. At the same time, your average maturity remained constant at three years. If interest rates rise, your maturing bonds allow you to buy new ones at higher rates. If rates fall, you generate higher income with your longer-dated bonds. Also, if rates fall, the value of your bond portfolio can rise in value to produce capital gains.

The bond ladder is flexible, allowing you to use any fixed-income investment to construct your portfolio: CDs, tax-free municipal bonds, corporate bonds, or US Treasuries. You can mix and match the fixed-income choices. For example, you can structure a ladder with US Treasuries, corporate bonds, and tax-free municipal bonds. The treasuries can be short-term—from one to two years—corporate bonds from two to ten, and municipal bonds from ten to thirty years.

Investors often have a high percentage of cash in their accounts, waiting for interest rates to rise or the stock market to crash. If you hold a significant cash position, you can use short-term US Treasuries to create your money-market fund with better results. In addition to higher rates, your investments are guaranteed, regardless of how much money you invest.

Several years ago, I helped a client construct a short-term bond ladder with US T-Bills. He inherited several million dollars and wanted to buy CDs from local banks for safety and liquidity. I informed him he’d have to contact fifteen banks to qualify for the full FDIC insurance coverage, and as a result, we built a short-term US T-Bill ladder guaranteed by the US government. It was one-stop shopping for his inherited assets with superior income, liquidity, and guarantees.

In summary, a bond ladder built for you and your family can help you achieve your financial goals without worrying about the direction of interest rates.

The ladder of success is best climbed by stepping on the rungs of opportunity. ~ Ayn Rand

March 2, 2023

Buy Bonds?

February 11, 2022February 12, 2022Posted in InvestmentsTagged Bonds, Federal Reserve, Fixed Income, Inflation, Interest Rates, Wealth ManagementLeave a comment

Buying bonds is the ultimate contrarian play because everyone knows interest rates are rising, and when rates rise, bond prices fall. The yield on the 1-Year US Treasury increased 1,528% over the past year, while the yield on the 10-Year US Treasury “only” jumped 64%. All rates along the yield curve have increased substantially, and they will probably continue to rise.

In 1990, long-term interest rates reached 9%, and I could not give bonds away since investors were convinced rates were going higher because, in the 1980s, they touched 15%. However, rates declined from 1990 to 2020, falling to a low of .62% – a drop of 93%. The ultimate bull market in bonds occurred from 1982 to 2020.

A 30-year bond will fall 19% if interest rates rise from 2% to 3% – not a compelling argument to buy bonds. And the higher rates go, the lower prices will fall. We sold most of our long-term bond holdings in March 2020 as yields pushed below 1%, and we shortened our maturities to about two to three years and realized gains while transitioning to a defensive position. As interest rates rise, we will extend the maturities of our bond holdings to capture higher yields.

If rates rise, is there a bond strategy that makes sense? I believe there is, and it’s called a bond ladder. A bond ladder works in a rising or falling interest rate environment, and as rates rise, a bond ladder allows you to generate more income.

Here is how it works. You purchase a three-year bond ladder with bonds maturing in one, two, and three years and they pay 1%, 2%, and 3%, respectively.

Bond 2023 pays 1%
Bond 2024 pays 2%
Bond 2025 pays 3%
Average yield = 2%

When the 2023 bond matures, the remaining bonds are now one-year closer to maturity. You now purchase a new three-year bond maturing in 2026, paying 3% with the proceeds from the 2023 bond. Your new ladder now looks like this:

Bond 2024 pays 2%
Bond 2025 pays 3%
Bond 2026 pays 3%
Average yield = 2.6%

Your income increased from 2% to 2.6% or 30%.

When the 2024 bond matures, the remaining bonds are now one-year closer to maturity. With the proceeds from the 2024 bond, you buy a 2027 bond, paying 3%. Your new ladder now looks like this:

Bond 2025 = 3%
Bond 2026 = 3%
Bond 2027 = 3%
Average yield = 3%

Your income increased by 15%.

Your bond ladder can consist of any maturity from one to thirty years, depending on your appetite for risk. Eventually, your ladder will contain higher-yielding long-term bonds with monthly, quarterly, or annual liquidity.

A physical ladder will take you higher with each rung you climb, and a bond ladder can produce higher income as you purchase new bonds. In addition to higher yields, buying bonds can protect your principal if stocks fall, especially if you own short-term bonds. For example, the NASDAQ is down 9.3% this year, while short-term Treasuries are only down 1.57%.

If interest rates continue to rise, you will have the opportunity to buy bonds at a discount, increasing your total return. For example, if you buy a 10-year bond with a 2% coupon at $100, your current income and yield-to-maturity will be 2%. If rates rise by 2%, the price could fall to $84. If you purchase the bond at $84, your current yield jumps to 2.4%, and the yield-to-maturity increases to 3.9%. It pays to buy bonds at a discount. One person’s trash is another person’s treasure.

What is the top for inflation and interest rates? I don’t have a clue, nor does the Federal Reserve. No one can predict where inflation or interest rates are going. If interest rates continue to rise, consider adding bonds to your portfolio so you can generate more income.

As I mentioned, buying bonds is the ultimate contrarian play because everyone knows interest rates are going higher, but what if everyone is wrong? What if rates don’t rise? What if inflation falls? If you buy when others are selling, you could make money with your shrewd investing skills. Who knows?

Bye, bye and buy bonds.

Bond selection is primarily a negative art. It is a process of exclusion and rejection, rather than of search and acceptance. ~ Benjamin Graham

February 11, 2022

Bill Parrott, CFP®, is the President and CEO of Parrott Wealth Management, located in Austin, Texas. Parrott Wealth Management is a fee-only, fiduciary, registered investment advisor firm. Our goal is to remove complexity, confusion, and worry from the investment and financial planning process so our clients can pursue a life of purpose. Our firm does not have an asset or fee minimum, and we work with anybody who needs financial help regardless of age, income, or asset level. PWM’s custodian is TD Ameritrade, and our annual fee starts at .5% of your assets and drops depending on the level of your assets.

Bye bonds or buy bonds?

November 10, 2021Posted in InvestmentsTagged Bonds, Financial Planning, Fixed Income, Interest Rates, Wealth ManagementLeave a comment

I started my investment career in 1989 when the 30-Year US Treasury Bond yielded more than 8%. Investors were reluctant to buy bonds because they worried interest rates were going higher. They remembered the double-digit yields from 1979 to 1985; convinced interest rates would climb again, they kept their money in cash. Thirty-two years later, they are still waiting for rates to rise.

Today, interest rates are a fraction of where they were many years ago, and investors are still focused on rising rates. Reluctant to buy bonds for fear of missing a rate rise or losing principal, they keep their money in cash or a money market with a near 0% yield waiting for the Fed to raise rates. Though rates are low, investors should not ignore the safety, and income bonds provide to a portfolio.

In the October 1, 2015 issue of Fortune Magazine, Josh Brown of Ritholz Wealth Management outlines a compelling case for owning bonds. He suggests allocating a portion of your portfolio to bonds to help “cushion a portfolio for down years.” Adding that stocks and bonds have only had three times where their returns were both negative – 1931, 1941, and 1969. He suggests investors should ladder their bond portfolio, which will help investors with “a built-in-defense mechanism against a gradually rising interest rate.”

In fact, when stocks fell in 2002 and 2008, bonds performed well. In 2002 stocks dropped 22.1%, bonds rose 17.8%. In 2008 stocks were fell 37%, bonds climbed 26%.

So, I would recommend giving bonds another look.

Bye, bye and buy bonds.

I would never be 100 percent in stocks or 100 percent in bonds or cash. ~ Harry Markowitz

November 10, 2021

Should You Own Bonds?

July 14, 2021Posted in UncategorizedTagged Bonds, Financial Planning, Fixed Income, Interest Rates, Retirement Planning, Wealth ManagementLeave a comment

Long-term interest rates are near historic lows. In 1981, rates peaked at 15.32%; today, they’re 1.37% – a drop of 91%. The yield on the US 10-Year Treasury Note is currently 1.3%, and the inflation rate is 4.99%, so if you bought a bond today, your real rate of return is negative 3.69%. Negative interest rates aren’t too compelling.

Investors buy bonds for income and safety, especially in retirement, as stocks are considered risky investments. Bondholders have enjoyed generous returns since 1981 as interest rates fell because when interest rates drop, bond prices rise. For example, if you buy a 30-year bond for $100 paying 5%, and interest rates fall to 2%, the price of your bond would soar to $229. Bond fund managers have enjoyed a one-way trade for the past forty years, but now that rates are near all-time lows, is the party finished? And if the party is over, does it make sense to own bonds in your portfolio?

In 1982 bond prices soared 40%. It was the beginning of the end for bondholders; it just wasn’t evident yet. If bonds continue paying real negative rates, are they safe? When interest rates start to rise, bond prices will fall. For every 1% interest rates rise, the price of a 30-year bond will lose 16%.

However, don’t be quick to jettison your bonds. During the lost decade of 2000, bonds outperformed stocks by nearly 90%. Vanguard’s Total Bond Index rose 80%, while the S&P 500 lost 10%. Bonds can add protection to your account when stocks crash. If you have a balanced portfolio, you can sell your bonds to buy stocks. For the most part, bonds and stocks are negatively correlated – when one rises, the other falls.

Also, adding bonds to your investment accounts will lower your risk level. According to Riskalyze, a 100% stock portfolio dropped 53.1% during the Great Recession, whereas a portfolio consisting of 60% stocks and 40% bonds fell 34.2%, or 36% less than the all-stock portfolio. So, if you want to reduce risk in your portfolio, add bonds.

Most of us already own a substantial bond portfolio in the form of Social Security. For example, if you receive $24,000 in annual benefits, this is equivalent to owning a $2.4 million bond portfolio if interest rates are 1%. Also, your Social Security benefits increase with the cost of living. Last year the adjustment was 1.3%, and in 2022 it may climb 6.1% – the most in forty years![1] If you consider Social Security as part of your portfolio, it reduces the need to own bonds.

Few people have the stomach to handle an all-stock portfolio, especially during challenging market environments like the crash of 1987, the Tech Wreck, the Great Recession, or the Covid Correction. It’s easy to hold stocks when they rise 10% to 20% per year, not so much when they fall 40% or 50%. When investors are scared, and fear is high, they sell stocks to buy bonds. As they say, anybody can sail a ship when the seas are calm.

I still recommend diversified portfolios because no one knows which asset class will perform well in any given year. Diversifying your assets across sectors is still a prudent strategy, but think about reducing your bond allocation if you’re a long-term investor with diamond hands and a strong stomach.

“Confronting a storm is like fighting God. All the powers in the universe seem to be against you and, in an extraordinary way, your irrelevance is at the same time both humbling and exalting.” ―Francis LeGrande

July 14, 2021

[1] https://www.cbsnews.com/news/social-security-cola-2022-increase-biggest-nearly-40-years/, Aimee Picchi, July 13, 2021

Want More Income?

September 26, 2019September 26, 2019Posted in UncategorizedTagged Financial Planning, Fixed Income, Income, Retirement Planning, Wealth ManagementLeave a comment

Interest rates are falling, and investors are starving for income. Coupon rates on U.S. Treasuries are paying less than 2% except for the 30-Year U.S. Treasury bond, which is paying 2.25%. Corporate bonds, CD’s, and tax-free bonds aren’t paying much more. The Federal Open Market Committee recently lowered interest rates by a quarter of a point, and they’ll probably do it again at their next meeting. With rates falling, how is it possible to generate more income?

One strategy to incorporate is a systematic withdrawal plan (SWP). This approach allows you to receive income from your mutual funds while taking advantage of the long-term growth from the stock market. Your payout will be a combination of income, dividends, capital gains, and principal. For example, if you invest $100,000 in a globally diversified portfolio of mutual funds and instruct your advisor to send you a monthly check for $400, then your payout will be 4.8% of your principal.

Your payout can be fixed or variable. With a fixed payout you’ll receive the same dollar amount regardless of your account balance. A variable payout will pay you a percentage of your account balance annually, so if your account rises, you’ll earn more income.

Let’s look at a few real-world examples.

Since 1926, a 60% stock and 40% bond portfolio has produced an average annual return of 8.92% while inflation averaged 2.89%, so the real return was 6.03%.[1] Starting an example in 1926 is not realistic, so let’s look at three different periods: 2000, 2007, and 2009.

Each example will begin with a value of $100,000 and an annual withdrawal rate of 4% of the account balance. The mutual funds are managed by Dimensional Fund Advisors, and they’ll be rebalanced annually. The asset allocation mix is 60% stocks, 40% bonds. Here is the list of funds:[2]

DFA Large Cap Value (DFLVX) = 20%
DFA Large Cap International (DFALX) = 20%
DFA Small Cap (DFSTX) = 5%
DFA International Small Cap (DFISX) = 5%
DFA Real Estate (DFREX) = 5%
DFA Emerging Markets (DFEMX) = 5%
DFA Intermediate Government (DFIGX) = 20%
DFA Two-Year Government (DFYGX) = 20%

Example 1: January 1, 2000 to December 31, 2010. During this stretch, the S&P 500 lost 14.4%. Your original investment of $100,000 grew to $106,667, and you received $66,471 in total income. The average annual return was 6.6%.

Example 2: October 1, 2007 to August 31, 2019. From October 2007 to March 2009, the S&P 500 fell 48% during the Great Recession, so your investment timing was horrible, one of the worst times to start investing in history. As a result of your poor timing, your $100,000 sunk to $77,640, but you received $58,512 in income. Your average annual return was 3.4%. Despite the initial drop, you still made money.

Example 3. March 1, 2009 to August 31, 2019. During this stretch, the S&P 500 soared 298% or 14.05% per year. As a result of your great timing, your $100,000 is now worth $137,036, and you received $90,071 in income. Your average annual return was 10.98% per year.

Example 4. January 1, 2000 to August 31, 2019. During this time, the S&P 500 averaged 2.25% per year. Your original investment of $100,000 is now worth $99,975, and you received $121,534 in total income. Your average annual return was 6.27%.

A globally diversified portfolio of low-cost mutual funds gives you an opportunity to receive above-average income. You probably won’t start investing at a market top, or bottom, so rather than trying to time the market or trade your way to wealth, focus on your long-term goals. A diversified portfolio will allow you to capture global market returns over time, and over time, stocks win.

Invest globally, receive locally.

Here is part of the tradeoff with diversification. You must be diversified enough to survive bad times or bad luck so that skill and good process can have the chance to pay off over the long term. ~ Joel Greenblatt

September 26, 2019

Bill Parrott, CFP®, CKA® is the President and CEO of Parrott Wealth Management located in Austin, Texas. Parrott Wealth Management is a fee-only, fiduciary, registered investment advisor firm. Our goal is to remove complexity, confusion, and worry from the investment and financial planning process so our clients can pursue a life of purpose. Our firm does not have an asset or fee minimum, and we work with anybody who needs financial help regardless of age, income, or asset level.

Note: Investments are not guaranteed and do involve risk. Your returns may differ than those posted in this blog. PWM is not a tax advisor, nor do we give tax advice. Please consult your tax advisor for items that are specific to your situation. Options involve risk and aren’t suitable for every investor.

[1] Dimensional Fund Advisors Returns Web, 1/1/1926 – 7/31/2019.

[2] Morningstar Office Hypothetical, gross returns before taxes and fees.

Tag: Fixed Income

Five Percent, guaranteed!

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