Clients don't need income, they need money, planners say

While some bond strategies are eking out a modest return, a shift in thought toward taking distributions from a total return portfolio broadens advisers' options

Nov 28, 2016 @ 3:17 pm

By John Waggoner

If you've got a client looking for income, you've got a problem: Most investments don't yield enough to buy a flea an itty-bitty trampoline. And, while it's worthwhile looking for income, your best bet in today's market might be looking at a total return portfolio instead.

InvestmentNews asked financial planners this question: Your client, 60, has 40% of her assets in cash, and wants more income from her portfolio. What income investments would you recommend she get now, and why would you recommend them?

Naturally, most planners noted that you have to make sure about your client's tolerance for risk. An investor who doesn't want much risk won't get much return. Despite one rate hike by the Federal Reserve Board this year and another expected in December, rates remain exceptionally low. A 10-year Treasury note yields 2.33% a year, and a money market mutual fund yields 0.15%, according to iMoneyNet.

But you do have some alternatives to give yields a boost.

“With the recent decline in muni-bond prices, I would consider those if the client was in a high tax bracket,” said Gustavo J. Vega, a Miami-based financial planner and managing director at Vega & Oprandi Wealth Partners.

A 10-year, AAA-rated muni yields 2.45%, which is the taxable equivalent of a 4.06% yield for someone in the 39.6% federal tax bracket. Investors who wanted to take on more interest-rate risk and more credit risk could get 3.32% in a 20-year, A-rated muni. Taxable equivalent yield for someone in the top bracket: 5.5%.

San Asato, a Bloomington, Minn., financial planner, suggested short-term bond funds.

“Bonds, even in a rising interest-rate environment, are self-healing, meaning that as bonds pay interest and mature, managers are able to buy current, rising interest-rate bonds,” he said.

Some funds with a duration of three years can yield about 3%, and managers have the latitude to reduce duration even further, lowering interest-rate risk.

Other planners suggested a mix of bonds and high-yielding stocks, such as utilities and real estate investment trusts. Currently, the Vanguard High Dividend Yield ETF (VYM) yields 3.24%. Fidelity Real Estate Income (FRIFX) yields 4.24%.

But several offered this advice: Forget concentrating on income.

“Investing for income could be short-sighted, especially now,” said David Haraway, a Colorado Springs, Colo., financial planner. “The client should invest in a total return portfolio, and take distributions at a certain rate, as a combination of income, capital gains and principal, if needed. Say the risk tolerance of the client dictates a portfolio with an expected return of 6%. She could take a 3.5% distribution, leave 2.5% reinvested for inflation protection and to cover fees. This is basically what perpetual endowments do.”

David Mendels, a New York City-based planner, agreed.

“There are few things as destructive to a retiree's prospects than the misplaced focus on the 'need for income,'" he said.

The current distinction between “income” and “principal” is largely a relic of the past, Mr. Mendels said.

Retirees don't need income, they need money. Yet to maintain this artificial distinction (and especially in the current environment) retirees end up with increasingly concentrated portfolios of increasingly risky investments — which is the exact opposite of what they thought they were doing by "investing for income."

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