The never-ending, slow and steady grind during the first half of 2015 has yet to pave the way toward opportunities or riches for retirement income investors. Instead, it’s likely left you with that unsettling feeling that you’re withdrawing more from your account than you have been able to produce in total return this year. For the newly minted retirees, this feels a bit odd since we’ve experienced steadily rising asset prices during the last six years. Yet, for those select few who remember, you wouldn’t be at all shocked to notice that in some years the market posts negative returns.
The crux of the sideways stumble we find ourselves in is that many investors become impatient. Up until just a few weeks ago a balanced 50/50 mix of equities and fixed income, using the S&P 500 and the Barclays Aggregate Index as proxies, was only up a few tenths of one percent. In turn, a retiree using the 4% withdrawal rule has suffered a principal lapse to the tune of a percent or two from their nest egg during that same period.
But if there was one facet of portfolio management that I could coach investors to keep their eye on; it would be to keep yourself from making rash decisions with your portfolio that could compound the problem come year end. Mind you, this isn’t a typical buy-and-hold guy telling you to “stay the course”. Quite the contrary, it comes down to fine-tuning your asset allocation and security selection appropriately so you are able to maximize the second half of the year and make up for some of the time and headway you’ve lost.
The first step in the process is identifying your asset allocation, or the percentage of your accounts distributed amongst stocks, bonds, alternatives, and cash . Secondly, identify your portfolio’s income stream or yield; so that you are able to decipher how much of your total return comes from income vs. capital appreciation. Lastly, audit your investment expenses — are you in high-fee products or low-cost ETFs ?
Now that you have much of that baseline data established, the hard part is translating the information so that it aligns with your goals. I wish I could tell you that ratcheting up your equity exposure or buying high-yield bonds could make up the gap come year end; but it’s simply not that easy for most investors.
What I can say is that we’ve made two important changes to our Strategic Income Portfolio over the last 30-60 days. These adjustments come as a result of recent volatility and presumed opportunities, all of which we feel will allow us to better achieve our return objectives by the end of the year.
Beginning with fixed income, it’s no secret that bonds exhibited a lot of volatility in the first half of 2015. We went from a low of 1.65% to a high of 2.5% on the 10-year Treasury note yield, which exerted downward pressure on most bond funds. As a result, higher-quality bonds offer more value to investors that need income and now you don’t need to assume more credit risk to achieve a better yield.
We transitioned out of our dedicated holding in the PIMCO 0-5yr High Yield Corporate Bond ETF /zigman2/quotes/205210165/composite HYS +0.15% to the higher-quality, more diversified, and actively managed SPDR DoubleLine Total Return Tactical ETF /zigman2/quotes/200730527/composite TOTL +0.07% . Although we sacrificed a minor amount of yield, we transitioned from a credit-heavy fixed-income position to a quality-heavy stance. This posturing adorns our portfolio with an additional shock absorber if risk assets remain volatile and the fund better aligns with our total return objectives given the current level of interest rates.
On the equity side of the portfolio, due to the volatility in foreign income stocks, we transitioned out of our small position in the iShares International Dividend Select ETF /zigman2/quotes/206137041/composite IDV +0.98% and added the proceeds back to our core holding in the Vanguard High Dividend ETF /zigman2/quotes/205740569/composite VYM +0.25% . At first glance, this change might seem contrary to fundamental measures of relative valuation between U.S. and foreign equities.
However, by doing so, our objective was clear: the risk and volatility in foreign equities given the wide currency fluctuations and eurozone challenges simply didn’t align with the reward characteristics. Just like our transition out of HYS, we weren’t wooed solely based upon stated yield, but instead we believe domestic equities could exhibit a better second half if the Fed pushes a rate increase out to late 2015 or early 2016.
These two examples of changes that we have made to our portfolio come with the belief that we will see a positive net outcome when we reach this year’s finish line. The key to making changes to your own portfolio is to not let yourself be motivated by performance chasing. Instead, take a hard look at your own accounts, and decide whether or not you can do better with a few common sense adjustments.
Ultimately you have to weigh the pros and cons of whether or not you stand to face additional risk if an undesirable outcome were to materialize, even if a correction is transitory. Above all, always take the time to develop a plan and then implement it decisively.
Disclosure: Fabian and clients of FMD Capital Management own TOTL and VYM.