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Total Return Approach

Another method to turn assets into income is not commonly used by individual investors, but it is used by professional wealth managers, as does Lifetime Wealth. The total return approach essentially utilizes both income and capital gains (growth) to supply needed income using a disciplined strategy. This approach allows for portfolio growth to provide protection from inflation while using sufficient fixed income (e.g., bonds) to protect the income stream during down markets.

The total return approach is the method that Lifetime Wealth employs to generate the needed income from a portfolio. Our approach uses historical stock and bond market returns going back to 1926 to develop our model hypothetical portfolios and the returns that can be expected over very long periods of time using a specific asset allocation. Asset allocation simply refers to the percentage of the portfolio that is allocated to any one “asset class,” such as large company stocks, small company stocks, bonds, etc. By specifying a target allocation for each asset class and keeping that allocation constant through a process known as “rebalancing”, we can generate income while keeping a consistent exposure to stocks and bonds. This may be best explained through an example. 

Let’s say that John and Mary Client have a portfolio of $1,000,000, which is allocated 50% to very stable bonds and 50% to a highly diversified portfolio of equity (stock) asset classes which includes a 7% allocation to large company stocks (e.g., S&P 500). They need to generate $40,000 (on an inflation adjusted basis) in additional income to supplement their other income sources (e.g., social security). During the period from 1998 to 2000, large company stocks (e.g., the S&P 500) did exceptionally well, far exceeding the returns of other asset classes. Let’s say that one quarter, the S&P 500 grew to 10% of the total portfolio. To keep John and Mary at the target allocation of 7% for the large company stocks, we sold off the amount in excess of 7% (in this case, $30,000) and added that amount to the money market account (from which they automatically withdrew $3,333 per month). Now fast forward to March of 2009 and the horrendous crash in the markets that was experienced starting in October of 2008. At this point all equity asset classes were down, but high-quality bond funds were actually up and up substantially relative to all the other asset classes. In this case, we sold the amount they were over weighted in short-term bond funds and added this amount to the money market fund. By this process we are always selling an asset class that is up, or at least up relative to the other asset classes. This process forces one to sell high, one of the fundamental tenets of investing! Those are the basics of generating income through rebalancing a well-diversified portfolio. 

Lifetime Wealth also has developed a proprietary program that allows us to determine how much income can be safely withdrawn from a portfolio so that the client does not risk running out of money before age 100. This program takes into account the returns of the portfolio and the withdrawals of the client over time. This analysis is performed on an inflation-adjusted basis so that income needs rise in tandem with the inflation experienced during the period being examined. For example, in the 1930s Depression era, Americans experienced deflation such that income needs actually dropped during the period of the early 1930s. Consequently, someone retiring in 1926 and dying in 1956 may have only seen their income needs double or triple over this 30-year period of time. However, contrast that period with someone retiring in 1956 and dying in 1986. They will have experienced a period of high inflation such that their income needs may be as much as five times (or more) higher than originally needed. In John and Mary Client’s case, their original $40,000 income need could be closer to $80,000 or $200,000 at the end of their life just depending on the period of time they would have retired in. Of course, we do not know for certain what future returns or inflation rates are going to be, but we do know that over the past 85 years we have experienced periods of very high inflation and very high interest rates, as well as periods of tremendous stock market volatility and a Great Depression. We feel fairly confident that future rates of returns and inflation rates will be in the range of those experienced in the past. Lifetime Wealth's planning tools allow us to conservatively estimate safe withdrawal rates from a portfolio that still allow for growth of income and protects from downside market risk.

This approach is very easy for an individual investor to implement in theory with knowledge of relatively simple math and a well-diversified portfolio of low-cost index funds. The downside to this approach is that it is difficult to implement in practice. The reason for this is that emotions get in the way. Believe it or not, it is very difficult to sell high. Fear and greed cause most investors to let capital gains build up rather than incrementally taking the “money off of the table.” Unfortunately, the market can quickly turn around and those gains start to fall off and investors start to see “losses, ” when in fact the initial “losses” are just a reduction of the gains they had experienced. At this point many investors are paralyzed and unable to act, or assure themselves that the market is just about to turn around. We have had two periods over the last 12 years (2000-2002 and 2008-2009) where significant gains turned into significant losses for a number of investors. Unfortunately, greed turns to fear about losing all and the average investor tends to sell near the low of the market. Using a total return approach requires tremendous discipline to sell when the asset class is going up (and to buy when the asset class is going down if you are not managing the portfolio to generate income). Most investors are so emotionally attached to their money that this is very difficult, if not impossible, for them to do. This is where a professional wealth manager is beneficial. Taking the burden of managing income generation from a portfolio off of the clients shoulders so that they can concentrate on their lives and do what they WANT to be doing rather than worrying about where the money will come from. The principals of Lifetime Wealth have been using this approach for the past 15 years to generate income for clients through both up and down markets. We have many clients who have offered to be references attesting to this method of generating income and the success that they have had. Please contact as if you would like to receive client references.

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