The retirement crisis is over—forget it. All of the hand-wringing and teeth gnashing from advisors about underfunded defined-contribution plans, longer life spans, guarantees, appropriate withdrawal rates, etc.? Done, kaput, move on.
OK, maybe not quite. But Fred Taylor has “a solution to a problem that every baby boomer faces”: quite a boast in this era of “new normal” volatility and one that’s attracting attention.
Taylor, president and co-founder of Northstar Investment Advisors, wastes no time in getting right to it.
“We have a way for them to get income to live off in retirement,” he says. “Right now, with money market yields at zero and the 10-year Treasury bond under 2%, baby boomers are being forced to look at equities as a way to get income. Our portfolios of roughly 48 stocks produce about 4% in dividend income and, more importantly, they increase their dividends on an average of almost 10% a year. People are actually getting a raise on their money, and it’s a way to hedge inflation down the road.”
Sure, it’s a dividend play (what isn’t right now?), which might not sound like anything new, but the way they employ the dividend strategy certainly is; enter the Farrell-Northstar Retirement Income Index.
Named for Charlie Farrell, the firm’s CEO and index developer, it seeks to “help investors gain a better understanding of how to combine specific investments to produce income and protect principal in retirement,” according to the firm. “The FNRI Index comprises securities that are designed to help investors meet the following investment objectives: current and stable income, growing income, principal protection and capital gains.”
The reason for the index, Taylor says, was that “most of our clients would compare us to the S&P 500, but it wasn’t a fair apple-to-apples comparison. On March 2009, the stock market was down 48% and our balanced portfolio was down 16%, so the proof is in the pudding.”
To use an overwrought Colorado reference, each investor’s situation is “as different as a snowflake,” so does this one solution really translate to a wide swath of the generation?
“Their homes may be flat or down 20% to 30%,” he counters. “No longer can you use their home as an ATM machine. Baby boomers, generally speaking, have gravitated in the last three years toward buying bonds because bonds have done very well through the crisis. But now with yields at historic lows, when we are back to the 1950s in terms of interest rates, they’re not going to have enough money to live on.”
For example, he notes that four or five years ago an investor could get 5% on a bond portfolio of $1 million and get $50,000 a year in income. Today, those same bond portfolio yields are 1.8% or 2%, and they’re getting $20,000 a year in income with inflation of roughly 2% to 3% a year.
“So unless you want to absolutely cut your lifestyle in half, which baby boomers typically don’t want to do, you have no choice but to invest in the stock market, in stocks that pay dividends,” he exclaims. “And what we’ve done in the last three and a half years is identify companies that increase their dividends every single year and pay a meaningful dividend to start, which is roughly between 2.5% and 5%.”
As for who else might be taking such an approach to retirement income, Taylor claims Northstar is totally unique in Colorado and probably in the country.
“Vanguard has a dividend growth fund, but it only yields 2%,” he says. “We yield almost 4%. We also use what we call high-yield stocks, which are mostly master limited partnerships. Vanguard and these other mutual funds can’t own the MLPs in their general mutual fund because of tax reasons.”
Speaking of which, how tax efficient are they? Taylor says turnover in 2011 was under 10%.
“We’re very focused on picking the right stocks to begin with. Most portfolio managers turn over their portfolios 100% to 200% and never collect the dividends. More importantly, you never get the increase in the dividends. So our goal is to do the work up front to identify the 48 or 50 names in the portfolio.”
But what if President Obama gets his way and raises rates on dividends and capital gains? How is the strategy affected?
“I would argue that at least you’re getting some income,” he says. “Otherwise, everybody has been told to take the total return approach, which is to have 15 different asset classes and all these different managers and hope that your portfolio goes up. So yes, you are going to probably have to pay more in taxes, but at least you are getting something on your investments. If you can get 4% and still pay taxes on that, you’re still way ahead of a money market fund getting 1.8% on a 10-year Treasury bond.”
As for their buy and sell disciplines, he adds that there has to be a real catalyst to sell a stock, noting they sold a natural gas stock earlier this year and bought a large integrated oil company as a replacement. The reason, he says, is that the natural gas stock dividend was less than the integrated oil company stock. With natural gas prices continuing to fall due to over-supply in the market, he thought it made sense to take a loss and swap to a larger integrated position.
“By doing that, we were able to pick up 1.5% to 2% on the dividend,” he says.
When it comes to due diligence in their picks, the Northstar team doesn’t travel much or meet with management, since they buy large-cap multi-national companies on which there is plenty of publicly available research.
“The names in our portfolio, by and large, except for the MLPs, are names that most people would know,” he says. “Those would be the biggest companies in the world.”
Taylor started Northstar Investment Advisors with three other partners back in 1995. He felt at the time there was a void that could be filled with a money management firm that really had a focus on income generation for clients. A Denver native, he went to college back East, did his requisite stint on Wall Street and was transferred back to Denver to trade bonds for a venture company before striking out on his own.
Farrell, who had a similar philosophy, joined the firm in 2007 and has done the yeoman’s work on the income index while writing “Your Money Ratios: 8 Simple Tools for Financial Security,” which The Wall Street Journal in 2009 called “one of the best financial books to cross our desks this year.”
Today, the Schwab-affiliated Northstar has over 225 relationships and over 600 accounts, and it manages approximately $350 million. The minimum client investment is $750,000, but the firm’s sweet spot is typically $1 million to $5 million.
“The reason for that amount is that they’re the kinds of clients that come out of a divorce; typically they get a settlement of that size. If you retire from, say, practicing law, you typically have $2 million or $3 million maybe in a retirement account. Or if you sell a business, that’s kind of the sweet spot of what you might get. On a $1 million to $5 million portfolio, if you can generate 4%, that’s quite a bit of money to live off.”
As for performance, Taylor is more than happy to brag.
“The S&P 500 was up 2.11% last year and our Farrell-Northstar Retirement Index, which is 50% in bonds and 50% in our 48 equities, was up 10.82%. Our Farrell Retirement Stock Index, which is 100% in equities, was up 11.08%. Even more impressive, over the three years since our inception date (which if you remember was right before the Lehman crisis), our retirement index is up 8.10% and the stock index is up 8.25%, compared with the S&P 500, which is up 1.75%.”
It’s a great story, one that certainly resonates with baby boomer clients. But let’s face it, it’s all about dividends at the moment. How does Taylor respond to critics who might yawn at all that he’s had to say?
“Dividends may be the hot thing at the moment, but we’ve been doing it for 17 years,” he answers. “We can yield twice what people are finding in these income stock funds. The one that probably compares most to us is the Vanguard Dividend Growth Fund and we’re yielding roughly 2% over that.”