Two diverging paths to income

With 85% of his assets under advisement held by clients in retirement, Theodore Feight can't afford to wait and hope for the markets to come to him. Mr. Feight, the owner of Creative Financial Design, has been in the financial planning business since the early 1970s, but the 2008 financial crisis was the tipping point for his shift to tactical investing. “I'm absolutely using tactical strategies, and my clients are enjoying it,” he said. “When I started doing this, I was an outlier, and I had a lot of people tell me I'm nuts and that I should just buy and hold.” While Mr. Feight's more active strategy would never be confused with day trading, it does involve more portfolio activity than a lot of fee-based advisers are used to. With a list of retired clients ranging from 52 to 96, Mr. Feight has been embracing a somewhat eclectic income-focused strategy that involves a heavy dependence on dividend-paying stocks and high-yield bonds. Any conversation about portfolio management with Mr. Feight inevitably leads to his reliance on stop-loss orders, illustrating his intention to avoid big declines. “We have completely shaken up our old asset allocation and the ETFs we use to better take care of our retirees' income needs,” he said. For most retired clients, Mr. Feight advises withdrawing 5% annually for income. And if portfolio performance is strong enough, he will increase the annual distribution by 4%. For example, a $1 million retirement portfolio would take an annual distribution of $50,000. Assuming a portfolio performance could justify it, Mr. Feight would add a 4%, or $2,000, cost-of-living increase the next year. “During bad years, we ask clients to forgo increasing their income,” he said. The income portfolio generally has “bond replacement stocks that provide good income with the possibility of going up in value,” high-yield corporate bonds, and large-cap-value, small-cap-value and international large-cap-value ETFs that provide above-average dividends. “The allocation does change based on a client's situation, and stop-loss orders do play a major role in protecting clients during periods of major market corrections,” he said. Mr. Feight's model portfolio has 20% allocated to high-yield bonds, which is something that might have been considered extremely aggressive for a retirement portfolio just a few years ago. “It is harder to find income, so for a lot of advisers, it has become a balancing act when dealing with risk-averse clients,” said Michael Fredericks, head of U.S. retail distribution for BlackRock Inc.'s multiasset-portfolio-strategies group. For advisers such as Mr. Feight, the greater risk in such a low-rate environment is not being nimble enough to protect portfolios while generating income. “We are simply trying to protect clients from the major stock market meltdowns like 1990, 2000 to 2002, and 2008,” he said. “And with more than 80% of the money we manage in retirement accounts, you have to get the money to grow.”

Approach #2: Seeking preservation over yield in bonds

One might assume that a traditional bond-laddering strategy would have little value in a period of historic low interest rates, but that's not how Charles “Chip” Simon sees it. Mr. Simon, president of Taconic Advisors Inc., is staunchly committed to fee-only planning and is a subscriber to the principles of the Alliance of Cambridge Advisors Inc. Mr. Simon admits that with yields so low, it would be futile to adhere strictly to a bond-laddering strategy that includes a staggered portfolio of Treasury bonds held to maturity. But that doesn't mean he has abandoned the idea behind the bond ladder. “The bond ladder is, at its ideal, risk-free lifestyle expenses for 15 years or so,” he said. In essence, while it might not make economic sense to continue buying new longer-dated rungs on the bond ladder as bonds mature and liquidate, Mr. Simon, along with most ACA members, still believes in the concept that safety trumps yield. “The clients with bonds they bought five years ago are thrilled right now,” Mr. Simon said. “But the problem is, what do you do for a bond ladder right now?” It is actually a rhetorical question, because he has already decided that until bond yields become more attractive, safe money will be sitting in short-duration, low-cost holdings. Specifically, Mr. Simon, at least temporarily, has diverted some of his clients' bond ladder assets to short-term-bond funds, intermediate-term-bond funds and cash. “If a client has no rungs left on his ladder, he still has the money for a bond ladder, it's just not currently in the structure of a ladder,” he said. “What I'm not doing is having him go out and reach for yield or taking on risk by being a yield chaser.” Mr. Simon said about half his clients are currently retired, and for those clients, he generally starts with a model portfolio of 50% stocks and 50% bonds. “The purpose of the bond portfolio is to be a stable pantry from which to draw retirement cash flow,” he said. “I think first of preservation rather than returns, and I prefer to seek risk in the equity portfolio, not in the bond portfolio.” That's the other piece of the Alliance of Cambridge Advisors strategy — performance is designed to come from the equity side. “Equities are for growth, and we encourage clients to not look at retirement as not earning any income,” said Mary Alpers, owner of Alpers Financial Planning Inc. Ms. Alpers, a member of the ACA, also subscribes to the bond-laddering strategy for fixed-income allocations. “The bond ladders are for safety, and with newer clients right now, we're just setting aside the cash for the ladders,” she said. “I see the ladders as a type of pension inside an [individual retirement account]; it is a way to build a stream of income for clients.”