A client called me this morning with this observation: "I've noticed that my account balances and income levels are regularly at or near all time high levels . People are talking about the sociopolitical climate here and abroad and it's getting pretty scary. Is there any preemptive, protective, action you can take, just in case we have another major meltdown?"
Perhaps you are in the same position. Do you know what's inside that inflated market value figure on your account statement? What happens to your retirement plan if the numbers are halved once again, as they have been at least three times in the last 30 years?
Do you understand that neither "market value" nor "total return" are directly related portfolio income?
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If you are depending on either your portfolio "market value" or the "total return" it has been generating, you are not prepared for even the mildest of corrections. These numbers have nothing to do with "Spending Money"! (Most plans assume that you will liquidate a portion of the investment capital with every monthly disbursement, just like an annuity provides a small amount of earned income, these days, along with a much larger portion of principal.)
In most IRA, 401k, etc, programs, the actual income being produced is negligible... probably less than 2%. Please, check it out for yourself. Ask your "investment person" what percentage rate of income your portfolio produces... expect a lot of mumbles. Total Return is NOT income.
The most popular retirement mutual fund, the Vanguard Target Retirement Income Fund (VTINX) pays only 1.76% on the billions of dollars it holds for potential retirees, and 30% of the assets are invested in the stock market. When you look at most Mutual Fund descriptions, you can't even find the "income produced" number. Hmmm... what's in your wallet?
The typical MCIM retirement program (IRA or personal 401k) generates more than 6% income... with less risk of actual financial loss (I'm thinking) than your portfolio.
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Let's look at the portfolio impact of each of the three major market debacles: 1987, 2000, and 2008
The "Crash of 1987"
- The market value of all equities plummeted. Investment Grade Value Stocks (NYSE dividend payers rated B+ and higher by S & P Corp) rebounded faster; none of the companies cut their dividends or went out of business.
- Investment grade income purpose securities continued their regular dividend and interest payments; there were no major defaults directly related to stock market problems; prices generally increased, as interest rates cycled downward.
- If you were living off the income generated by your investment portfolio, you may not have even noticed "the crash", (and if you were spending 70% or less of the income from an MCIM portfolio, your income would have grown throughout the crisis).
The "Dot Com Bubble" Bursting of 2000
- The market value of NASDAQ companies plummeted, and many companies went out of business. Investment Grade Value Stocks went up in price providing profit opportunities, and none of the companies cut their dividends or went out of business. There are no individual NASDAQ equities in MCIM portfolios.
- Investment grade income purpose securities continued their regular dividend and interest payments; there were no major defaults directly related to stock market problems. A new form of income investment media (still ignored by most financial advisors), the Closed End Fund, was introduced in the mid eighties. CEFs make interest rate volatility the income investors' "VBF", by adding low cost and total liquidity to managed portfolios of illiquid securities.
- If you were living off the income generated by your MCIM investment portfolio, you were not affected at all by the chaos, and if you were spending 70% or less of the income, you would have watched it grow throughout early 2000.
The "Financial Crisis" of 2008
- The market value of all equities (and CEFs) plummeted. Investment Grade Value Stocks) rebounded rather quickly; very few cut their dividends but a few were put out of business (at the expense of your retirement account) by our feckless friends in Washington.
- Investment grade income purpose securities (with the exception of mortgage based varietals) continued their regular dividend and interest payments; there were no major defaults directly related to market problems. More Income Closed End Funds (still ignored by most financial advisors) raised payouts than lowered them, and they rebounded faster through 2012 than all the equity market indices... producing outlandish profits for those who kept adding to positions throughout the downturn.
- If you were living off the income generated by your investment portfolio, you were not affected (financially) at all by the chaos. If you were spending 70% or less of the income from an MCIM portfolio, your income would have grown significantly throughout the correction.
The Preemptive, Protective, Income Growing, Correction Solution
The preemptive portfolio protection plan has been available for decades--- and it works amazingly well for anyone who has the courage to follow the general principles and disciplined strategies developed and explained in "The Brainwashing of the American Investor" .
Corrections, big or small, are a simple fact of investment life... where, why, and when they begin can only be identified by using "institutional grade" rear view mirrors. If you cannot make the following statement, you are not ready for a correction:
- Neither a major stock market correction nor rising interest rates will have any meaningful impact on my retirement plans or spending money.
Investors constantly focus on the event instead of the opportunity that the event represents. Being retrospective instead of hindsightful helps us learn from our experience. The length, depth, and scope of all three major meltdowns were unknowns during the corrections themselves. The "end" parameter of the current, unprecedented, eight year advance is equally mysterious... rally duration is always unpredictable as well.
MCIM portfolios typically contain three types of securities: Investment Grade Value Stocks (not Wall Street's "value stocks") purchased at a minimum 20% discount; diversified, high quality, generous payout, experienced, income and equity CEFs with active professional managers ...i.e., the kind of securities that kept their heads above water through the three major financial tsunamis of our lifetime.
A stubborn refusal to speculate, experiment, hedge, and/or index your portfolio allows you to operate in a much less scary environment, one that emphasizes buying lower and selling higher in all securities, and in all markets.
Understanding and disciplining ourselves to take advantage of cyclical market oscillations forces us to prepare for the next directional change, through several, sometimes counter intuitive actions:
- We take reasonable profits on all securities quickly, whenever they are available; at significant "all time market highs" we shed our worst performers (stocks that have refused to go up to profit taking levels throughout the rise, and the least generous of our income producers).
- We maintain our "cost-based" asset allocation formula using only long-term goals, unconcerned with the market direction forecasts of institutional gurus. Quality, Diversification, Income and Profit Taking are, in my experience, the only proven safety net in all market scenarios.
- We own no security, (individual equity, CEF, ETF, REIT, or MLP) that does not have a dependable history of either dividend or interest payments.
- We move slowly into new (IGVSI) equity opportunities only after individual downturns of at least 20%, and never say "no" to a reasonable profit.
- We use CEFs for both income production (both taxable and tax free) and for equity allocation sector diversification. We also use a small group of sector ETFs, REITs and MLPs... most often when individual equity prices are at historically high levels.
So, a better question, concern, or observation, given the extraordinary performance scenario that the investment gods have provided over the past eight years would be:
- What more can I do to take advantage of the market cycle even more effectively --- the next time?
The answer is as practically simple as it is emotionally difficult. You need to welcome the correction, recognizing the opportunity it provides to benefit most from the unpredictable market cycle. Add to portfolios slowly during precipitous or long term market downturns to take advantage of lower prices --- just as you would do in every other aspect of your life.
Always establish new positions firsts, and then consider adding to older ones that continue to live up to MCIM quality standards. Maintain your asset allocation by adding to both "buckets" according to the cost-based formula... monitor cost based diversification levels closely.
You need to apply cyclical patience and understanding to your investment decision making and hang on to the safety bar until the climb back up the hill makes you smile. Repeat the process. Repeat the process. Repeat the process.
The retrospective?
The MCIM methodology was nearly fifteen years old when the robust 1987 rally became the dreaded "Black Monday" correction of October 19th. Sudden and sharp, the 50% "break" in the market provided the opportunity to put tons of "smart cash" back to work for future benefit.
Dot-Com Bubble! What Dot-Com Bubble? The MCIM credo, when the technology led bubble finally got "pinned", summed up how the process worked so profitably: "no NASDAQ, no Mutual Funds, no IPOs, no Problem."
Embarrassed Wall Street investment firms used their influence to ban the "Brainwashing of the American Investor" book and sent the authorities in to stifle the free speech of the author --- not just a rumor, but it would be reckless to put the whole story in writing here.
Once again, through the "Financial Crisis", for the umpteenth time in the forty years since its development, this disciplined methodology got users through unscathed. Quality only security selection; Diversification of several types; Income from every pore of the portfolio body, and disciplined Profit Taking that allows no reasonable profit to go unrealized.
A preemptive portfolio protection strategy for the entire market cycle... one that even a caveman can learn to use effectively.
