I believe we are in the midst of an inevitable shift in the investment
model. We are moving from a model where our lifetime investment objective is
accumulation to one where our lifetime investment objective is generating
income. Such a shift requires us to retool old thinking - something which is
never easy - and may be impossible for some.
The accumulation model is a race against time. We measure success in
the accumulation model by our performance - a number - our net asset value at
any one point in time. The goal is for the market value of your portfolio to be
as high as possible at all times. But ,in particular, we are working toward the
net asset value at two different artificial milestones.
The first milestone is the day you retire. The assumption is that as
you approach retirement, you will convert larger and larger percentages of your
assets to income producing assets. If you are going to convert them over time -
in other words sell them so you can replace them with assets that accomplish a
different goal - the market value at the time of conversion is very important.
It is devastating to your lifetime net worth to sell assets when their value is
sharply depressed because you have to. The second milestone is the day you die.
The assumption here is that, on the day you die, whatever you have left will
pass to your heirs.
Our grandparents and great-grandparents were not concerned with either
of these two outcomes. Our great-grandparents worked all their lives then they
died. The life expectancy after age 65 was short. If they happened to outlive
the normal life expectancy they were cared for by their family. What our
great-grandparents passed to our grandparents who then passed to our parents
was, in all likelihood, not money or securities but possessions: their house,
land, businesses, furniture, jewelry and family heirlooms.
In 1965, stock market investments were rare. Less than 10% of us owned
common stock. Most of our parents were guaranteed a lifetime income by employer
pension plans and Social Security. Even as the life expectancy lengthened
healthcare was affordable and provided by retiree health benefits and Medicare.
Our world changed significantly in 1974 when congress passed the
Employee Retirement Income Security Act, better known as ERISA. Contrary to its
name, ERISA began the process where the burden and risk of providing retirement
income shifted away from employers and on to employees. ERISA began the
inexorable shift from a certain, if modest, retirement income to an uncertain
future based on high-risk stock market investments in 401(k) plans and IRAs.
Accumulation using diversified, high risk investments came into being
not because it was the best alternative but because it was the ONLY
alternative. The only way to guarantee a secure retirement was to work for 40
years, during the prime of your life, at something you didn't really enjoy, so
you could accumulate enough money that you could maintain a decent lifestyle
for an indefinite period of time on safe but low bond yields.
It doesn't have to be that way any more. And shouldn't. The Internet
and the democratization of the financial markets have brought about game
changing shifts in the way we can and should invest. Because we have cheap and
real-time access to information and to markets that twenty years ago was
reserved for only the institutional investors, new and better ways to meet
lifetime investment objectives are coming to market on a daily basis - which
brings us to the reemergence of the income model. Only in the last few years
have financial engineers devised high yielding investments with low levels of
risk.
The income model is not new. It is a throwback to the days of our
grandparents. But, as the old car ad said, "This is not your father's
Oldsmobile." The income model is about outcomes instead of numbers and
artificial milestones. The income model is about creating a real and increasing
cash flow over your lifetime. Success
for the income investor is the amount and consistency of that periodic paycheck
generated by their portfolio instead of by their labor.
Market value of the portfolio is not a primary concern of the income
investor. The income investor has a luxury the accumulation or growth investor
doesn't. The income investor does not have to concern himself, or herself, with
temporary losses in value, only in permanent ones. This is indeed a luxury
given their is no way to avoid short term, unrealized losses of capital except
by putting your money in CD's, savings accounts or burying it in the back yard.
The market value of all investments fluctuate commensurate with the level of
return. The higher the return, the more fluctuation in market value. The lower
the return, the less fluctuation.
In trying to mitigate short term market risk, accumulation investors
achieve the opposite result. Accumulation investors, who keep score by trying
to maintain an ever-increasing net asset value, try to outsmart the market by
timing. Unfortunately, the academic evidence tells us markets cannot be timed
and stocks cannot be picked successfully over long periods of time.
The focus on net asset value for
the accumulation investor achieves the opposite result from what they seek.
Over the 19 year period 1984 to 2002, the S&P 500 was up an average of
12.9%. U.S. stock mutual funds had a return over the same period of 9.6%. Even
professional mutual fund managers cannot beat the market by picking stocks. The
stock mutual fund investor had a return of only 2.7% which goes to show
investors who try to pick funds or time the market do so at their own peril.
As I said previously, the objective of the income investor is to
generate the biggest paycheck possible for his portfolio with the least amount
of risk. I will talk about how that is accomplished in a moment but for now,
let's just assume that it can be. Income investing provides for all of the
outcomes the accumulation investor is seeking, it removes some of the potential
pitfalls and has additional benefits as well.
A portfolio which generates a reliable and consistent cash flow is much
more flexible than a portfolio aimed at some future date. What happens if you
need that money sooner? What happens if your future date comes at the wrong
time? Conversion, in either case, can be crippling.
At this point, it may be helpful to use an example. Although there are
other ways to generate portfolio income, the one I am most qualified to speak
on and the one I assume you are most interested in hearing about is the Snider
Investment Method. The Snider Method has two objectives: no permanent losses of
capital and to generate a real cash flow equal to 1% of the investment each and
every month.
Let's address the permanent loss of capital first. The Snider Method
makes no attempt to pick stocks that are going up in price. The method focuses
on fundamentally sound, well run companies that are unlikely to go bankrupt. We
use the academic work of Dr. Edward Altman, the father of forensic
accounting and the inventor of
bankruptcy predictors as our primary means of evaluating companies. (I should
note that in my ten year history with the method, I have only had one Snider
Method position experience a permanent loss of capital. The stock was Redback
Networks. It did go bankrupt but it was picked prior to the implementation of
the bankruptcy screens.)
The second objective is a paycheck which is as close to 1% of the net
investment each and every month as we can possibly make it. The mechanics of
the method - the way and the order in which we combine the underlying stocks
and the sale of options together - are what allow us to do this consistently
over long periods of time, even if we are in a secular bear market or long term
economic recession.
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So let's take the hypothetical case of Sally and Stan. Sally and Stan
are 35 years old. They invest $500,000 in the Snider Method during a ten year
period that the market is going up, on average, about 10% a year. Assume that
over this period of time, the Snider Method portfolio yields its historical
average of 13%. On average, Snider Method positions close within six months,
and they do not need the money so they reinvest it to get compounding growth.
Net asset value is going up over this period of time because stock prices are
rising and positions are closing. At the end of the ten year period, their
portfolio has grown to $1,697,283.
Sally and Stan are now 45 years old. The economy is stagnant. The stock
market spends the next ten years trading sideways. The average return for the
S&P 500 over that ten year period is 1%. Stan, the primary breadwinner in
the family, is a software developer. He earns $120,000 a year. At the beginning
of that ten year period, Stan is in a car accident. He cannot work for one
year. Sally and Stan's Snider Method portfolio is generating a monthly cash
flow of 1% or $16,970. They need that in order to meet their living expenses
while Stan is recuperating. Each month, they withdraw $10,000 and reinvest the
remainder. There is no need to liquidate assets. At the end of that one year,
the portfolio has a market value of $1,780,923 even though the market has been
flat and Stan has been out of a job.
After a year, Stan goes back to work and the income generated by their
portfolio is again reinvested. Nine years after Stan has gone back to work, his
portfolio has a value of $5,349,967. It has more than doubled in a period the
stock market was only growing by 1% and it gave them a safety net when Stan had
his accident.
Stan and Sally are now 55 years old. Osama bin Laden has attacked the
United States, the economy has really gone in the dumper and the stock market
with it. In the first year, the market lost 60% of its value and it remained at
that level for the next nine years. The market value of Stan and Sally's
portfolio dropped from $5,349,967 to $2,139,986 but their portfolio paycheck
remains unaffected. The real cash flow being generated and reinvested is
$53,350 a month!
Stan and Sally are now 65 years old and Stan decides its time to
retire. The market value of his portfolio is still only $2M but he does not
need to sell his portfolio for $2M to convert it to bonds. He holds the
portfolio in the Snider Method and takes the income he needs for his living
expenses.. The next ten years are just as bad as the last ten but Sally and
Stan are unaffected. The market on average, loses about 3% a year. The market
value of Stan and Sally's portfolio declines to $1,578, 077 but their paycheck is unchanged. Last time their kids
heard from them, they were on safari in Africa and having a ball. The stock
market was the least of their worries. The mosquitoes were a much thornier
issue.
Stan and Sally are now 75 years old. They are still traveling and
having a ball. Fortunately, they have weathered the twenty year bear market
quite nicely and the stock market begins to show signs of life. Over the next
five years, the stock market return is 4% a year on average. Their portfolio
value increases to $2,335,939 but their paycheck is still around $50,000 a
month. They are thinking about many things, but their financial security is not
one of them.
Sally is now 85 years old. Stan passed away a couple of years ago. The
next few years are tough on Sally. She and Stan were together for a long time.
It's hard, and lonely without Stan. But she has her kids and fortunately, she
wasn't having to deal with financial issues at the same time she was grieving
Stan's death. Over the next ten years the market went up 6% a year on average.
Sally's portfolio value is now back to $4,183,311.
Sally passed away at the age of 95. She lived through a 30 year bear
market when stock market returns stunk at a time when most people can least
afford it. Even though the market value of the securities in her portfolio are
still not back to the highest point, 30 years later she has collected payments
totaling $19M. Do you think she cares about the value of her portfolio? Do you
think her kids care?
Upon Sally's death, her kids inherited equal portions of her portfolio.
Neither sold off any of the Snider Method positions but had learned from
watching their parents to keep them intact. Each now has a monthly paycheck of
approximately $25,000 which, when the market rebounds, will likely grow. Until
then, they are just happy their Mom and Dad lived well, without worry and left
plenty for them as a foundation.
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There are a lot of assumptions in this little story - some of them as
yet unproven. But I feel comfortable in making them or I wouldn't have 100% of
my own available assets invested this way. The first is that the income stream
would remain constant even if positions lost value and remained depressed for
30 years. While I cannot guarantee that, of course, I believe it to be true.
That is what it is designed to do and I think it will. Hopefully, we will never
have to find out. The second is that the yield will remain constant at 13%.
There is no way to know that for sure either.
But, given my own belief in the outcomes, I think the Snider Method is
the best alternative to meet my objective, which is to always have enough
passive cash flow to pay my bills - no matter what. That is my objective. Only
you can say whether the Snider Method meets your objective or whether there is
something you believe can meet your objectives better with lower risk.
I've done my job. I have created an investment method that I believe
will take care of me and my family indefinitely out into the future. Now your
job, as your Family CFO, is to evaluate and decide what's best for you.
DISCLAIMERS: The hypothetical example uses current averages which may
or may not hold true over time. In addition, even if they do hold over time,
you may not be average. This story is for illustration purposes only. Past
performance is no guarantee of future results. All investments incur risk and
the Snider Method is no exception.
Kim Snider, Kim Snider Financial Communications, Chronim Investments
and/or Snider Advisors make no representation that the information and opinions
expressed are accurate, complete or current. The opinions expressed should not
be construed as financial, legal, tax, or other advice and are provided for
informational purposes only. Call 866-952-0100 to request the Snider
Investment Method™ Owner's Manual, which includes a description of the
Snider Investment Method, investment objectives, risks, suitability and other
information. Please read and consider carefully before investing. All
investments are subject to risk including possible loss of principal.
