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The Quest for Low-Risk Retirement Income

FORECASTS & TRENDS E-LETTER
by Gary D. Halbert
December 20, 2011

IN THIS ISSUE:

1.   The Retirement Income Dilemma

2.   Convertible Bonds as an Income Option

3.   The Wellesley Advantage

4.   Learn More in Our Online Webinar

5.   Merry Christmas!

Introduction

Every other year or so, we send a detailed survey to a sampling of our clients just to get a feel for their thinking on a variety of topics.  In our last survey, almost 70% of respondents said that they need help as they move from the accumulation stage (i.e. - working career) of their lives to the distribution phase (i.e. - retirement).

This is especially true at this time of year for those who anticipate retirement in the near future.  There are some big decisions to make:  How should your investment strategy change?; How much income can you draw from your assets?;  How can you avoid outliving your nest egg?; and more. 

Given that these decisions will help shape your future retirement, it’s important to consider all of the options.  This week I will revisit one of our favorite investment programs which is ideal for those who need income.  The Wellesley Convertible Bond Program actively manages portfolios of individual convertible bonds, a special class of bonds that has both equity and bond characteristics, which can be managed to provide an income stream.

The Wellesley Convertible Bond Program delivered a stellar 34.6% return in 2009 and 11.98% in 2010, net of all management fees.  So far this year, Wellesley is essentially flat, but even this has a silver lining that I’ll discuss later on.  Over its 16-year-plus actual track record, this program has delivered average annualized returns of 9.68% as of the end of November with only one losing year.  (As always, past performance is no guarantee of future results.)

Obviously, when considering any investment program for income, you want to see a solid long-term performance record, which Wellesley certainly has (almost 17 years), and you want to see a serious commitment to capital preservation, which Wellesley also has demonstrated.  While capital preservation is important before retirement, it’s imperative afterwards.

Since this is the time of year that many think about retirement planning, I want to share with you how the Wellesley Convertible Bond Program has delivered impressive absolute returns over many years and why it may be a natural choice for anyone seeking retirement income.

The Retirement Income Dilemma

A successful income strategy can be attractive to many investors, but especially for those at or near retirement.  Obviously, today is a very uncertain time to be making decisions about how to withdraw funds for retirement.  Plus, those who are at or near retirement age are more wary than ever of programs that offer guarantees but tie up their money for years (ie – annuities), or those that expose them to potentially significant market losses. 

There are many income strategies out there.  Some are successful but many are not.  In light of having experienced two bear markets over the past decade and the threat of another Euro-driven recession, many retirees are attempting a balancing act between having enough money to live comfortably in retirement and making sure they don’t run out of money. 

The insurance industry is quick to offer up “immediate annuities” as a solution to this dilemma, which might be a solution for part of your money.  However, many investors do not want to tie up their money for years in exchange for guaranteed income.  Plus, the guarantees offered by these companies are only as strong as the companies themselves.  Having lived through the credit crisis, most investors are no longer convinced that a company’s size translates into safety.

In the investment management world, investors are often counseled to adjust their asset allocations during retirement to favor bonds over stocks.  However, many classes of bonds (but not all, as I will discuss below) could be hurt badly as interest rates inevitably rise in the future.  Plus, many investment-grade bonds are paying rates of interest that are far below an amount needed to keep up with long-term inflation, much less provide meaningful income.

Convertible Bonds as an Income Option

Fortunately, there is a particular bond strategy that is, in my opinion, tailor-made for retirees needing to draw income from their investments.  Earlier this month, I revisited the advantages of the Wellesley Convertible Bond Program.  Convertible bonds, by their very nature, are hybrid investments, having characteristics of both stocks and bonds.  Plus, many convertible bonds offered today have a unique “put” option that provides interim liquidity (exit opportunities) and the ability to manage risk. 

The bottom line is the Wellesley Convertible Bond Program is my hands-down favorite of all the convertible bond strategies I have seen.  It has almost zero correlation to stocks or bonds.  And best of all, it can be used to provide income, as I will illustrate below.

The table below illustrates an investment of $500,000 in Wellesley’s Convertible Bond Program at its inception and taking a 5% annual distribution at the end of each year:

 $500,000 Investment at Inception with 5% Annual Withdrawals 

* Because no client actually took a 5% annual distribution in every year shown above, the results are hypothetical.  Please see inherent limitations of using hypothetical results under Important Notes below.

As you review the numbers above, there are a couple of points that deserve your attention.  First, total income withdrawn over the past 16 years would have been over $599,000, meaning that an investor would have been able to withdraw more than the original investment as income over that time.  Not only that, but the original $500,000 would have grown to over $873,000 even after paying out over $599,000 in annual income.  That comes to a net annualized return of 3.55% over and above paying out significant income.  This is possible due to Wellesley’s focus on consistent absolute returns.

In the illustration above, annual withdrawals were made at the rate of 5% of the accumulated balance.  As you can see, this results in annual income of varying amounts, making it somewhat hard to budget for expenses.  We usually counsel our clients to work out a budget to determine their income needs, and then withdraw that flat amount from their investment on a periodic basis. 

To illustrate this option, the table below shows a $500,000 investment at the inception of the Convertible Bond Program and withdrawals beginning at a flat $30,000 the first year, and then increasing by a 3% cost of living adjustment (C.O.L.A.) over time:

 $500,000 Investment at Inception with Flat-Dollar Annual Withdrawals and 3% C.O.L.A. 

*Because no client actually took the exact annual distribution in every year shown above, the results are hypothetical.  Please see inherent limitations of using hypothetical results under Important Notes below.

As you can see, the income produced using a flat-dollar withdrawal is much more predictable and stable for budgeting purposes.  Even using a flat amount increasing by 3% each year, the Wellesley Convertible Bond Program still grew the original investment to over $860,000 while producing over $600,000 of accumulated annual withdrawals.

We could go on and on with illustrations, showing monthly withdrawals, different withdrawal amounts, etc., but I think you get the picture.  Wellesley’s historical ability to produce consistent positive returns while also preserving principal would have made an excellent retirement income investment in the past.  Of course, we can’t guarantee you the same level of performance or income for the future, but we do know that Greg Miller and his staff at Wellesley will be using the same types of fundamental analysis techniques to manage money in the future as they have in the past.

Wellesley requires a higher minimum investment than our mutual-fund-based programs.  Since the managed account holds individual bonds, a higher minimum is needed to provide sufficient diversification among issuers.  Wellesley is also better able to tailor the account to meet the specific needs of the individual investor, including being structured for income.  Call one of our Investment Consultants at 800-348-3601 for more details regarding Wellesley’s flexibility and minimum investment.

The Wellesley Advantage

Wellesley’s approach to the market is that good companies pay their debts and offer growth potential.  Thus, when evaluating a convertible bond issue, Wellesley uses fundamental analysis to not only determine the company’s balance sheet strength, but also its future prospects.  As a CPA, Greg knows how to dig into financial reports to get the real story on an issuer.

And this analysis doesn’t stop after the purchase.  Each existing bond is subjected to constant review in a process that Wellesley calls its “buy, hold, sell, put or convert decision.”  Wellesley constantly monitors each position in relation to strength of the issuer, conversion value of the bond and any upcoming “put” and “call” dates. This is very important for anyone needing stable income, as well as one of the key advantages of Wellesley’s managed accounts.

Over its almost 17-year actual track record, this program has delivered average annualized returns of 9.68%, with only one losing year.  These are real composite returns, not some hypothetical or “model” track record.  For more detailed information on Wellesley’s actual performance record,  click here to review our detailed Advisor Profile. 

Anyone who says that a convertible bond program can’t produce a reasonable return with limited risk obviously hasn’t seen Wellesley’s actual track record.  While much has been written about the stock market’s “lost decade,” Wellesley has actually made money for their clients. 

The goal to produce consistent absolute investment returns makes the Wellesley Convertible Bond Program a natural for investors wanting the potential for reasonable growth, dependable income and principal protection. 

A common question we are asked by prospective investors looking at Wellesley is: How should convertible bonds perform in a rising interest rate environment?  Wellesley’s research has shown that, historically, convertible bonds have often fared very well during periods of rising interest rates, which is definitely not the case with many other types of bonds.  With interest rates likely to move higher in the future, Wellesley’s Convertible Bond Program may be a better choice than other, more interest-sensitive bond investments. 

Learn More in Our Online Webinar

Based on our experience, it’s not likely that you’ll ever hear about convertible bonds from your broker or financial planner.  Convertibles are usually the realm of institutional investors that know the value of their unique structure.  Wellesley’s founder, Greg Miller, CPA, likes to say that anyone who listens to his presentation will know more about convertible bonds than 90% of all investors, as well as many investment professionals.

To give you an opportunity to get a leg up on most other investors, we have archived our most recent online webinar featuring Greg and the Wellesley “Limited Risk Investing” strategy.  You’ll not only learn a lot about how convertible bonds work, but also about Wellesley’s strategy that uses fundamentals to select bonds that offer the potential for absolute returns with limited risk.  It is this strategy that has enabled Wellesley to grow from just managing Greg’s personal money to apprx. $1 billion in client assets.

Conclusions

If you have been reading my E-Letter very long, you know that I do not shy away from highly recommending the Wellesley Convertible Bond Program.  I feel that it could be an excellent choice for virtually any investor, but especially those who are trying to make decisions on how to take current income from their nest eggs.

And what about convertible bonds in today’s uncertain, news-driven market?  I can answer that in two words: “On Sale.”  That’s the silver lining of this year’s flat performance that I mentioned in the Introduction.  According to a recent market update from Wellesley, they are now able to buy convertible bonds at much better prices and with more favorable terms than previously available.  Wellesley produced an informative Market Commentary on that subject that you can read by clicking on this link.

If you have read this far, I trust you agree that the performance results illustrated above are very impressive!  I think you would also agree that the Wellesley Convertible Bond Program may be an excellent choice for investors whether or not they need retirement income from their investments.

If you would like more information about the Wellesley Convertible Bond Program or how it might be used to provide income for you during retirement, feel free to contact us in any of the following ways:

  • Give us a call at 800-348-3601 and ask to speak to one of our Investment Consultants;
  • Send an e-mail requesting information to info@halbertwealth.com;
  • Visit our website at www.halbertwealth.com and click on the “Contact Us” link at the top of the page; or
  • Click on the following link to access our Wellesley online request form.

Merry Christmas!

Since this is my last E-Letter before Christmas, I want to take this opportunity to wish each and every one of you a Merry Christmas.  My prayer is that you have a warm and wonderful holiday with your family and friends, and that any travels you may embark upon are safe.

I’ll be back on December 27th with my regular weekly E-letter.  Until then…

Wishing you the Merriest of Christmases,

Gary D. Halbert

IMPORTANT NOTES:  Halbert Wealth Management, Inc. (HWM) and Wellesley Investment Advisors ("WIA") are Investment Advisors registered with the SEC and/or their respective states.  This report does not constitute a solicitation to residents of any jurisdiction where the program mentioned may not be available.  Information in this report is taken from sources believed to be reliable but its accuracy cannot be guaranteed.  Any opinions stated are intended as general observations, not specific or personal advice.  Please consult a competent professional and the appropriate disclosure documents before making any investment decisions.   Investments mentioned involve risk, and not all investments mentioned herein are appropriate for all investors.  HWM receives compensation from WIA in exchange for introducing client accounts.  For more information on HWM or WIA, please consult the respective Form ADV 2 for the Advisor, available at no charge upon request.    Officers, employees and affiliates of HWM may have investments managed by Advisors discussed herein and others.

For all years up to and including 2009, this presentation reflects only the convertible securities portion of WIA's client accounts.  Returns are based on all securities held in accounts of all WIA clients and the Miller Convertible Fund during the periods reflected.  Actual client accounts may include positions other than convertible securities.  Such other positions are not included in this performance presentation.  Accordingly, the actual return of WIA client accounts is different, in some cases substantially, from the performance information presented for convertible securities.   

WIA's convertible returns during this period have been calculated using the following methodology.  Such methodology includes several assumptions that results from systems limitations on aggregating the convertible security portion of multiple client account.  Returns do reflect the reinvestment of interest and dividend income, but do not reflect transaction costs. The security’s market value on the last day of the month is determined as is the weight of each security in the portfolio (individual security value/total security value).  Each security's return for the month is calculated (monthly interest earned plus/minus monthly price change).  It is assumed that the security entered the portfolio on the first day of the month in which it was first purchased.  When a security is completely sold out of a portfolio, the prior month-end value is adjusted to reflect the final sales price. Each security's return for the month is weighted by the security's weight in the portfolio.  The security’s weighted returns for the month are summed to get the portfolio's return for the month.  These numbers are compounded to calculate the annual returns.

For all years starting in 2010 and after, performance numbers are compliant with Global Investment Performance Standards (GIPS).  The monthly returns are size-weighted average returns and are compounded to calculate annual returns.   Performance numbers cited here are for all clients whose account value consisted only of cash and registered convertible bonds.   Accounts with 144A non-registered bonds are not included in this presentation. Performance measurement for clients generally began on the last day of the month the account consisted of only cash and/or registered convertible bonds.  Performance measurement for clients generally ended on the first day of the month in which the client account either terminated or held managed positions other than cash and registered convertible bonds.    

The illustrations, “$500,000 Investment at Inception with Flat-Dollar Annual Withdrawals and 3% C.O.L.A.”  and “$500,000 Investment at Inception with 5% Annual Withdrawals” are hypothetical.  They are based on WIA Convertible Bond Returns, hypothetical $500,000 investments in WIA, and end of year withdrawals equal to either flat dollar annual withdrawals with a 3% C.O.L.A. or 5% annual withdrawals.  No actual WIA client received these exact returns or withdrew these exact amounts.  There are inherent limitations in using hypothetical results, particularly the fact that such results do not represent actual trading, and that they may not reflect the impact that material economic and market factors might have had on the adviser's decision-making process if the adviser were actually managing client money. 

When reviewing past performance records, it is important to note that different accounts, even though they are traded pursuant to the same strategy, can have varying results.  The reasons for this include: i) the period of time in which the accounts are active; ii) the timing of contributions and withdrawals; iii) the account size; iv) the minimum investment requirements and/or withdrawal restrictions; and v) the rate of brokerage commissions and transaction fees charged to an account. There can be no assurance that an account opened by any person will achieve performance returns similar to those provided herein for accounts traded pursuant to the Wellesley Limited Risk trading program.

In addition, you should be aware that (i) the Wellesley Limited Risk trading program involves risk; (ii) the Wellesley Limited Risk trading program’s performance may be volatile; (iii) an investor could lose all or a substantial amount of his or her investment in the program; (iv) Wellesley will have trading authority over an investor’s account and the use of a single advisor could mean lack of diversification and consequently higher risk; and (v) the Wellesley Limited Risk trading  program’s fees and expenses (if any) will reduce an investor’s trading profits, or increase any trading losses.

Past performance is not indicative of future results.  The performance presented may not be representative of investments held in any client account or performance realized in any one client's account.  An investment in convertible securities involves a risk of loss.  Returns reflect the deduction of a 1.75% annual management fee, which is deducted monthly.   Fees are deducted quarterly in actual client accounts.  The value of an investment in convertible securities may decrease as well as increase. Performance does not reflect the effects of taxation, which results in lower returns to taxable investors.  Consult your tax advisor.  “Annualized” returns take into account compounding of earnings over the course of an investment’s track record.  The returns reflect the reinvestment of interest income and dividend income. The results shown are for a limited time period and may not be representative of the results that would be achieved over a full market cycle or in different economic or market conditions.


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Forecasts & Trends E-Letter is published by Halbert Wealth Management, Inc. Gary D. Halbert is the president and CEO of Halbert Wealth Management, Inc. and is the editor of this publication. Information contained herein is taken from sources believed to be reliable but cannot be guaranteed as to its accuracy. Opinions and recommendations herein generally reflect the judgement of Gary D. Halbert (or another named author) and may change at any time without written notice. Market opinions contained herein are intended as general observations and are not intended as specific investment advice. Readers are urged to check with their investment counselors before making any investment decisions. This electronic newsletter does not constitute an offer of sale of any securities. Gary D. Halbert, Halbert Wealth Management, Inc., and its affiliated companies, its officers, directors and/or employees may or may not have investments in markets or programs mentioned herein. Past results are not necessarily indicative of future results. Reprinting for family or friends is allowed with proper credit. However, republishing (written or electronically) in its entirety or through the use of extensive quotes is prohibited without prior written consent.

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