Retirement Investing (Connolly Report © October 1996 page 370)

Always on the lookout for new ideas in the area of retirement investing, I scour scores of sources. Most of the literature is junk. In the Money Guide issue of Forbes magazine (June 17 1996), however, I found an article with some good ideas. The writer interviewed a 48 year old money manager named James Garland. Bluntly put, Garland's advice to people wanting to pass along their nest egg is to (quoting from the article, not Garland unfortunately) “avoid bonds: put most of your assets–all, if you can stomach the price swings–into common stocks. Spend the cash dividends. Count on their rising fairly steadily as an offset to inflation. Avoid the temptation to substitute fixed income instruments as an income booster.” Garland oversees a portfolio which is 85% invested in equities and 15% in bonds. His reason for such a low portion in bonds is simple: the income from bonds erodes over time and if you spend all the income from a bond, you consume capital. Garland's reason for having any bonds at all is most interesting. It's not to increase current income. If there is another depression, Garland reckons dividends will decrease. To keep the income flowing to his clients, he plans to dispose of some of the bonds rather than sell stocks at low prices. I've considered this possibility, too. Stock prices could decrease if there is a depression. This does not mean, however, that dividends would also decrease. This is one reason I buy utility stocks rather than growth stocks. I reckon that, regardless of what happens, there will still be a need for essential services, that profits will still flow to the utilities. I've been researching this point at the National Archives. What happened to dividends between 1928 and 1932? So far I have only done a few companies: I have yet to find a dividend decrease. Like Garland, I eschew bonds and other fixed income instruments–preferreds, mortgage-backed securities and resource units–as a way to boost income. Instead, I buy common stocks which have a yield some three hundred basis points above the yield of the TSE 300. Before I start, I'm 3% ahead. Then I use the sorted list of common stocks to uncover value. Stocks which are out of favour have an even higher yield. To secure capital, I stick to companies with a long record of dividend payments. Finally I wait patiently for dividend increases to regularly boost my income. While this Forbes article was good, one point bothered me: the columnist paraphrased, rather than quoted, this experienced money manager. One little word revealed to me that the writer really did not understand income growth. Can you spot the offending word in this sentence? “…a 2 million nest egg, properly protected against inflation, will yield only $37,000* a year in after tax spending money.” In the first year the income will be $37,000. That part is correct. But, with dividend growth, which is implied with the words “properly protected against inflation”, income will be higher in year two and subsequent years. While mentioning that “over the past 70 years dividends have climbed faster than the cost of living” and that “In real terms they have been growing at 1%”, the columnist did not seem to grasp the implication of this significant information. The concept of income growth is ill-understood. The message of the column is simple. Because the current income from common stocks is low, a retirement portfolio must be set up early. Dividend growth has to be given a chance to produce a rewarding yield. A 6% yield combined with 4% dividend growth, for instance becomes 8% in seven years. If you can attain a yield of 7.3% growing at 4% a year (the average dividend growth rate of the stocks in my list), you might never have to dip into capital in your RRIF. If you don't have income growth, you'll have to use fixed income instruments as an income booster: in the long run this will make you a loser to inflation as your capital and income erodes. At only 3% inflation, one third of your funds will disappear in 14 years. * The $37,000 is based on an average stock yield of 2.2% (1.3% after tax) plus $15,000 from bonds. Link back to front page index

Here are the twenty questions I developed for this Garland column in Forbes of June 17 1996: ( Note: Question numbers are tied to paragraph numbers.)

I'll try to find a link to the column sometime soon.

1. Can you obtain a yield higher than 5% on your investments? Supply an example. 2 a) Is there such a thing as a tax-exempt municipal bond in Canada? 2 b) Can you explain why, if you spend the entire income from a bond, you are dipping into capital? 3 a) How does this author define the central problem in investing? Do you agree that this is the problem? b) If inflation is 6%, how many years will it take to lose half your purchasing power? 4 a) What does the author mean when he says “Accept a low rate of return”? b) Why does this money manager suggest avoiding bonds? 5 From this paragraph, jot down an important point about dividends. 6 a) How can “the drawback” mentioned here be overcome? b) If you spend all your dividends, are you depleting capital? 7 a) How have dividends fared, relative to the cost of living, since the 1930s? b) What is the real (inflation adjusted) rate of dividend growth? 8. What's the message in this paragraph? 9 a) Why does Garland have 15% of his portfolio in bonds? b) If stock prices decline, does it follow that dividends will too? 10 a) Would you have 85% or more of your portfolio in equities? b) Is it wise to invest all of you money at once? 11. What two important points are made in this paragraph? 12 a) What word do Canadians have to cross out in the first line. b) In one word, what is the major risk with bonds rated A? c) How will inflation kill you if you invest in bonds? 13 a) List three points of good advice from paragraph #13. b) It's not mentioned in the article, but can you guess at the average annual management fee (MER) charged by Canadian equity mutual funds. ___% 14 a) Will the income from this portfolio invested primary in equities be $37,000 in the second year? b) Is the authors concluding sentence correct? c) What's the message of the article for you?