Related Resources Screen for the best stocks for you Decision Center: Plan your dream retirement Retirement income calculator Jubak's Journal Recent articles: • A recovery built on retirees' backs, 3/2/2004 • 5 stocks for the skeptical tech investor, 2/27/2004 • A safer way to play higher oil prices, 2/24/2004 More... | Jubak's Journal 5 stocks to retire on -- and count on Political meddling makes interest rates, inflation and Social Security wild cards for every retiree. That's why you need to imagine the worst and invest to beat it. By Jim Jubak Predicting how much income a retirement portfolio realistically can generate just got a lot tougher because of what I call the Greenspan Squeeze. This is the combination of economic and policy trends that add up to a huge tax on the value of your retirement. (For more on this, see my March 2 column, A recovery built on retirees backs.) The trick to retiring comfortably is being able to accurately predict cash flow from your investments. An accurate forecast means you can actually reduce the amount of money that you have to save for retirement. Building a portfolio to fight the Greenspan squeeze (named after Federal Reserve Chairman Alan Greenspan, if you hadnt already guessed) starts with strategies to increase that predictable retirement cash flow. In this column, Ill lay out a general approach for doing just that and name five stocks that you can use to improve the predictable cash flow in your retirement portfolio.
Uncertainties mean you must save more But first lets start by making sure that everyone understands exactly how the unpredictability of such things as investment returns can increase the amount of money youll need to set aside for retirement. Ill start with an extreme example, an all-equity portfolio that doesnt pay any dividends at all. Lets say youve sat down with your financial planner, and, after a lot of head-scratching calculations, youve decided that youll need $80,000 in pretax annual income to retire the way that youd like. So how big a retirement nest egg would you need to generate $80,000? A back-of-the-envelope way to answer that question is to work backward from the desired income. If your all-stock portfolio returned, say, 11% annually, youll need a portfolio valued at $727,273. That simple calculation ignores a couple of things. Inflation, for example. Each year, inflation eats away at what that pretax $80,000 will buy. Returns can vary widely And then theres the little matter of the unreliability of that projected 11% return itself. As an average, its not unreasonable. The long-term average annual return on U.S. large company stocks is about 11%. But many Wall Street strategists now project that annual returns on equities over the next decade will be closer to 8% or even 6%. To get an $80,000 return at 8%, you would need $1 million. At 6%, the required portfolio jumps to $1.33 million -- nearly double what you had originally projected. Related news and commentary on MSN Money
The returns from an all-stock portfolio can swing widely even over relatively long periods of time. According to Ibbotson Associates:
But the possibility that returns will be just 8% or 6% instead of 11% does create the potential for a massive retirement shortfall. You'd be short $272,727 if the return drops from 11% a year to 8%, and $606,000 shy if the return drops to 6%. This is a very, very oversimplified example, but it makes a critical point: Anything that increases the volatility of future returns increases the size of the retirement portfolio youll need or should plan to build. The same is true for inflation, by the way. The more volatile potential future inflation is, the more youll have to put away to make sure that you dont get caught short in the worst-case scenario. Estimate the worst-case scenario Thats why anybody saving for planning for retirement over the next 10 years is facing a big problem now: the fiscal and monetary trends in place -- everything from the federal budget deficit to the weak dollar -- are likely to increase volatility in returns, interest rates, inflation and purchasing power. But you can use strategies that attack the key problem by reducing the worst-case uncertainty in your projected retirement cash flow. Thats easier than it sounds -- even given todays yield famine -- because anything that adds a guaranteed cash flow above that worst-case possibility improves your financial picture. For example, lets say that you can count on shares of Enbridge Energy Partners The result of the mix, even though youre getting only 7.4% on about a fifth of your portfolio, is to reduce the size of the nest egg needed to reach your retirement goal even in the worst case return scenario by about $63,000. (On the other hand, if the 11% return projection turned out to be right, you would generate $130,000 in income from this portfolio.) Youll get the same positive results -- that is, a reduction in the amount that you have to put aside in your worst-case portfolio -- from anything that reduces the volatility of the other variables as well. Lets say you inflation-proof part of your returns by buying investments that yield more cash as inflation kicks up. That would reduce the amount of money you have to set aside to insure your retirement from your worst-case inflation scenario. Just remember that this strategy will only work if the guaranteed return, including the effect of any inflation projection, is above the worst-case return you project. Putting an investment yielding a guaranteed 5% into your portfolio when you project a 6% return as the worst case wont help. Look for high yields, solid cash flows To find the combination of a high guaranteed yield and inflation-proof returns for part of my portfolio right now, I would not look at, say, Treasury Inflation-Protected Securities (or TIPS). Instead, look at energy and commodity stocks with high yields and growing cash flows. The growing cash flow part of this is extremely important. You want to avoid companies that are paying a high dividend now when times are good but have a history of cutting dividends when the cycle turns down again. To find stocks with yields above my 6% worst case threshold, in the current market youll need to look at master limited partnerships and trusts. Again, Id favor the energy field because the sector gives you the extra bang of inflation protection. Plus, energy is riding a long-term increase in price that increases the chance that these yields are guaranteed. (Click here for a screen to pick these out.) Ive already mentioned Enbridge Energy Partners. The Houston-based oil and natural gas transmission company, pays a 7.4% dividend. Here are three more companies to consider:
Some of these stocks have had substantial rallies in recent months. Fording is up 55.4% in the last three months and 100% over the last year. Amerigas is up nearly 17% in the last six months. But remember that what youre buying is guaranteed yield to help reduce the volatility of your portfolio. It would have been great to buy these shares earlier and catch more of the capital gain in the stock price, but these shares will still get the job done in a retirement portfolio. (And as common stocks that come with the likelihood of annual dividend increases, these shares are likely to withstand a climb in interest rates better than fixed-payment bonds or preferred shares.) Dont chase any of these stocks if the yield drops below the worst-case-return projection that youve made. One advantage to this approach is that it gives you a clear yield and safety threshold that any potential investment must pass. A buyback strategy that pays off It takes a little bit of analysis to understand why my fifth pick, Texas Pacific Land Trust But Texas Pacific is an example of a liquidating trust. Each year, the company sells off some of the 1 million acres of land it owns in western Texas, collects oil and gas royalties on almost 400,000 acres of Texas land, and receives another cash flow from grazing leases on its land. Some of that goes to pay that dividend, and pretty much all the rest goes to buy back shares. Since the company has been stripped down to just its administrative and cash management functions, Texas Pacific shows a whopping 78% gross operating margin and a net profit margin of 53%. Return on equity is almost 40%. With the company buying back shares each year, the cash flow and income is spread among fewer and few shares, which gradually increases the value of the shares. Its not a dividend, mind you, but the companys structure makes the total return from this stock the kind of guarantee Im looking for. The 10-year average annual return is 13%. And dont worry if you cant find enough stocks to put this strategy into effect today. Run these screens every month or so looking for opportunities. Investors periodically overreact to short-term difficulties, and that creates the chance to buy a high yield at a quality company. And remember that the likely direction of interest rates in 2005 is up. If you cant find the yield stock or bond you want today, the odds are youll have a better chance tomorrow. That, too, is part of the Greenspan squeeze. Changes to Jubaks Picks Buy Shell Transport & Trading The March 3 announcement that Royal Dutch/Shell Group CEO Sir Philip Watts was out as CEO turns Shell Transport & Trading Im adding Shell Transport & Trading to Jubaks Picks with a September 2004 target price of $49.50. (Full disclosure: I will be buying shares of Shell Transport & Trading three days after this column is posted.) Sell Carbo Ceramics What does Carbo Ceramics With the stock now above my $63 target price for September 2004, Id like to avoid what looks like a potential rough patch ahead. Demand for the companys product is running so strong that Carbo could be facing shortfalls in supply sometime around the middle of the year. The company has added new production lines at its China plant, which are due to start up this summer, and it will add about 8% to existing capacity. The bulk of the companys new capacity, however, wont come on line until mid-2005. Im selling with a 31% gain since I added the stock to Jubaks Picks on Jan. 16, 2004. (Full disclosure: I will be selling my shares of Carbo Ceramics three days after this column is posted.) New developments on past columns 7 stocks that like a falling dollar On Feb. 5, BorgWarner Editor's Note: A new Jubaks Journal is posted every Tuesday and Friday. E-mail Jim Jubak at jjmail@microsoft.com. At the time of publication, Jim Jubak owned or controlled shares in the following equities mentioned in this column: BorgWarner and Carbo Ceramics. He does not own short positions in any stock mentioned in this column. | ||||||||||||||||||||||||||||
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