Written by Dave Haviland
Using Total Return to Meet Your Clients’ Withdrawal Needs
May 21, 2020 | ECONOMICS & INVESTING
We originally posted this piece back in 2016 when the 10-year U.S. Treasury (UST) yield was ~1.9%. At that time, most were predicting a rise in interest rates and it would have been hard to imagine that four years later, the 10-year UST would be ~0.65%—especially given where interest rates had been for the preceding decades. Now, the Total Return concept is even more relevant today with interest rates at record lows and no one knows how long they will remain at this level, or where they may go from here. Read on as BCM Portfolio Manager, Dave Haviland, describes the Total Return concept from his own experience as a financial advisor.
Your clients need to withdraw 4-5% a year, but interest rates are at record lows. Here’s what you can do to help get them there.
For decades most financial plans were created with withdrawal rates of 4 to 5% to meet clients’ living needs. Yet today, the 10-year U.S. Treasury yield is hovering around 0.65% and even the 30-year has a ~1.0% yield. Worse yet, yields on equities have also trended lower with the dividend yield of the S&P 500® Index sitting at ~2.1%. Today, trillions of international bonds and even some U.S. bonds have negative yields! One can stretch for yield in relatively less liquid, riskier income-producing asset classes, but investors are wary of risk in this unprecedented market environment and, as the chart below shows, this may not work out so well for retirees or the rest of the boomers nearing retirement in a bear market. Clients don’t want extra risk; they just want to live off their portfolio and avoid losing a significant portion of their assets along the way. So, what can an advisor do?
Source: Global Asset Allocation (Chapter 3) via mebfaber.com, Meb Faber, March 6, 2015. Bloomberg for the period 1973-2019. The data shown for Convertible Bonds, Preferred stock, High Yield Bonds and MLPs is sourced by Bloomberg. They use the same end date as the rest of the asset classes (12/31/19) but have different start dates due to the fact the indices for these asset classes did not exist in 1973. Convertible bonds is for the time period starting on 6/17/1986, Preferred stock data starts 9/9/2003 and the MLP data begins 12/21/1995. The returns shown are “Nominal Returns” for the time period specified. For more information on what each asset class performance is represented by, please reference the disclosure pages. “EAFE” represents the regions of Europe, Australasia and Far East. Past performance is no guarantee of future results. An investment cannot be made directly in an index. Refer to the disclosure page for additional, important information.
My father started financial planning in 1981. When I joined him in the early 1990’s, he taught me an important concept: Use Total Return when yield alone does not meet a client’s living needs. The Total Return concept is simple: Instead of relying on dividends and interest alone, include a portion of the capital gains to meet client needs. Let’s look at a hypothetical example:
As you can see, this method can generate the money needed to meet the desired withdrawal rate. Then, the remainder of any capital gains remains in the portfolio to provide growth and/or to keep up with inflation.
On a practical basis, in a separate cash flow account, we kept 1-3 years of income needs in one-, two- and three-year treasuries. This way, when markets faltered, we would not have to take from the investment portfolio at market lows, exacerbating the losses. Dividend, interest and gains remained in the investment account. Provided markets were not faltering though, once a year a withdrawal for the full amount was transferred to the income account and a new 3-year Treasury was purchased to refill the reserve. The matured Treasury in the cash flow account was used to meet client needs for the year with a periodic distribution.
If the accounts are set up to automatically distribute, all the advisor needs to do is make sure there is $20,000 of cash raised in the investment account a few days before the transfer to the cash flow account.
On a separate note, the cash flow account can also be a “holding tank” for any low-cost basis positions that need to be liquidated over time. Once sold, these proceeds can be added to the investment portfolio, but I digress.
The simple total return concept and process allows you to work with clients to help meet their withdrawal needs despite the ultra-low interest rates of today’s unprecedented market environment. If you would like to learn how we seek total return, please click here.
Sources and Disclosures:
1 WSJ Daily Shot, 3/28/20
2,3 WSJ Daily Shot, from 3/30/2020
4,5,6,7 “What the Federal Reserve Can Do to Fight Recession.” Wall Street Journal, 3/26/20. https://www.wsj.com/video/what-the-federal-
reserve-can-do-to-fight-recession/D23403CC-088F-472C-848A-814BC1829E74.html
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Past performance is no guarantee of future results. Index performance is shown on a gross basis and an investment cannot be made directly in an index. The performance of any ETFs, as contributors or detractors to the strategy, are provided on a gross basis. An Exchange Traded Fund (ETF) is a security that tracks an index, a commodity or a basket of assets like an index fund, but trades like a stock on an exchange. ETFs experience price changes throughout the day as they are bought and sold. All BCM strategies invest only in long-only ETFs.
This material is provided for informational purposes only and does not in any sense constitute a solicitation or offer for the purchase or sale of a specific security or other investment options, nor does it constitute investment advice for any person. The material may contain forward or backward-looking statements regarding intent, beliefs regarding current or past expectations. The views expressed are also subject to change based on market and other conditions. The information presented in this report is based on data obtained from third party sources. Although it is believed to be accurate, no representation or warranty is made as to its accuracy or completeness.
As with all investments, there are associated inherent risks including loss of principal. Stock markets, especially foreign markets, are volatile and can decline significantly in response to adverse issuer, political, regulatory, market, or economic developments. Sector and factor investments concentrate in a particular industry, and the investments’ performance could depend heavily on the performance of that industry and be more volatile than the performance of less concentrated investment options and the market as a whole. Securities of companies with smaller market capitalizations tend to be more volatile and less liquid than larger company stocks. Foreign markets, particularly emerging markets, can be more volatile than U.S. markets due to increased political, regulatory, social or economic
uncertainties. Fixed Income investments have exposure to credit, interest rate, market, and inflation risk.
Diversification does not ensure a profit or guarantee against a loss.
The Standard & Poor’s (S&P) 500® Index is an unmanaged index that tracks the performance of 500 widely held, large-capitalization U.S. stocks. Indices are not managed and do not incur fees or expenses. The S&P Small Cap 600® Index is an unmanaged index that tracks the performance of 600 widely held, small-capitalization U.S. stocks. The MSCI World Index is a free float-adjusted market
capitalization weighted index that is designed to measure the equity market performance of developed markets. The MSCI World ex-U.S. Index is a free float-adjusted market capitalization weighted index that is designed to measure the equity market performance of developed markets, excluding the United States. The MSCI ACWI Index captures large and mid-cap representation across 23 Developed Markets and 26 Emerging Markets countries. The MSCI ACWI Index ex-U.S. captures large and mid-cap representation across 22
Developed Markets and 26 Emerging Markets countries, excluding the United States. The Bloomberg Barclay’s U.S. Aggregate Bond Index is a broad base index and is often used to represent investment grade bonds being traded in the United States.
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The BCM investment strategies may not be appropriate for everyone. Due to the periodic rebalancing nature of our strategies, they may not be appropriate for those investors who desire regular withdrawals or frequent deposits.
For Investment Professional use with clients, not for independent distribution. Please contact your BCM Regional Consultant for more information or to address any questions that you may have.
Beaumont Capital Management was originally created in 2009 as a separate division of Beaumont Financial Partners, LLC. Beaumont Capital Management LLC spun off as its own entity as of 1/2/2020. Beaumont Financial Partners, LLC was originally registered as
Beaumont Trust Associates in 1981 and was reorganized into Beaumont Financial Partners, LLC in 1999.
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