FMD Capital Management

Avoid These 3 Pitfalls In Your Retirement Portfolio

Written by David Fabian, April 22nd, 2015

Investors facing retirement must be careful to shelter and maintain the value of their capital given the multitude of risks inherent in drawing income without any means of replacement. Running out of money is likely one of the biggest concerns that retirees face when analyzing the need for essential living and discretionary expenses.

Given the late-stages of the current bull market in stocks along with the historically low interest rate environment, the margin for error is razor thin. With that in mind, retirees should be focusing on several key steps within their portfolio to reduce volatility and add sensible income techniques.

1. Beware of high fee mutual funds and annuities.

There are literally billions of dollars still languishing in high fee mutual funds and annuities that have been sold with the sole purpose of generating cash flow for the providers – not you. These products can contain front and back end sales loads, commissions, ongoing management fees, and a host of other hidden agendas.

The blog Alpha Architect recently profiled an S&P 500 Index fund with a 3% sales load and annual expenses of 0.60%. A 5-year look back of this A-share mutual fund versus the same basket of stocks in the iShares Core S&P 500 ETF (IVV) shows a shocking 13% disparity in total return. Almost all of that is due to the ongoing expenses dragging on returns and doesn’t even include the sales load that you would pay up front on the mutual fund.


If you find yourself in a legacy mutual fund or an annuity that was sold to you ages ago, consider moving the capital to a more cost-efficient ETF or highly rated no-load mutual fund. Even small differences in fees add up significantly over time and can lead to more money in your pocket to generate the income you need in retirement.

In addition, if you are seeking a more dividend-oriented focus, you may want to consider funds such as the Vanguard High Dividend Yield ETF (VYM) or PowerShares S&P 500 Low Volatility ETF (SPLV). VYM is an extremely low cost basket of high dividend paying large-cap stocks, while SPLV tracks 100 stocks within the S&P 500 exhibiting minimal price fluctuations. SPLV also has a unique feature of monthly dividend payments, which may be attractive to some retirees as well.

2. Avoid overdependence on high yield or aggressive income strategies.

Most experts recommend that retirees target an income withdrawal rate in the neighborhood of 3-5% in order to weather the fluctuations of the market and still maintain principal values. Nevertheless, those with higher expectations of 7%+ withdrawal rates are often lured into riskier asset classes. These can include: private REITs, leverage-heavy mortgage REITs, business development companies (BDCs), distressed junk bonds, and other high yield categories.

The allure of much higher yields in excess of a 10-Year Treasury Note may seem like something you can’t pass up. However, in a distressed market environment, these assets may become highly illiquid and significantly marked down.

Instead of overdependence on high yields to generate income, you may want to take a broader view on the concept of total return. Having a core allocation to traditional stocks and bonds will help provide balance and smooth out the volatility of your portfolio. In addition, a small allocation to alternative assets such as publicly traded REITs, master limited partnerships, or preferred stocks can often play a role in enhancing income and providing non-correlated returns.

Each of those alternative styles can be purchased through individual ETFs, which allow you to control the size of each allocation. Another approach is to use a combined fund as the First Trust Multi-Asset Diversified Income Index Fund (MDIV). This ETF includes all of the aforementioned alternative asset classes along with traditional dividend paying stocks. MDIV has a 30-day SEC yield of 6.58% and charges an expense ratio of 0.67% annually.

The key thing to remember in this category is that high yield = high risk. Moderation and a conservative allocation methodology will serve you well in reducing overall volatility without sacrificing your income and capital appreciation needs.

3. Don’t be your own worst enemy.

The psychology of the markets is something that can’t be underestimated in making sound decisions for your portfolio. Josh Brown recently wrote an excellent article describing all of the things investors do wrong in reaction to worries or volatility. His message was simple and I wholeheartedly agree: The biggest threat to your portfolio is you.

Often times investors get caught up in the fear and greed cycle that takes over their normally rational decision making process. They want the instant gratification and safety of cash when the market is falling, yet find themselves in a similarly uncomfortable situation if stocks immediately turn around and head higher. The key to overcoming those emotional habits is to have a well-defined investment strategy.

For some that means passively following the market with the expectation that prices will eventually be higher over the long-term than they are now. Others that want to take a more hands on approach should have well defined sell points that allow them to step aside in the event of a decline. Then consequently they will have to implement a reliable strategy to get them back into the market when the dust has settled. The key to being more active is making sure that your investment decisions are based on sound reasoning rather than in response to stress.

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