Q. What is your opinion of a retirement plan that would consist entirely of investments in high-dividend-yield stocks, aiming for a dividend yield of 3.5 to 4.0 percent? The dividend income would be used to pay living expenses. There would seldom be any need to sell shares--- unless there was a significant problem with the company (e.g. Ford, GM). Shares sold would be replaced by other names. Over the long run, 25 to 30 years, would this approach be safe, and would it beat the 50 percent stocks, 50 percent bonds of the Couch Potato portfolio?

---S.T., by e-mail from Dallas, TX

 

A. In the late '70s this was called a "yield tilt" strategy. Today it is most commonly seen in "equity-income" funds that attempt to provide a dividend yield greater than the S&P 500 Index. I admire this approach and think it is particularly useful for retirees.

The greatest losses happen when we are forced to sell assets to meet income needs--- so the more you can do to have your investments provide all the cash income you need, the better. This, by the way, is the reason portfolio survival for any given income rate can be improved by buying a life annuity with a portion of your savings.

The greatest danger in a high-yield-stock portfolio is that it will be concentrated in a few industries. Banks are among the top dividend payers today, along with REITs, some electric utilities, the tobacco companies, and a few pharmaceutical companies. Less diversification means more risk.

Another danger is that you can lose a great deal of money if you are forced to sell stocks to pay for an illness or other disaster. The only thing you can be certain of is that your personal disaster will happen during a period of falling stock prices, not rising stock prices.

So you won't find me endorsing a 100 percent stock portfolio. As a source of protection and diversification you should consider an 80/20 stock/fixed income portfolio with the bonds invested in a 5-year ladder of Treasury notes. The ladder will provide you with a minimal risk source of emergency funds and a relatively good yield. With yields on 1 to 5 year Treasurys now around 4 percent, it would meet your income requirement as well.

 

Q. Do you subscribe to the notion that the higher than normal price to earnings (P/E) ratios the stock market has been experiencing is due, in part, to U.S. demographics? In other words, are baby boomers savings driving up P/E ratios and will things shift downward in the next 10 years as boomers shift out of stocks?

If so, are you aware of any solid foreign markets to invest in with demographics that run counter to the U.S.?

---M.G., by e-mail from Dallas, TX

 

A. The two largest levers on common stock prices are interest rates and inflation expectations. As interest rates and inflation rose in the '70s, for instance, investors were willing to pay less for a dollar of corporate earnings because there was more competition from the bond market. In addition, the price of growth stocks was hit hard because most of their earnings are in the future. The greater the rate of inflation, the greater the value of dollars received today relative to dollars expected in the future.

As interest rates and inflation peaked in the early '80s, stocks sold at only 8 times trailing earnings. Dividend yields were well over 4 percent. The bull market we've experienced since then has ridden on the back of declining interest rates, not demography. Today, we're in the reverse situation: Both interest rates and inflation are low--- so stocks are selling at high multiples of current earnings.

One of the ironies of the current concern about Social Security and Medicare is that the United States compares well with the profoundly dismal demographic realities in most of the world.

Don't get me wrong: It's a matter of proportion. Our problems are huge, but demographic problems in the rest of the world are gigantic. Our demographics are milk and honey compared to Europe and the former Soviet Union. Japan may be the fastest-aging nation on the planet. And China has both an aging problem and a catastrophic imbalance between their population of young men and young women.

We should never forget that this is the best "problem" human beings have ever faced --- living "too long."