Asset Allocation on Retirement
from Connolly Report February 2000
“[T]hose of us who lived with the market during the 1966-1982 period can attest that there have been long stretches when equities returned only the dividend; there were no capital gains.” A recurrence of such a period of flatness “would wreak havoc with the retirement plans of many Baby Boomers, who have become accustomed to annual double-digit percentage returns on their equities,” says Walter Weil writing in the December 27, 1999 issue of Barron's. Weil, a retired hedge-fund manager, thinks such a flat stretch is probable and that “a rethinking of asset allocations in retirement funds would be appropriate” for Boomers who own index funds or low-yield stocks. Why will a flat market mess up the retirement plans of most Boomers? Mutual funds are not noted for providing income, and dividend yields on most common stocks are very low. Boomers could not survive on the income provided by their funds. Most Boomers would be forced to sell their funds and switch to assets with a higher yield. Most would turn to bonds: it's conventional wisdom.
What's going to happen when Boomers start selling their no-yield or low yield stocks, when the tidal wave of Boomers money going into mutual funds reverses? Faced with massive redemptions, mutual fund managers will be forced to sell: share prices will be pushed down.
“The timing is hard to predict,” Walter Weis says. “Though a Boomer born in 1946 reaches 60 in 2006, it's uncertain he will retire then and if so, when he will start to alter the asset mix of his retirement funds to prepare for this life change. Furthermore, though there will be equity purchasers to provide the other side of the transaction, I doubt that there will be more urgent buyers than urgent sellers - mutual fund managers faced with Boomers' redemptions. Whenever a forecast of an event is highly probable, the stock market discounts it well in advance. The arrival of Baby Boomers' retirement age is one such event. Suffice it to say that the one factor that arguably has provided the most significant tail wind behind our current prosperity will become a stiff headwind, perhaps sooner than expected.”
What kind of return (yield + capital gain) will we be looking at when the indexes revert to the norm? If this regression to the norm comes by year-end 2004, Weis estimates the annual compound rate of return of the S&P 500 index at -3.3%. If it's before year-end 2009, it's 2.5% annually, if regression is before 2014, the return is 4.4%.
The yield we are obtaining right now on our common stocks is higher than returns the Walter Weis is expecting from the stock market. And our yield does not count the dividend growth we will get in the future. Our plan is working. Furthermore, when (not if…it's only a question of time) Boomers start selling their funds and low-yield stocks, I expect those of us who subscribe to the buy and hold for the dividend growth theory will benefit in two ways: 1. Faced with low or negative capital gains, Boomers, many of whom will be in charge of corporations, will influence and pressure corporations to increase dividends. As John Neff says, “the quest for yield” will return. 2. Some Boomers will switch to higher yield stocks instead of bonds, causing the prices of the type of stocks we hold to rise.
As I re-read this page in September of 2008 (The day Lehman Brothers files for Chapter 11), I have just been sent a column in the New York Times of August 24 2008. Weis was correct. “Since the end of the 1990s, dividends have accounted for all of the markets's [S&P 500] gains. In fact, without dividends you would have lost money…”
