Be Careful Selling Out For Yield

A couple of interesting retirement-related reads that I want to try to weave together. 

First was a very long read titled The End of Retirement written by Cathrin Bradbury. Bradbury is a retired journalist in Canada. If you read the whole thing, you might pick up some different attitudes, culturally, toward retirement and aging. The tone of the article is very negative on people's financial ability to have a traditional retirement and also hammers on the idea that retirement is a short path to graveyard. There is also a preoccupation about assisted living as being an inevitability and how expensive that sort of care is. 

Before you get too doomy about your prospects by reading that article, if you look, you can find multiple sources that say only about 2% of American seniors live in assisted living. The source I'm linking to says an additional 4% live in nursing homes. I'm not sure what the difference is so lets just go with 6% very generally.  The average stay in assisted living is 28 months and the average stay in a nursing home is nine months. Sorry, still not sure the difference.

In my opinion, the article places way too much weight on the nursing home/assisted living outcome. Not that we should not try to mitigate the impact but understanding the actual numbers is very productive. Now, you knew this was coming, layer in some good habits and the odds of ending up in nursing home/assisted living go way down from there. It is all incredibly simple, even if not easy. Lift weights and cut carbohydrate consumption. I realize the irony of talking about carb consumption on Thanksgiving night. The combination of lifting and proper diet will absolutely slow aging dramatically. Dig a little deeper and you will find research that concludes by some measures, biological aging can actually be reversed. Avoiding insulin resistance and retaining the ability to walk fast and pick up heavy things is crucial on this front. 

The other article was by Rida Morwa at Seeking Alpha. I've long ago detached from Seeking Alpha but I know this guy writes prolifically and has a ton of followers. I've read very little of his stuff before but it had a good title about retiring at 55 that hooked me. 

Rida covered a lot of ground but there was one point he made that I'd never really thought of before. I read it and was like "wait, is he right?" I believe he focuses on securities with high payout rates, so more than just stocks with high dividends...again, I believe this to be the case. He has apparently long recommended the Pimco Corporate Income & Opportunities Fund (PTY) which is a closed end fund that Yahoo says yields 10.46% and Annaly Capital Management (NLY) which is a mortgage REIT paying 14.6%.

His thought with these very high yields is not to spend more than 4% (give or take) but to instead take what he calls extra income they pay to buy more shares because both of these go down in price. PTY is a couple of bucks lower than where it was 20 years ago and NLY is trading at about 1/4 of where it was in 2010.

In a simplified example if you split $1 million evenly between PTY and NLY they would pay $52,300 and $80,645 respectively for a total of $132,935. Still though, you only take out $40-ish thousand, the 4% and buy more shares with the remaining $92,000. This hopefully allows for keeping up with the price declines of the shares. Another complicating factor is the variability of the dividends. PTY's has sort of ebbed an flowed over 20 years, currently at 11.9 cents/mo after a long run at 13 cents/mo. NLY has cut its dividend many times over the years.

Let's model the idea out using PTY and NLY against a couple of simpler portfolios.

There is a flaw here that overstates Portfolio 1's result. Portfoliovisualizer is all or none on reinvesting the dividends and I chose all. 4% would have come out every year. VOO is the Vanguard S&P 500 and XYLD is the Global X S&P 500 Covered Call ETF.

PTY/NLY 50/50 was just to make the example simple, I don't think Rida was suggesting owning just two things but generally, high income closed end funds and other very high yielders move from the upper left to the lower right at some slope. Implementing the extra income approach has me wondering if maybe this is too clever by half. A much simpler equity portfolio would likely go up orders of magnitude higher than a basket of closed end funds and an investor could just sell the 4% they might want to take or maybe bump that up ever so slightly if they need to account for the 15% capital gains tax (15% between $89,251 and $553,850 married filing jointly). 

I wouldn't put it all into an S&P 500 fund of course, it is important to manage for sequence of return risk too. In the context of a diversified portfolio, having some exposure to a very yielder can be additive so nothing negative against that but going all in to sell out for yield as I'll call it, seems like a tough way to make a living. Ignored in the one article, but maybe covered in others by Rida, is what happens when you have to pay for some unbudgetable thing that is very expensive. I perceive Rida's idea as having less flexibility in the face of that sort of event.  

The information, analysis and opinions expressed herein reflect our judgment and opinions as of the date of writing and are subject to change at any time without notice. They are not intended to constitute legal, tax, securities or investment advice or a recommended course of action in any given situation.