Transcript: Extreme Income Portfolio Makeover

Washington has shown a complete disregard for our nation’s savers, especially those in — or near — retirement.

Interest rates on traditional income investments are being kept artificially low.

Social Security and other programs are being neglected.

And the situation is being made worse by problems in both corporate and state pension systems.

That’s why I held an important call with my 62-year-old father last Thursday. We talked about his personal retirement plans … the challenges he’s facing … as well as the solutions I’m proposing to get him the kind of safe, reliable income he deserves.

What follows is the complete transcript of our phone call. Dad and I know you’re probably dealing with many of these same issues, and we hope our frank discussion is helpful …

Extreme Income Portfolio Makeover
June 17, 2010
(Edited, as needed, for clarity)

Nilus Mattive: Hey, Dad.

Larry Mattive (Nilus’ Dad): Hi, bud. How are you doing?

Nilus: Good. So are you ready for your big, extreme income portfolio makeover?

Dad: Absolutely!

Nilus: I figured. But like I said when we talked last week, you’re 62 years old and you only want to work a couple more years and you’re going to have a pension and you’re going to have some Social Security income. But those are not going to be enough to pay for all the rising costs you’re going to face over the next twenty or thirty years. And they’re certainly not going to give you the lifestyle you want. Especially not a trip to Italy, or a motorcycle, or any of that kind of stuff.

Dad: You’re right about that. You know, when I started my job, one of the really big selling points was that, if you worked 25 years, your health insurance would be totally state paid. Well, that didn’t happen. They changed it and now, not only do I pay a monthly premium, but it’s gone up every year. So, if there’s one thing I’ve learned, don’t count on government.

Nilus: That’s what I’ve been saying all along. All we’ve been doing so far is talking, talking, talking. And all the while, you had your own retirement money sitting there, earning nothing, in the Vanguard Prime Money Market fund.

Dad: Yeah, tell me about it.

Nilus: Do you know exactly what that fund is earning right now?

Dad: Well, I know it’s not much.

Nilus: Try .06 percent! That means you get 6 cents for every $100. So for $100,000, it’s $60 … that’s one round of golf.

Dad: It’s funny. They actually give you more to open the account then what they pay you once you have your money in those things. But what do you think I could be getting with other investments?

Nilus: I’m not going to guarantee high returns; I’m not going to say that you won’t experience a loss … there are far too many factors outside our control. But what I can tell you is that today on this call I want to talk about some investments that are currently paying anywhere from 4 percent to 9 percent a year. And it sounds crazy, but that’s literally 50, 100, even 200 times the amount of money that you’re getting from that money market fund!

Dad: Well, 50, 100, 200, that sounds good. You know, when I left my job with PA a couple of years ago, I cashed out my sick time and deferred comp; I put it all into an IRA. And I thought I was going to get at least 5 percent. But I was hoping for 8 or 10 percent. So I figured that, in 10 or 12 years, my money was going to double.

Nilus: Yeah, well guess how long it’s going to take for your money to double at 0.6 percent a year.

Dad: I don’t even have a clue. 100 years?

Nilus: Ten times that! It would take you 1,156 years to double your money!

Dad: That’s unbelievable.

Nilus: I know! So a more practical question: How much interest do you think you’d need to get to double your money in a decade?

Dad: 10 percent?

Nilus: Actually, it’s just 7 percent — if you factor in compounding interest.

Dad: That doesn’t sound too bad, but I’m not even sure why you’re so worried about it. I mean, you know my ultimate goal really is leaving this money to you or Vela. As long as there’s something there and I’m building on it as opposed to having nothing …

Nilus: First of all, right now we’re not building on it. We’re not going to make any money where it is. So, if you leave the money to me or Vela later, great. Obviously we aren’t going to complain. But that’s not the goal right now. Right now this money is still yours and the goal is to get income for you! Income that can help you meet these challenges that you’re going to face in retirement. Income you can use if you just want to enjoy your life and you’ve got mom to think of. Even if you decide you don’t want to take any of this money out right now, fine … you can take it out later and let it boost the size of your nest egg until you do need it.

Dad: I definitely want it to increase, so what exactly are you planning? I know you mentioned dividend stocks to me before — and I have a little bit of an idea about that.

Nilus: I specialize in dividend stocks, and the recommendations I’ve been making have been doing really well. So as I’ve been telling you all along, it’s sad that you and I have not been buying those stocks for your own account. But better late than never.

And I don’t want to say dividend stocks are the end-all-be-all answer for your portfolio, but I do think they should definitely be a piece of it. I would call it “Income solution #1.”

Dad: But is this a good time to be getting into the market? I see it going up and down all the time, and some people are even talking about another really big decline.

Nilus: It has been up and down and that is a concern. But this is an income portfolio we’re building. This is not going to be a trading portfolio. So we don’t have to try to time the market perfectly. We can simply spread out our purchases over time, that way we don’t get caught in a downdraft.

We’ll start cautiously, and then if prices continue dropping, I’ll be happy … great!

Dad: GREAT? You’ll be happy if it goes down?

Nilus: I’m not only going to be happy, I’ll be really happy! Because when a stock’s price goes down, the yield that you get goes up. So as long as the dividend payments don’t change, they make up a greater and greater percentage of what you paid. So if you buy the dividend stock as prices go lower, then that means you just get higher yields.

Now here’s the thing. For now, we’re going to stick to very conservative companies.

Dad: What does that mean?

Nilus: It means that I’m going to pick companies that have businesses I understand. Businesses that have not only paid out dividends for many years straight … but that have raised their payments year after year after year. The best example I can think of, the one I always use, is Altria.

Dad: I never heard of it.

Nilus: They changed the company name a few years ago … but it’s Philip Morris, it’s the old tobacco company. Obviously you’ve heard of them. And it’s the first stock I recommended to my subscribers when I started my dividend service.

Dad: When Vela was born?

Nilus: Right, three years ago. It’s hard to believe the time has gone by that fast.

We bought Altria right around the time the stock market was topping out. What’s amazing is that even though the market is still down 26 percent since then, I still have Altria in the portfolio and my recommendation is up about 7.7 percent over that same time period!

Dad: How does that happen?

Nilus: Well, because of the dividends partially. A lot actually. They helped give us steady returns on our investment even when the market was crashing. But it’s also because companies like Altria have real value and there’s demand for their products, tobacco for example, even in the recession.

Dad: Okay, but what kind of dividends can I get from that stock right now? My guess is they can’t be that high if my money market fund is only paying 6 percent.

Nilus: Actually, your money market account is only paying .06 percent. And Altria is paying out about 7 percent a year … right now. And remember, 7 percent is enough to double your money in just ten years.

Dad: Wow!

Nilus: The thing is, even more importantly, 7 percent is 116 times the yield you’re getting from that money market fund right now.

Dad: Yeah, but suppose it goes down.

Nilus: It might. But like I said, it held up very well during the last crash, especially once you factor in those big dividends. And the other thing is, not every stock I’m going to add to your portfolio is going to have a yield as high as 7 percent. But they’re all going to give you a chance to boost your income pretty dramatically based on what you’re getting now. Plus, were going to get a basket of stocks to lessen your risk even further. Obviously you can’t just put all your money in Altria because, even though I like that stock, it may not even be the one I pick for your portfolio. There are a lot of good options out there.

Dad: I don’t want to get too greedy, but don’t you have some stocks that yield even more than 7 percent?

Nilus: I do, but we have to be really careful once we get into that kind of high-yield zone because this is your retirement money we’re talking about. What might be a great speculative play for an aggressive investor is not going to work for this income portfolio.

One example I can think of, there’s this company called Annaly Capital Management, and it’s currently yielding 15.2 percent. Now when I was at the Money Show in Orlando I had all these retirees coming up and asking me about it, what do I think, and should they buy it for their account and some of them already owned it.

Dad: I can see why. I’d be making 15 percent!

Nilus: Right, but the other side of it is you could lose up to 50 percent of your investment pretty quickly. When you buy Annaly Capital Management, you’re basically betting on pools of mortgages. That’s what the company does. And while it’s been working lately, I think the shares could get absolutely whacked if interest rates go up. Especially because so many investors have piled in.

If they start running for the hills, there goes all the income you collected and probably a lot of your initial investment, too.

My point is, picking stocks based on how high the yield is, it’s like playing chicken with your retirement money. And obviously we don’t want to play chicken with your retirement money.

Dad: Okay, so how are you going to pick them, then?

Nilus: I’m going to focus on things that are really important. I’m going to focus on what the company is, what it does, whether it has a real business that can withstand stormy choppy markets, whether it can survive recessions, and, very closely related to that, I’m going to make sure that the company can pay the dividends it’s promising you.

Let’s go back to the Altria example again. They’ve been raising their payments every year for 43 years straight! That makes me feel pretty confident that they’re going to keep doing the same thing in the future.

Dad: I can accept that. But I’m still a little leery of getting too heavy into stocks.

Nilus: Well, first off, the sum total of my dividend stock recommendations has risen even though the market has fallen. But, more importantly, stocks are just the first part of this portfolio makeover that I have planned for you.

Before I get to the next idea though, I just want to say a couple more things.

I won’t stick to U.S. stocks for your portfolio.

Dad: But what else is there?

Nilus: Well, we can look overseas at nice foreign dividend payers. I follow a lot of them — there’s this company América Móvil, it’s a South American telecom … there’s Huaneng Power, a Chinese utility … Unilever, the European consumer products company, literally I have a huge list of them. And all of them can be bought right here in the U.S. through your regular brokerage account. You don’t have to call some foreign company to buy them.

There are also all kinds of stocks that give us stakes in real estate … natural resources … loads of stuff beyond just the usual corporate America, blue chip type stuff. So we need to build you a portfolio that has all kinds of income-boosting stocks and I’ll continually help you trade up to better opportunities whenever I see them.

Dad: It sounds good, but what about gold and real estate and things like that? When I talk to my friends, it seems like they all are investing pretty heavily in them right now.

Nilus: Right. Like I just said, there’s no reason you can’t do that in the portfolio.

For real estate, we can use Real Estate Investment Trusts (REITs), which basically hold and manage baskets of real estate for you. And legally, those companies have to pay out at least 90 percent of their profits to you!

Dad: Well, that would be good. I remember grandma and grandpa got nice income from owning that double-block, but being a landlord, that was a real pain.

Nilus: And that’s the advantage of these things: They do it for you. You get a whole portfolio of real estate in one shot and the coolest part is there are REITs focused on everything from shopping malls to apartments. Things we could never even buy on our own.

For example, I’ve been looking at this one REIT that owns storage units. It’s called Public Storage, and it owns those strips that are always near shopping malls where people park their boats, and their RVs, and all the stuff they can’t fit in their houses.

Dad: Yeah, like the U-Store-It places.

Nilus: Right. So with so many foreclosures and all these people downsizing, I think that’s a pretty recession-proof kind of a play.

Dad: But would I gain income from that?

Nilus: Right now the stock yields about 3.6 percent. So it’s not huge. But I would look to buy it on a pullback when the yield would be much higher.

Dad: And what about gold?

Nilus: Again, I don’t have anything against gold itself. But I look at it as more of a cash alternative. So with this new portfolio, we’re going to focus on income. And in and of itself, a gold bar doesn’t produce any income.

And the other thing is, let’s not forget that gold prices can drop … just as suddenly as stocks, or bonds, or anything else.

So, if you’re holding physical gold in your retirement portfolio, what would happen if prices drop a couple hundred bucks an ounce, even if it’s just temporary?

How are you going to get income in the meantime? Are you going to sell your metal at lower prices?

There’s a risk to it.

So that’s why for this income portfolio, I’d much rather buy into a company that operates a mine … or drills for oil … or runs pipelines transporting gas.

As long as they’re paying out big, fat income checks to you on a regular basis, then, yeah, natural resource investments are great. We’ll get a stake in gold and oil and we’ll get regular income.

For example, I have a mining stock I like that pays more than 6 percent right now. I have a couple other resource companies yielding as much as 8 percent right now … and, again, those are very stable businesses.

And as far as the inflation concern, I would point out that even regular dividend stocks are going to rise in value because they represent real assets. They’re not just paper.

Dad: Okay, I understand the stock part and all the different things we can invest in there. But you said my big portfolio makeover is not just switching from a money market fund to stocks.

Nilus: Right. Let’s talk about the other “standard” income investment, which is bonds. I’m sure you remember what it was like in the 80s when you were able to get double-digit yields from basic Treasury bonds, right?

Dad: I remember. The only problem is, I wish I bought them back then! Instead, I was taking out a mortgage at those same rates!

Nilus: I think that you’re going to get a second chance because based on everything I’m seeing with our government’s spending habits, and all the other trends that I watch, I really think that interest rates can shoot higher much faster than people realize. That’s why, for right now, I would definitely not put any of your money into long-term Treasuries.

Dad: But if yields went up, we would jump in then and buy them, right?

Nilus: Heck yeah. For now I’d rather start with some TIPS, which is are Treasury Inflation Protected Securities. They’re U.S. government bonds designed to keep up with inflation, doesn’t matter how high inflation goes. They could give you good income and they’ll add a nice layer of protection to your portfolio. So that’s one option we can do with bonds.

And there are some other areas that I’m also looking at. There are preferred shares to consider, which combine the benefits of stocks and bonds.

The only problem there is a lot of preferred shares are issued by financial companies, and I think it would be a huge mistake to go crazy with those right now.

There are preferred shares offered by non-financial companies, and those are the ones that I think would be really attractive for this income portfolio we’re building for you.

Dad: So what are the next steps, what do we do next?

Nilus: First we’re going to set up a separate IRA for you. That way it will be easier to keep track of what we’re doing and it will just take a phone call.

Second, I’m going to suggest that we start this new income portfolio with $100,000 of your money. That way you can get comfortable with everything. I want you to get comfortable, I want you to see how it goes. I know that this is kind of a big change from just having it in the money market fund so let’s just start with $100,000. That’s still a pretty good amount of money.

What I’ll do is whittle down the list of investments I have on my radar screen, to figure out which are the very safest for your retirement portfolio. I’m going to pay attention, also, to how well they work together.

I’ll separate that list into two piles. One pile has the investments that are worth buying either right now or in the near future … and then I’ll keep another pile on the side that we’ll watch and when they come into our buy zone on further weakness, then we’ll scoop those up. I’ll run these investments by you, and then we can decide whether you want to buy them in your account or not.

Dad: Listen, thanks, I really appreciate you for doing all this work for me. And I hope you know I’m really very, very proud of you.

Nilus: Thank you. It’s the least I can do for you because, you know, you helped put me through college. I’m a dad now, I know how much work it is and you supported me. And you’re always saying all you want is more time together and, working on this portfolio, is going to give us that.

Dad: Let’s get started!

Nilus: We already have.

Dad: Okay. Love ya’, bud.

Nilus: Love you too, Dad.

Bottom line: If you’re like my Dad and earning a pittance from your current portfolio, you do have other choices available to you.

I hope this transcript gave you a few good ideas to start with, and I look forward to introducing you to more investments and strategies in the future.

Best wishes,

Nilus

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