We talked to an investor this week who, like many, sold out of the market because of the volatility. He simply wants to know how to invest in this market. In his particular situation, he and his wife are 66 and 65 years old, respectively. He held a large position in a community bank that paid him nearly $100,000 in dividend income for many years and in the economic crisis, the bank cut the dividend to zero. He has roughly $6 million in liquid assets in CDs and money market accounts. He and his wife spend about $150,000 annually, and have no heirs.
While we should all be so lucky to worry about having only $6 million, he shares the same concern we all have in that his wealth used to be considerably more before he was beaten up in the markets. Like other investors, he is scared to put his money into what he views as risky assets, i.e., common stocks. However, money market accounts are paying barely half a percent, and at that rate, you cannot outpace inflation or taxes.
Let’s look first at the financial planning side of his situation first, and assume he earns nothing and just spends his principal. If he were to follow our Ten Year Rule by putting 10 years of liquidity into fixed investments, in the most simplistic terms, that would mean $1.5 million. If he truly earned zero percent interest, in 10 years, he would be 76 with $4.5 million left.
Currently, our high income dividend portfolio is yielding more than 4% and our high growth dividend portfolio is earning a little more than 3.5%. Part of our conversation with this investor is about how he and his wife are so scared of the markets. So we took this a step further and calculated putting aside 20 years of liquidity. That would put $3 million in fixed investments, and if we put these in 20-year U.S. Treasury bonds, the truth is he will earn some interest. Twenty-year Treasury bonds will probably average 2.5% in interest, which would earn him about $75,000 a year in interest income until the couple are 86 and 85 years old.
In our opinion, this investor could earn 3% by investing his remaining $3 million in dividend paying stocks and generate about $90,000 a year. Between the interest on his Treasuries and the dividends from his investments he could be earning $165,000 a year. In this case, he would not have to touch his principal, and he would have half his money hedged against inflation with the equity investment.
Consider dividend paying stocks like McDonald’s Corp. (NYSE: MCD). In March 1990, you could purchase McDonald’s for $7.94 a share. As of June 30, 2010, it was paying $2.15 in dividends. That would equal a 27% return on cash—and that is not including the capital gain of the stock.
The best investment today is in corporate America. We might have deflation, and if we did, cash or 30-year Treasury bonds would be a nice place to be. But has any country ever had deflation for 30 years?
The general life expectancy for a man is 85 years old, so this investor is looking at making his money last 20 years. If he were to sit 100% in cash, he could be worse off if we have inflation because the cost of living will increase. We have had years with 12% inflation, so it is possible. This investor could also face increased taxes and a rise in health care costs. In our opinion, people need to make investment decisions based on time, not just the quality of the investment or what the market may do tomorrow. We feel investors need to have a long-term outlook with their investments.
Additionally this investor mentioned his broker offered to get him into some preferred stock paying 5.5%, which is great income for today. However, what corporation with good credit would opt to offer a preferred stock paying near 6% that is not tax deductible to the corporation when they could borrow money at 4.5% that would give the company a tax deduction? We feel he would be buying the stock of a company with the risk level he is trying to avoid. Corporate bonds and preferred stocks are only as safe as the company issuing them. We know many of the preferred stocks available now are in the financial sector, and we feel he would be better off buying companies like Johnson & Johnson (NYSE: JNJ) or McDonald’s.
Disclosures
This article is meant to provide valuable background information on particular investments, NOT a recommendation to buy. The investments referenced within this article may currently be traded by Henssler Financial. All material presented is compiled from sources believed to be reliable and current, but accuracy cannot be guaranteed. The contents are intended for general information purposes only. Information provided should not be the sole basis in making any decisions and is not intended to replace the advice of a qualified professional, such as a tax consultant, insurance adviser or attorney. Although this material is designed to provide accurate and authoritative information with respect to the subject matter, it may not apply in all situations. Readers are urged to consult with their adviser concerning specific situations and questions. This is not to be construed as an offer to buy or sell any financial instruments. It is not our intention to state, indicate or imply in any manner that current or past results are indicative of future profitability or expectations. As with all investments, there are associated inherent risks. Please obtain and review all financial material carefully before investing. Henssler is not licensed to offer or sell insurance products, and this overview is not to be construed as an offer to purchase any insurance products.
