Fixed Income Choices

[celcius]

It is not as hard or risky as you think.

Not to be crass, but your post implies that you do not fully appreciate the power of dividends in retirement planning.

Firms in the dividend achievers index have flawless track records of paying fixed and increasing dividends every year. Some like ExxonMobil routinely increase well-above a typical COLA -- upwards of 10-20% (21% increase two years ago).

Now, mathjak likes to warn people that dividends can and do disappear in rough times, but I think he overestimates this possibility. I don't care how "risk averse" you are -- a fund like VIG is effectively "fixed income equity" and possibly the least risky thing to put in almost any retirement portfolio.

[mathjak107]

nah i warned enough about using dividends as a proxy for interest in retirement planning.

but as far as investing a very interesting study at compounding investors money was done since it is the power of compounding not dividends that grow wealth.

a penny doubled and compounded every day for only 31 days is over 10 million bucks . such is the power of compounding.

what is interesting is dividends have increased to the highest levels since 1998 with a record increase of 17.8 billion dollars in increased dividends payed out just 1st quarter. the 2nd quarter may be even bigger.

all dow stocks pay dividends and 84% of the s&p 500 does too.


according to a study done by howard silverblatt at s&p those dividends have been coming at a price as they go up and up..

a good part of that capital from free cash flow is gone forever and no longer available for compounding.

mid-caps and small caps who pay little in dividends have been far and away providing far better compounding and use of investor money for much greater returns..

in fact one of the least efficiant ways to grow investor money now is paying it out as a dividend.

as chuck akre said ,free cash flow in a company can be used to compound by buying back its own stock, investing in its own company or buying other companies . cash flow paid out as dividends loses its compounding ability and much of it is gone forever and can no longer compound.

many of the great companies in the s&p 500 have lagged behind their non dividend payers in the midcap and small cap markets who now seem to be much more efficient at generating compounding on investor money.

midcaps and small caps have compounded the last 5 years at rate of 5-6% higher then their dividend paying cousins.

[celcius]

I completely agree with that.

However there is a good reason for dividends in the large cap space. Due to economies of scale, a large cap firm does not have the ability to reinvest all of its free cash flow at their current ROIC or better. To the extent they cannot, it is better to pay out a dividend than drag ROIC down.

ExxonMobil for example has normalized free cash flow of $20B, and that's after capital spending. Buybacks are limited to the $4B board/shareholder authorization, and they cannot reasonably do $10-15B worth of M&A every year. After all is said and done, $12-15B is still left over. At this point they are out of moves. So they pay out $11B and save a few $B.

This is the smartest move for the cash-cow large caps, and it gives the investor a return of capital without having to liquidate stock, and a more stable stock price... a perfect storm for retirement.

But as far as investing for growth, your logic is correct in that small caps have the advantage of smaller size in how to compound free cash flow.

[mathjak107]

as you know i would disagree with the more stable stock price and the not selling the stock issue but that has been beaten to death already.

the dividend darling of wall street with its proprietery selection software plunged more than the market did. anyone can creat a dividend off any stock on their own if they don't mind a small commission and the effect would be the same.

as long as the stock goes up in both cases it is a non event.

stock buy backs have accounted for more growth the last few years then earnings did for many s&p 500 companies. had they done more buybacks and less giving away profits those same issues might have been soaring.

lets not forget the s&p with dividends and all barely moved over 14 years and in fact on an inflation adjusted bases is still down from 1999..

1st quarter 2014 Large companies tapped cash reserves to buy back more stock in the first quarter than any quarter since mid-2007.

more and more investors want better returns and these large companies that give money away are utilizing that money in the least efficiant manner a company can and the returns the last 14 years for most reflect that fact.

more and more it is becoming a stock pickers market. selecting stocks that can compound money is where things are headed.

since i only follow fidelity funds i can tell you their results.

you had fidelity large cap funds beating the s& p 500 with 75% of its large cap funds the last 4 years in all but 1 year..

looking at some of the 2013 results.

out of 26 fidelity large cap funds only 6 failed to beat the s&p 500.

looking back to 2012 at fidelity we had 27 large cap funds ,21 beat the s&p 500


2011 saw the s&p beat all but 2 of fidelitys large cap funds


2010 saw out of 27 funds, 21 again beat the s&p 500

that is all i have access to in the archives .

so out of the last 4 years you had the index win once and the managed funds win 3x

[clb10]

Originally Posted by soulsea

Hi,

Hypothetically speaking ...

Let's say Mr and Mrs Smith receive a windfall of $5,340,000 (maximum allowable lifetime tax free gift), and if they add to it their liquid (cash) life savings, their net cash wealth is $7m. Their ($1.5m) home is paid for and have no debt.

Mrs Smith is in her late 30s and Mr smith is in his mid 40s. They are thankful for their blessings and would like to use their capital to generate fixed income to sustain their lifestyle without eating into their capital. They have computed that in order to sustain said lifestyle, and to account for capital gains tax, their $7m needs to generate 5% annual yield ($350,000 - tax).

Mr and Mrs Smith are not greedy, they are extremely happy to live on $350,000 gross a year and they see no reason to risk any more than is required to try to get any more out of their principle than 5% yearly.

But Mr and Mrs Smith are weary of all the different types of investments available to them, and despite trying to educate themselves as much as they can through research, are not knowledgable enough to differentiate between what is sound financial advice in the midst of never-ending 'pitches' from people who line up to manage their money.

In short, if anyone here knows, what would be the lowest risk approach to achieving guaranteed fixed 5%/yr return on capital for relatively high net worth individuals?

The question of course presumes that such an investment mechanism exists. If it does not, then of course the question shifts to what are the lowest risk to reward investments available that are likely to generate 5%/yr income.

I hope all that makes sense. Essentially the Smiths reasoning is that there is hopefully a fixed income investment mechanism that can generate 5%/yr with little risk, so that they may use their $7m to live comfortably for the rest of their lives without cannibalizing their principle.

On their behalf, I thank you for any input and/or suggestions.

- soul

T Bills and money market funds for safety. $100 billion market cap or larger dividend payers for growth. Split 50/50.