Cash Flow That Only Occurs In Equal Amounts Each Year Managing the Income Portfolio

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Managing the Income Portfolio

The reason people take investment risks in the first place is the possibility of achieving a higher rate of return than is achievable in a risk-free environment…ie. FDIC insured bank account. Risk comes in many forms, but the primary concerns of the average investor are “credit” and “market” risk…especially when it comes to investing for income. Credit risk involves the ability of corporations, government entities and even individuals to meet their financial obligations; market risk refers to the certainty that there will be changes in the market value of the selected securities. The former can be reduced by selecting only high-quality (investment) securities, and the latter by diversifying appropriately, understanding that changes in market value are normal, and having an action plan to deal with such fluctuations. (What does the bank do to get the amount of interest it guarantees to depositors? What does it do in response to expectations of higher or lower market interest rates?)

You don’t need to be a professional investment manager to professionally manage your investment portfolio, but you do need to have a long-term plan and know something about asset allocation…a portfolio organization tool that is often misunderstood and almost always misused within the financial community. It’s also important to know that you don’t need a fancy computer program or a glossy presentation with economic scenarios, inflation estimators and stock market projections to properly align with your goal. You need common sense, reasonable expectations, patience, discipline, soft hands and an oversized driver. The KISS principle should be the foundation of your investment plan; Focusing on working capital will help you organize and control your investment portfolio.

Retirement planning should focus on the additional income needed from the investment portfolio and the asset allocation formula [relax, 8th grade math is plenty] required to reach the goal will depend on only three variables: (1) the amount of liquid investment assets you start with, (2) the time until retirement, and (3) the range of interest rates currently available on investment-grade securities. If you don’t let the “engineering” gene take over, it can be a fairly simple process. Even if you’re young, you need to quit heavy smoking and develop a growing stream of income… if the income continues to grow, the growth in market value (which you expect to worship) will take care of itself. Remember, a higher market value may increase the size of the hat, but it doesn’t pay the bills.

First, subtract any guaranteed retirement income from your target retirement income to estimate the amount needed from the investment portfolio alone. Don’t worry about inflation at this stage. Next, determine the total market value of your investment portfolios, including company plans, IRAs, H-bonds…everything except the house, boat, jewelry, etc. Liquid personal and pension plan assets only. This sum is then multiplied by a range of reasonable interest rates (currently 6% to 8%) and hopefully one of the resulting numbers will be close to the target amount you got a moment ago. If you are less than a few years away from retirement age, they better be! Surely, this process will give you a clear idea of ​​where you stand, and that in itself is worth the effort.

Organizing a portfolio involves deciding on the appropriate allocation of assets…and this requires some discussion. Asset allocation is the most important and most commonly misunderstood concept in the investment lexicon. The most basic confusion is the idea that diversification and asset allocation are one and the same. Asset allocation divides the investment portfolio into two basic classes of investment securities: stocks/equity securities and bonds/income securities. Most investment grade securities fit comfortably into one of these two classes. Diversification is a risk reduction technique that strictly controls the size of individual holdings as a percentage of total assets. Another misconception describes asset allocation as a sophisticated technique used to mitigate the end effect of stock and bond price movements and/or a process that automatically (and unwisely) moves investment dollars from a weaker asset classification to a stronger one. .a sophisticated “market timing” device.

Finally, the asset allocation formula is often misused in efforts to place a valid investment planning tool on speculative strategies that have no real merits of their own, such as: annual portfolio repositioning, market timing adjustments, and mutual fund diversion. The asset allocation formula itself is sacred and if constructed correctly should never be changed due to conditions in either the equity or fixed income markets. Changes in the applicant’s personal situation, goals and objectives are the only issues that can be allowed in the allocation decision process.

Here are some basic guidelines for asset allocation: (1) All asset allocation decisions are based on the cost basis of the securities in question. The current market value may be higher or lower and simply doesn’t matter. (2) Any investment portfolio with a cost basis of $100,000 or more should have at least 30% invested in income securities, either taxable or non-taxable, depending on the nature of the portfolio. Tax-deferred entities (all types of retirement plans) should hold most equity investments. This rule applies from age 0 to retirement age – 5 years. Under 30, it is a mistake to have too much of your portfolio in Income Securities. (3) There are only two categories of asset allocation, and neither is ever described with a decimal point. All funds in the portfolio are allocated to one category or another. (4) From retirement age – 5 years onwards, the distribution of income must be adjusted upwards until the “reasonable interest rate test” shows that you have reached the goal or at least within reach. (5) At retirement, between 60% and 100% of your portfolio may need to be in income-producing securities.

Supervising or implementing an investment plan will be best done by those who are least emotional, most decisive, naturally calm, patient, generally conservative (not politically) and self-actualized. Investing is a long-term, personal, goal-oriented, non-competitive, hands-on decision-making process that doesn’t require advanced degrees or the IQ of a rocket scientist. In fact, being too smart can be a problem if you tend to overanalyze things. It is useful to set guidelines for the selection of securities and their disposition. For example, limit your equity holdings to investment grade, NYSE, dividend-paying, profitable and broadly traded companies. Don’t buy stocks unless they’re down at least 20% from their 52-week high, and limit individual stock holdings to less than 5% of your total portfolio. Make a reasonable profit (use 10% as a target) as often as possible. With a 40% income allocation, 40% of profits and dividends would be allocated to income securities.

For fixed income securities, focus on investment grade securities with above-average but not “best in class” returns. With variable yield securities, avoid buying near 52-week highs and keep individual holdings well below 5%. Also, keep individual preferred stocks and bonds well below 5%. Closed-end fund positions can be slightly higher than 5%, depending on the type. Make a reasonable profit (more than a year’s income to start with) as soon as possible. With a 60% equity allocation, 60% of profits and interest would be allocated to shares.

Wall Street-style monitoring of investment performance is inappropriate and problematic for targeted investors. It deliberately focuses on short-term dislocations and uncontrolled cyclical changes that cause constant disappointment and encourage inadequate transactional responses to natural and innocuous events. Coupled with a media that thrives on sensationalizing anything outrageously positive or negative (Google and Enron, Peter Lynch and Martha Stewart, for example), it becomes difficult to stick to any plan as environmental conditions change. First greed, then fear, new products replacing the old, and always the promise of something better, when in reality, boring and old-fashioned basic investment principles still get the job done. Remember, your misfortune is Wall Street’s most desirable asset. Don’t laugh at them and protect yourself. Base your performance evaluation efforts on the achievement of goals…yours, not theirs. So, based on the three basic goals we talked about: growth in basic income, production of trading profits, and general growth in working capital.

Basic income includes dividends and interest generated by your portfolio, net of realized capital gains, which should mostly be higher. No matter how you divide it, your long-term comfort requires regular increases in income, and using the total cost basis of your portfolio as a benchmark makes it easy to determine where to invest your accumulated cash. Because a portion of every dollar added to the portfolio is redistributed into income generation, you’re sure to grow your total annually. If market value is used for this analysis, you may be investing too much money in a falling stock market to the detriment of your long-term income goals.

Profit generation is the happy face of market value volatility, which is a natural feature of all securities. To make a profit, you must be able to sell securities that most investment strategists (and accountants) want you to marry! Successful investors learn to sell the ones they love, and the more often (yes, short-term) the better. It’s called trading, and it’s not a four-letter word. When you can get to the point where you think of the securities you own as high-quality inventory on the shelves of your personal portfolio boutique, you’ve arrived. You won’t see WalMart charge prices higher than the standard markup, and you shouldn’t either. Cut the markup for slower bidders and sell damaged goods you’ve held too long at a loss if you have to, and in the middle of it all try to predict what your standard Wall Street statement will show you… a portfolio of equities that they haven’t hit their profit targets yet and are probably in negative market value territory because you sold the winners and replaced them with new inventory… increasing profitability! Similarly, you’ll see a diverse group of earners punished for following their natural tendencies (this year) at lower prices, helping to increase your portfolio’s yield and overall cash flow. If you see big plus signs, you are not managing your portfolio correctly.

Growth in working capital (the portfolio’s total cost base) simply happens, and at a rate that will be somewhere between the average return on the income securities in the portfolio and the total realized gain on the equity portion of the portfolio. With larger equity allocations, it will actually be higher because frequent trading generates a higher rate of return than safer positions in the income distribution. But, and this is too big a but to ignore as you approach retirement, trading profits are not guaranteed and the risk of loss (although reduced by a sensible selection process) is greater than with Income Securities. This is why asset allocation shifts from a higher to a lower percentage of equity as you approach retirement.

So is there really such a thing as a managed income portfolio? Or are we really just dealing with an investment portfolio that needs the occasional adjustment in asset allocation as we approach the time in life when it needs to provide a yacht…and fuel money to run it? By using cost basis (working capital) as the number that needs to grow, by accepting trading as an acceptable, even conservative approach to portfolio management, and by focusing on growing income instead of ego, this whole retirement investing thing becomes significantly less scary. Now you can focus on changing the tax code, reducing health care costs, saving on Social Security, and spoiling the grandkids.

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