In my latest post, I started a 3 parts series on factors making a big difference in your retirement portfolio. If you don’t consider them, your retirement plan could go bust faster than the plane you are taking to travel Europe this summer.
The first article was about the infamous inflation. This post will explore another problem many retirees face when building their portfolio; asset allocation. There are a handful of sectors offering what retirees want: high yield and a solid business.
Retirees want both high income and safe return when they invest. Unfortunately, financial theory has decided that this combination isn’t possible. At best there is an anomaly in the market that will quickly be found and corrected. When a company is offering a high yield and there are no important risks attached to it; it’s probably because you have missed something doing your research.
But buying one high yielding stock isn’t the end of the world. In a well diversified portfolio, having one or two “bet” representing less than 10% of your portfolio isn’t that bad. The problem happens when you have a concentration of high yielding stocks coming from the same sector. If you have most of your portfolio invested in REITs, BDCs, MLPs and utilities, this article is for you!
Where do you invest your money?
No matter what your age and your risk tolerance is, I think you should never concentrate your portfolio in 2-3 sectors. In my opinion, showing more than 20% of your money in the same sector is looking for trouble. Oh please, don’t tell me that you have done it in the past 10 years and you show great results; my 12 yr old could have shown great returns just by picking stocks according to companies’ logos!
The problem with the current bull market is that everybody looks like Buffett. Pretty much all sectors, even those with higher level of risks, did well in the past 10 years. Therefore, many investors see “no risks” with their strategy as they kept receiving strong dividend payments for several years. But let me show you what it looks like when you concentrate your money into a sector that eventually hits a brick wall:
As you can see, any dividend investors thinking investing in banks was a smart move to finance its’ retirement got a serious paycheck cut during the latest financial crisis. Just because I know how many retirees love REITs, I’ve done a quick check over the past 3 years. Using Ycharts, I’ve tracked 400 REITs showing a dividend growth over the past 3 years from -100% to increase to +282%. Here’s what I found:
- 192 (48% of them) shows a dividend increase stronger than 2% (beating inflation).
- This numbers drops to 46 (so 11.5%) if I select REITs paying a 6% yield and over.
- 142 (35.55%) of them cut their divided in the past 3 years.
In other words; when you pick a REIT paying a high yield (6%+), you have a higher chance to pick one that will make no increase or cut its dividend in the next 3 years to raise it to match inflation afterwards. Imagine the result if you would pick 10 REITs paying over 6% yield… Yeah, I’m pretty sure you would show a few divided cuts in your portfolio!
Do not underestimate the power of your asset allocation
When I look at the current stock market, I like saying that everybody looks great on the prom night. Pretty much all companies paying high yield are at their best right now. They have enjoyed low interest rates, they benefited from an enthusiastic market that is eager to buy new bonds and a strong economy. Pretty much any bozo with a decent accountant could run a company with those conditions.
This circus reminds me of the tech bubbles. At one point, all you needed was a cool office with wide windows and “dot com” in your name. That was enough to raise hundred of millions in capital. Everybody was on their Prom night – they all looked good until they wake up the next morning once the party was over.
While I was at school during the tech bubble, I lived through the 2008 market crash as both an investor and a financial adviser to my clients. I noticed that the ones with a well diversified portfolio weren’t hurt much. Many of my clients ended 2008 with -15% to -18% and worst performing portfolios (more aggressive) were down -26 to -30% at the bottom. As an investor with a portfolio 100% invested in stocks, I’ve finished the year at -27%. That wasn’t too bad when you considered that concentrated portfolio could have went all the way down to -80% to -90%!
Your asset allocation is your ultimate shield to protect you from any catastrophe. Those who had too many tech stocks back in 1999, paid the price the same way Canadian investors did when rushed toward the oil sand industries in the 2000’s and when the world trusted big banks in 2008. During each crisis, there were sectors that went through the storm and kept raising their dividend. Sure, their stock prices were down, but their business wasn’t.
Therefore, patient investors cashed their juicy dividend and just had to wait until the storm was over to take a walk. Each time, they walked by weeping investors cursing their advisor, the market or God for having so many stocks in the same sector. Don’t be a “weeper”, be a “winner”.