From the November 2008 issue of Investment Advisor • Subscribe!

Reinvesting Profits to Generate Income

Stephan Cassaday, CEO of Cassaday & Company, Inc., has developed a retirement investment process that he uses to make sure retirees do not outlive their assets by generating a stream of income using a patented process of withdrawing money from reinvested profits.

The process, called DIESEL--which stands for Dividends, Interest, and Equity Select Liquidations--uses mutual funds and reinvests the dividends and interest while selectively liquidating parts of the portfolio and harvesting it for income. Depending on a client's risk tolerance, time horizon, and financial goals, the portfolio offers diversification among four main asset classes: stocks, bonds, hard assets, and cash, according to the McLean, Virginia-based company.

"Diesel is a process for generating cash flow out of a portfolio," says Cassaday, who has been in the financial planning industry for 31 years, having the same group of clients with him for most of that time. Cassaday has been using the system for a little over 10 years and recently trademarked DIESEL last year on the advice of a lawyer. He founded the company in 1993 after working at NYSE member firms for 16 years.

Most of Cassaday's original clients are now retired and need supplemental cash flow. The old way to generate income, Cassaday says, was to take dividends and interest payments from bonds. The problem is that stocks and bonds will go through periods when they have very poor returns and the portfolio is depleted. What's more, having only one to two asset classes won't work either because if you backtest 30 or 50 years, the portfolio ends up getting "mortally wounded" because of withdrawals when returns are low, and sometimes retirees can't recover unless they say, "Okay, I won't eat for a couple of years,'" Cassaday says.

The first order of business for Cassaday is creating a stable platform from all four asset classes from which to make withdrawals with as little volatility as possible. The stocks, bonds, cash, and hard assets--including real estate--include subclasses of value, growth, different types of bonds, and various raw materials. "That is what our [in-house] study showed. Other [industry] studies show similar data," he says. "A portfolio that is mostly bonds is not going to work."

Cassaday performed a study that showed his system could have sustained a 7% withdrawal rate over the prior 30 to 50 years, far above the standard 4% rule advisors stick to. The study used the actual CPI (consumer price index), inflating withdrawals by whatever the CPI was.

"We combine this pruning and harvesting with rebalancing. If you have four asset classes with 25% in each, that is a balanced portfolio. At the end of 90 days it might be at 20%, 30%, 18% and 28%," he explains. "So we go through at the end of each quarter and harvest what is up. We have an algorithm that does that for us." Then Cassaday & Co. takes the harvested amount--the profit--and places it into an account for the clients' incomes. "Then we rebalance it."

If all groups are down, he harvests equal amounts of all four classes. The level of return, though, is secondary to the consistency of performance that a stable portfolio allows.

"No one has ever called me or my associates and said 'I need to increase my withdrawals by the CPI.' The second point is that most people don't ask for raises. We end up calling our clients and saying, 'Do you need a raise?'"

But there are calls for "extraordinary withdrawals," Cassaday concedes. Thus, the advisor tries to get the client in advance to plan for these withdrawals, which many times are for cars, he notes, and amortize that into the clients' budgets.

During the current market crisis, Cassaday didn't change strategy, but is talking with clients on a daily basis and held a Webinar for 250 clients. Its models are diversified and investments in mutual funds are made for the long term, so everyone remained invested, according to a spokeswoman for the firm. Cassaday noted that the portfolios are indeed down--this was before the $700 billion bailout bill was approved--but not half as much as the market was down, as the strategy plans for only experiencing half the downside on the riskiest portfolios. The firm did sell real estate in 2006 and bought it back in April. Cassaday admits the firm should have waited on that, but the system was timely on commodities going up.


Elizabeth D. Festa is a freelance business writer based in Washington, D.C. She can be reached by e-mail at elizabeth.d.festa@comcast.net.
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