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Friday, January 18, 2008

Finacial Sense Newshour Transcript on Investing for Income

Investing for Income

Partial Transcript of Finacial Sense Newshour with Jim Puplava and John Loeffler on January 12, 2008

JOHN: Maybe the hallmark of the next few years is actually going to be the word “uncertainty” like we've been using here on the program today. A lot of people, baby boomers, a huge block of population moving into retirement, and if they are moving into retirement in a time of uncertainty, especially given the fact that the Social Security trust fund is bust, there is nothing in it, nor can it be sustained at these levels except by devaluating the currency (which means everybody will get their Social Security check, but it's not going to be worth very much), what does that mean for people who are trying to plan economically in these times?

JIM: Well, you know, we used to have these standard formulas. I started out as a certified financial planner –and you know, you retire, you put 50, 60% of your portfolio in fixed income because now you need income to live on because you no longer have a paycheck or money coming in from a business. But, John, that assumes that you're in a period where you have low inflation as we did throughout much of the 80s and 90s.

But what do you do in a period where you have high inflation? You know, it's very tempting, right now, to say, “okay, I'm going to retire, I'm going to turn my portfolio into fixed income, I'll get 4 or 5% income.” The problem that investors have today is if you look at where the yields are, you've got less than 2.6% on a two year Treasury note, a 10 year treasury note is less than 4% (it's actually less than 3.8) and it's probably going lower here in the short term. I sure in heck would not want to be investing long term given the levels of inflation that we see today. And so, you know, that's why we've always stressed about, you know, about blue chip dividend-paying stocks.

And over the long run, the rate of return is going to be much, much higher to an investor or somebody that is retiring today than, let's say, somebody who is going to be in a fixed income. I mean if I go out and buy a 10 year Treasury note today, let's say I invest $10,000. I can get right now 3.8%.

And every six months I'm going to get my check. I'll make $380 dollars a year every single year. The question is what is going to be the cost of living in the year 2018or 10 years from now, you know, because 10 years from now, I will get my $10,000 back, and I will have gotten $380 dollars a year. But that $380 dollars a year that I'm getting from that Treasury note is not going to buy the same goods and services 10 years from now that it will buy today.

And for that matter, the $10,000 that will mature 10 years from now is not going to have the same purchasing power. And if you just think about anything you're buying today, what does it cost to buy a house today compared to 10 years ago? My kids can only afford to buy a condo for the price that I bought a large house 10 years ago. And that's what's happened. I mean think of what a car costs today compared to 10 years ago.

Think of what it costs to send your kid to a four year college to get a degree compared to 10 years ago. Compare that to what you're paying to visit your doctor, compare that to what you're paying to just go out and take a vacation. It's just absolutely remarkable in terms of what we've seen and the cost of living in basic goods.

JOHN: Well, does that mean, then, that some people aren't going to retire? The day of Sun City Arizona and retirement places like that may be over, per se. People are going to have to work.

JIM: Yeah. I think that is probably more in the retirement formula today for a lot of boomers, which is going to be that you're going to retire, but during retirement, you'll be doing some sort of part-time work. And actually, you can look at it quite positively, John. They find people that keep themselves active in retirement, actually live longer, their minds are more alert.

And, you know, maybe you don't do what you did for a living during your working career. Maybe you do something that you enjoy doing. I had a client that retired many years ago who was in the publishing industry and he ended up being a tour guide at the Hearst Castle. Just absolutely loved it. I have another client that retired six, seven years ago and because he was a history professor he serves as a tour guide for one of the travel companies.

So let's say you're, I don't know, you're taking a trip to Europe, Italy or something like that, he's sort of a tour guide. So I mean he's having the time of his life. And actually, he gets to go free. So working during retirement is going to be part of the retirement picture for a lot of boomers, but I think more importantly investors or retirees are going to have to think differently about their portfolio in an age of low interest rates and higher rates of inflation.

I mean if you take a look at the yield on a two year Treasury note or one year Treasury bill or 10 year Treasury note, the yield on a 10 year Treasury note is less than the headline inflation number, and even though we know that headline inflation number is actually basically a sort of a fictitious number.

JOHN: Okay. Every year you put together, usually around this time of the year, a portfolio of 10 stocks. And say you had bought these stocks, what, 10 years ago?

JIM: Yeah.

JOHN: What would your income have been?

JIM: Well, what we do, and I use this as an exercise and I don't -- anybody listening to this, this is not an endorsement or recommendation. It is done for illustration purposes.

But mainly we take a look at the Dow 30 stocks. And we pick sort of a wide variety of stocks, some financial stocks, consumer stocks, industrial stocks, medical stocks, energy stocks. And we've been using this formula for these stocks mainly over the last couple of years to illustrate this point. But what we assume is you had a portfolio.

You had $100,000 and you put $10,000 into each one of these stocks and then you just held on to them for 10 years. And just once again, I'm going to mention the companies and this is not an endorsement. This is done strictly for illustration. But we had a financial stock, an insurance company AIG, a consumer retail McDonalds, Disney Entertainment, Johnson & Johnson (on the medical side), Honeywell, Exxon, American Express (financial company), 3M (manufacturing), GE (manufacturing) and Coca Cola (consumer products company). And so in 1998, had you invested in these stocks – remember, we were going through a stock market boom during that period of time, and stocks were expensive –but let's say you put $10,000 into each one of these stocks, you would have received in dividends at the end of 1998 holding them for a whole year roughly about $1700 in dividends.

Five years later in 2003, the 1700 in dividends grew to 2400 in dividends. So basically, we saw a 700 dollar increase in the value of those dividends. And finally 10 years later in the year 2007, dividends would have grown to a little over $4100. But what's really remarkable about this, assuming that you spent all of the dividend income, your $100,000 would have grown – and remember, that would have meant buying stock in 1998, and remember the terrible bear market that we went through for three years in 2000, 2001 and 2002 – during that period of time, you would have gotten over $81,000 of capital appreciation; you would have gotten almost $33,000 in income.

And so basically, without dividends, your return was 181,000. Final investment with dividends was 214,000. If you want to take a look at that, it was a simple return of 81% or 8.1% a year. If you want to look at total return, which was income –the dividends – plus capital appreciation, it was 114% return, or an annualized return of 11.4%, easily increasing what you would have gotten in fixed income.

What was even more remarkable, the top performing stocks, Exxon, McDonalds, 3M and J&J had the highest total dividend payments. So companies that had good business models, that had good cash flow and consistent earnings are able to increase their dividends at a much higher rate than companies that don't.

So the top performing of the 10 stocks were the stocks that had the highest total dividends payment. The worse performing stocks, AIG and Disney had the lowest dividend payments. And here's something that's even more remarkable. The average total return for the top two dividend players was 219%, an annualized return of 21.9% a year, while the total return for the two lowest paying dividend stocks was only 33.5%, or a return of a little over 3%.

The highest dividend paying stock out of the group was Exxon Mobil that had a total return of 282%; and even if Exxon stock price went nowhere, the dividend alone would have given you a return of 76%, an annualized return of 7.6% just on the dividends. And Jeremy Siegel in his book The Future For Investors did a comparison. I'm not going to repeat it here because we talked about it last year on the show where he took, from 1950 to the year, I think -- I think it was 2004, he took two stocks: and if one would have thought of the ideal growth stock in the year 1950, it would have been IBM (the computer industry was coming into itself and changing the way we work today with computers); and then Exxon, which is basically an oil stock. And the total returns from Exxon versus IBM were far superior. And here, John, is just the study that we do each year confirms this very same thing because the best performing out of those 10 stocks were the stocks that produced a consistent higher stream of dividends.

JOHN: And that would seem, you know, in this environment we're in right now of really high inflation, which threatens to stay that way for some time to have things in your portfolio that are going up which offset that, so you're keeping pace with it.

JIM: Absolutely. I mean if you look at Exxon in the last five years, Exxon has increased its dividends at an annual rate of 8.3% a year. Imagine getting an 8.3% pay raise every single year. If you look at Johnson & Johnson, another one of the top four performing dividend stocks, Johnson & Johnson has increased its dividends 15.3% a year over the last five years. Here's one that will blow your mind: McDonald’s. I mean we're talking about basically hamburgers here. McDonald’s has increased its dividend roughly 45% a year.

Think of that number. 45% a year over the last five years. How many of us would love to get a 45% pay increase every single year with the kind of inflation rates. And even 3M, a manufacturing company has increased its dividend roughly about 9.2% a year over the last five years. And this is why, John, I think that as you get into retirement, having blue chip companies, and that's why I like to look at the Dow stocks. They are the biggest, the most stable, sound financially. And you don't get to be a blue chip in the Dow without having a successful business model and being a very stable company. I mean Johnson & Johnson (medical), 3M (manufacturing), Exxon (oil), McDonald’s (food franchises and now they are getting into adding coffee bars to compete with Starbucks).

And whether you're looking at a book written by three authors Dimson and Marsh wrote a book called Triumph of the Optimists. They talked about dividend studies going back over the last 100 years. Not only just in the US but 16 other markets. Study after study after study, it's confirmed dividend investing is a far superior approach and a more stable approach. And especially for somebody entering into retirement that wants to be a little bit more conservative in thinking about what they are going to be doing when they retire: maybe they have 401(k) program or a pension that they are going to have to rely on. That's why I think in an age of inflation, you've got to think about the dividend approach for income with high stable companies because that's what's going to keep you even with inflation. A Treasury bond today, yes, it may allow you to sleep at night the first six months of the first year.

But with the levels of inflation that we're seeing today, it's not going to keep you even with inflation five years from now and you're going to be struggling 10 years from now if you're on a fixed income because what are you going to have that's going to increase and compensate you and allow you to buy the same goods and services that you buy today. It's absolutely amazing, but year after year, the study continue to improve itself.

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