Celebrate The Risk Takers This Labor Day

This piece first appeared on the Rich Investor.

I always make a point of working every Labor Day, if even just writing a few emails on my way to the pool.

I do it in an act of impotent protest.

Don’t get me wrong, I’m not a total ideological nut job. A day off is a day off.

Far be it from me to walk away from a day of cold beer and barbecues to make a point. I’m not going to die on that hill.

But all the same, it irks me that we celebrate Labor Day and give the lumpenproletariat a collective pat on the back, yet we don’t also take a day to honor the entrepreneurs and innovators that provide employment to the ungrateful slobs.

Labor Day really is an outlier.

Virtually every other public holiday celebrates risk-takers.

Think about it.

On the Fourth of July, we celebrate the independence of our country – a risk-taking venture, if there ever was one.

On Veterans Day, we honor our soldiers who risk their lives to guarantee our freedoms. And on Memorial Day, we honor those soldiers who risked and gave their lives.

On Thanksgiving, we give thanks for the harvest. But the first Thanksgiving was done by pilgrims who risked it all to settle a new land.

And Christmas celebrates the birth of a man whose entire reason for being was to offer himself as a sacrifice for others.

In January, we dedicate a holiday to Martin Luther King, Jr., a man who risked – and ultimately gave – his life for the cause of racial equality.

And even Columbus Day celebrates a man who took enormous personal risk sailing into uncharted waters to find an alternative path to India… and managed to find the Americas instead.

Presidents’ Day is sort of iffy.

Sure, most of the men to have held the office were rent-seeking parasites who risked other people’s lives and money rather than their own. But there were at least a few risk takers in the mix worth celebrating. I’ll be generous and give it a pass.

I can even stretch it and argue that New Year’s Day celebrates risk taking because the only thing there is to do that day is watch college football… and the college football players might be risking injury in order to get a pro contract come spring. (Hey, I told you this one was a stretch. Humor me.)

But Labor Day…

Labor Day is the only federal holiday that doesn’t honor risk-taking.

It’s the proverbial participation trophy of holidays, a day that celebrates Homer Simpson for doing nothing more than showing up to collect a paycheck.

That’s ridiculous and un-American.

Now, like I said earlier, I’m not a total ideological nut job. I’m not going to tell you to forego Labor Day festivities. The beer isn’t going to drink itself, and it’s flat-out wrong not to enjoy one last day of sunshine before the days start getting shorter and temperatures start dropping.

But take a moment and raise a glass to all the entrepreneurs since the dawn of the Republic that have taken the risks that helped to create the abundance we have today.

Think of Steve Jobs slaving away in his parents’ garage with Steve Wozniak as they made the first Apple computers.

Think of Jeff Bezos, who also started Amazon.com in a garage.

Think of Ray Kroc, who nearly went bankrupt building McDonald’s into a fast food empire.

Think of the Wright Brothers, who could have gotten themselves killed building the first airplanes.

Think of the countless aspiring entrepreneurs pouring their hearts into new business plans on their kitchen tables.

Most of their plans will fail. Many of these men and women will be ruined financially.

Some may see the marriages fail or see friendships ruined as a result.

Some may quite literally drop dead of a heart attack from the stress. It happens.

But their sacrifice will not be in vain.

It’s not just the successful entrepreneurs that create jobs and opportunities. Failed entrepreneurs push us forward too by allowing others to learn from their mistakes.

Some enterprising young lad or lass may find a way to do it better the next time.

But that evolution can never happen without the first entrepreneurs that took those initial risks and ultimately failed.

From the humble taco stand owner to the founder of the next great tech startup, every person that puts their ass on the line and forgoes the safety of a regular paycheck for the uncertain risk of business ownership is a hero, whether they get a holiday or not.

That’s enough grandstanding for today. Enjoy the rest of your holiday.

Throw a steak on the grill, toss a football with your kid, and take pleasure in the fact that we live in a country wealthy enough to enjoy something as frivolous as Labor Day.

When Should You Take Social Security?

This article first appeared on The Rich Investor.

Florida Senator Marco Rubio proposed a plan earlier this month that gives new parents additional paid time off work to care for their children.

That sounds good, of course.

Parental leave benefits are a little on the skimpy side in America, and a lot of mothers and fathers would love to spend more time with their newborns.

There’s a catch though: Rather than fund the additional leave via new taxes or simply by forcing companies to eat the costs, Rubio’s plan would allow the new parents to effectively cash in their Social Security benefits decades early.

In exchange for taking benefits in your child-bearing years, you would accept lower benefits in retirement and might have to work longer (i.e. retiring at 71 instead of 70).

Rubio’s bill isn’t likely to pass. Parental leave tends to be more of a priority for Democrats rather than Republicans, and the current Democrat proposal on the table calls for additional payroll taxes.

Furthermore, Social Security is the proverbial “third rail” of American politics. You touch it at the risk of getting electrocuted.

But let’s say Republicans decide to take Rubio’s proposal seriously and it passes.

Should you take Social Security benefits today in order to spend more time with your newborn?

The answer is “probably.”

My reasoning here is a little unorthodox, so hear me out.

I love Whataburger, a delightfully unhealthy burger chain based in my beloved home state of Texas.

I love the way their hamburger grease bleeds through the wax wrapper, and I love washing it all down with a large Dr. Pepper over crushed ice.

And the fries… I can taste their salty goodness as I write.

Perhaps not surprisingly, my cholesterol is a little on the high side.

My doctor has nagged me for years, telling me I’ve probably taken a good five years off my life by eating as many burgers as I do.

But it’s not like the five years I’ve potentially lost are my hellraising years of 18 to 23. Those years are long gone.

The lost years will (presumably) be in my 80s or 90s, and I’m OK with that.

If I check out at 90 rather than 95, that’s five fewer years of riding in a motorized scooter and yelling at hooligans to get off my grass. I’m not going to miss those years.

So, by all means, take the benefit now and spend time with your new baby. Those years are precious, and if it means you might have to work a little longer, then so be it.

This is why we go to work in the first place.

There’s another element as well. As I wrote recently, I have very little faith in Social Security.

There’s no Social Security trust fund, and the program is essentially a Ponzi scheme.

It’s highly likely your benefits in old age will be curtailed or, at the very least, allowed to lose ground to inflation.

It’s likely better to take a sure thing today rather than hold out for an uncertain payoff later. A bird in hand is worth two in the bush.

The downside to taking Rubio’s offer is that low and middle-income Americans – the ones that depend most heavily on Social Security to fund their retirement needs – are also the most likely to need the money for parental leave.

Taking the money today means lower benefits later.

This could lead to widespread poverty among the elderly a few decades from now, creating a far-bigger crisis that will need to be fixed.

I can’t argue with that logic. But unfortunately, I fear that day is coming regardless of whether Rubio’s proposal is passed.

While I hope to draw Social Security in retirement, I’m not planning on it.

This was my rational when I started writing Peak Income. I wanted to create durable income streams that could fund a comfortable retirement.

As I write, the stocks in the Peak Income portfolio yield an average of 7%, which is more than double the yield you’re likely to find in the bond market, at least if you’re buying investment grade and avoiding junk.

I Hate AT&T

This piece first appeared on The Rich Investor.

I’ll be blunt: I hate AT&T.

But before you chime in with an enthusiastic “me too,” I’m not referring to AT&T’s mobile phone service or home internet service (both of which I dumped years ago for being overpriced).

I’m talking about AT&T stock (T). Though to be fair, I’m not any more fond of Verizon (VZ), Vodafone (VOD) or any of the other large telecom stocks.

As you might know, I’m Dent Research’s “income guy.” I focus on retirement issues and income stocks in my Peak Income newsletter.

Given that I recommend high-yield stocks, you might assume that high-yielding telcos like AT&T – especially with its merger with Time Warner (slowly) pushing forward – would be right up my alley.

AT&T sports a dividend yield of 6.1%, making it one of the highest-yielding stocks in the S&P 500. It’s also raised its dividend for 34 consecutive years and counting. That’s not a bad run.

So, if it pays a nice dividend and has a history of raising it… what’s not to like?

Let’s start by listing a few criteria I like to see in a dividend stock:

  1. The company should have competitive “moats” around it that protect it from competition. Companies in low-margin, hyper-competitive industries tend to be risky payers that cut their dividends when times get tough.
  2. The company should also be “future proof,” or as close to future proof as possible. You don’t want its business model disrupted by new technology.
  3. Demand for the underlying products should be growing or at least very stable.
  4. The company should pay out a relatively low percentage of its earnings as dividends. This gives the company a cushion in the event that earnings fall a little short one year. (Certain stocks, such as MLPs and REITs, are exceptions to this rule. Tax laws require them to pay out substantially all of their net income, and depreciation and other non-cash expenses tend to skew the numbers and make them hard to compare.)

So, how does AT&T stack up?

Well, to start, AT&T has nothing in the way of competitive moats. Not only does the castle lack a moat, the guards left the drawbridge down and left for lunch.

You can change mobile carriers in a matter of minutes now, and contracts are less of an impediment to leaving than they were in the past. Led by T-Mobile, virtually every carrier now advertises no-contract plans.

And its not just mobile phones. These days, it’s generally pretty cheap and easy to change your cable TV or home internet provider. So whatever moats AT&T might have enjoyed a decade or two ago have long since dried up.

Is AT&T future proof?

Not exactly.

Much of AT&T’s infrastructure consists of legacy copper wiring originally used for landline phones, and the company constantly is upgrading its mobile network to stay competitive. AT&T is stuck on a technology treadmill, and it has to keep running… or risk getting thrown off.

But isn’t demand for its services rising, at least?

Yes and no.

Yes, we all use more data today than we did a few years ago, and that trend isn’t likely to reverse any time soon.

But the smartphone market is now saturated in every developed country and not far from saturation in many emerging markets.

Everyone already has a smartphone. So, the only way to gain market share is to poach customers from another carrier, which means lowering the price and offering incentives… both of which lower margins.

So, while demand for service (particularly data) is growing, that growth is not leading to higher revenues or profits. And that’s just mobile data.

Home internet is a saturated market, and paid TV is actually shrinking due to cord cutting. All of AT&T’s businesses are mature, no-growth businesses at this point.

But the dividend payout ratio is low, right?

Sort of.

AT&T’s dividend payout ratio looks low, at 40%. But this headline number misses the fact that net income was inflated last year due to corporate tax cuts passed in December.

AT&T realized a $20 billion extraordinary tax benefit, which will not be repeated.

Between 2014 and 2016, the payout ratio averaged 107%, meaning the company paid out more than it was earning.

Lower tax rates going forward will help, of course. But in the first quarter of this year, the payout ratio was 67%.

That’s not a range that puts the company at immediate risk of cutting the dividend, of course.

But in order for AT&T to safely raise it from here, they need growth. And free cash flow has barely budged over the past decade.

AT&T changed its business model by merging with content creator Time Warner, the parent of HBO, CNN and a host of other networks.

But given the glut of content these days and the unrelenting competition from Netflix (NFLX), Amazon (AMZN), and other up-and-coming creators, its’s hard to see this being the growth vehicle AT&T needs.

And all of this assumes the government doesn’t torpedo the deal, which it has indicated it intends to do.

Bottom line, don’t expect to see AT&T in my Peak Income portfolio any time soon. We can do better.

Incidentally, I’ll be speaking at Dent Research’s annual Irrational Economic Summit October 25th to 27th in Austin, Texas, and I’ll be giving my thoughts the best places to hunt for income in this environment.

I’ll share some of my favorite investments… and, like I am today, I’ll tell you which ones – like AT&T – to avoid.

If you’d like to see me and the rest of the team, click here for more information and our list of speakers. And don’t wait. Only 200 seats remain. As a valued Network member you already have access; just reserve your spot.

Apart from speaking, I’ll also be making the rounds, talking to the attendees. If you want to pick my brain or just enjoy a beer with me, this is a good chance.

Will Your Portfolio Last You Through Retirement?

This piece first appeared on The Rich Investor.

You know the rule: Stocks “always” return 8% to 10% per year over the long term, right?

This is the assumption most financial planners make, and it’s practically considered holy writ in 401(k) promotional literature.

I’m not going to tell you that this received wisdom is wrong, per se.

Over the long term, stocks generate returns in that range, or at least they have up until now.

But this certainly doesn’t tell you the whole story.

That 8% to 10% number is an average, but the numbers are wildly different in any given year.

You might have a year of 10% gains followed by a year of 20% losses followed by a 40% gain. That averages to 10% per year, but it’s a wild ride to get there.

Furthermore, the “long term” generally means 20 to 30 years or more, and there are long stretches where returns are flat or negative.

As a recent example, the S&P 500 went nowhere between its peak in 2000 and 2013, getting chopped down by two nasty bear markets. Thirteen years is a long time to go without a return on your investment.

And if you were regularly selling stock and taking withdrawals to meet your living expenses, you could have seriously depleted your portfolio.

This is exactly why I focus on income investments in Peak Income.

I don’t know what stock returns will be over the next 13 years, but given today’s starting valuations I’m betting the number is lower than the historical 8% to 10%.

And, if they are, that’s perfectly fine. If you’re living off the dividends and interest produced by your portfolio, you don’t have to worry about dipping too heavily into your portfolio to meet your living expenses.

Let’s run the numbers…

Just for grins, let’s play with a Monte Carlo simulation.

A Monte Carlo simulation is a modeling tool that runs thousands of scenarios to come up with a probability of success or failure.

In each iteration, the simulator follows a random path of returns.

Though not perfect (all models are only as good as the assumptions used), a Monte Carlo is a better way to assess your risk than using historical averages alone.

In my model, I assumed the investor is freshly retired at 70 years old, is starting with a $500,000 portfolio invested 60% in stocks and 40% in bonds, and is planning to withdraw $30,000 per year, or 6%, adjusted by inflation.

The simulator showed that, by age 90, 12% of the scenarios had failed (i.e. the investor ran out of money). By age 100, 34% had failed.

Now for the fun part.

I changed the model to assume a 30% bear market two years into retirement (age 72). This raises the failure rate to 25% by age 90 and 53% by age 100.

Raising that number to a 50% bear market – which is in line with the last two crashes — raises the failure rate to 40% by age 90 and 69% by age 100.

And all of this assumes that stock and bond returns and inflation are all roughly in line with historical averages.

Playing with the numbers again, I reduced the expected annual return on stocks by 3% and the expected annual return on bonds by 1% to be more in line with today’s valuations.

Assuming no crash, the failure still jumps up to 32% by age 90 and 67% by age 100.

I don’t know about you, but the thought of running out of money in my 90s and living out my last days in a government-funded nursing home for the poor is simultaneously depressing and terrifying.

So again, it comes down to income generation.

Peak Income’s current recommendations have an average dividend yield of over 7%.

Based on the current allocation, you could take out 6% per year in dividends for your living expenses, leaving 1% to 2% of “excess” dividends in the account to be reinvested, and never touch your principal.

The specific stocks and funds I recommend change over time, of course, and a year from now these numbers might look a little different.

But you get my point: Investing specifically for income is a lot safer than simply buying a 60/40 portfolio and hoping for the best.

How Much Is In Your Neighbor’s IRA?

This piece originally appeared on The Rich Investor.

The Individual Retirement Account, or IRA, is the backbone of most middle-class Americans’ retirement plans.

Creating the tax-deferred savings vehicle back in 1974 was one of the few unequivocally good decisions Congress has made over the past half century.

Don’t give Congress too much credit though.

An infinite number of monkeys slapping their hands on an infinite number of keyboards will eventually pound out the entire unabridged works of William Shakespeare if given enough time.

By shear random luck our fearless leaders are bound to do something right once in a long while.

But that’s not my point today. This is…

Properly using an IRA’s tax benefits can vastly accelerate your savings plans.

For many Americans, the tax benefits, compounded over a working lifetime, might make the difference between retiring in style or having to move in with your adult children in your golden years.

This isn’t academic for me.

I keep the vast majority of my liquid savings in assorted IRAs, Roth IRAs and similar vehicles.

I’ve done the math and I know that, based on my return and tax rate assumptions, the tax benefits increase my annual returns by 20% to 40%.

At any rate, let’s take a look at how Americans as a whole are using their IRAs.

You can use it as a measuring stick to see how you’re doing relative to your peers, and to see if you need to make any changes.

The Employee Benefit Research Institute (EBRI) published a report earlier this year that looked at account balances, withdrawals, contributions and asset allocations for American IRA investors over from 2010 to 2015.

Interestingly, 87.2% of IRA owners did not contribute a single new dime to their accounts over the six year window, whereas only 1.8% contributed every years.

But before we throw the proverbial low-saving American spendthrift under the bus, I should point out that a lot of these IRAs were probably owned by retirees or by workers who weren’t eligible to contribute because they were (hopefully) squirreling away fresh savings in their company 401(k) plans.

(I say “hopefully” because various studies have shown that only about half of all Americans contribute to a 401(k) plan…)

The more interesting number to me is that, among those who did contribute new funds to an IRA, roughly half maxed out their plans. Good for them!

Not surprisingly, account balances jumped over the 2010 to 2015 period, as the stock market shot higher.

The average balance of investors that owned IRAs for the entire period rose by 47.1%.to $146,513.

But here’s where it gets interesting.

Few investors earn the “average” return, and actual results are scattered all over the place.

The bottom 25% had cumulative returns of just 0.1%, essentially earning nothingover a period of time in which the market was on fire. Meanwhile, the top 25% saw their balances explode higher by 87.3%.

This brings me to asset allocation.

If you didn’t make money between 2010 and 2015, it means you weren’t playing the game.

You were likely sitting in cash, having been shell-shocked by the 2008 meltdown.

And indeed, EBRI found that 27% of IRA owners had zero invested in stocks over the six years covered.

About 17% were fully invested in stocks over the period. The “average” account had roughly half its assets allocated to stocks, with the precise number bouncing around between the mid-40s and mid-50s.

Now, it’s easy to scoff at those who sat in cash over those six years, missing an epic run in the market.

But some of these investors were likely in or near retirement and didn’t want to risk a major drawdown.

And I’ve always said that the most important thing is to simply get the cash into the account to take advantage of the tax break. The allocation can follow later. I reiterate that point here.

But all the same, you shouldn’t be sitting in cash earning nothing. If you can’t accept the risk of a large allocation to stocks, you should at least have your cash in bonds, earning something.

Alternatively, you could consider using my Peak Income service, which is designed specifically to produce higher yields than what is generally available in the mainstream bond market while having a low correlation to the stock market.

The average yield on our current open recommendations is around 7%, which doesn’t include capital gains.

The larger takeaway isn’t that Americans are irresponsible spendthrifts who lack the discipline to save (though certainly there are millions of Americans that would fit that description).

It’s more an issue of Americans trying to be responsible but not quite getting the execution right.

The good news is that this is a much easier problem to fix. Once you’ve done the hard work of saving, allocating your funds well is the easy part.