Thinking Outside the Box - Why Our Formula Looks Different

A reflection by Wayne Wagner Jr., ChFC

Yesterday, I had a conversation with a client who is retired who was asking the question, "How much should we have in safe investments or bonds versus more risky assets like stocks and private equity?"

She was looking at the portfolio and she said, "It seems like we're a little heavy in equities at this point compared to some of the popular ideas are going. Aren't you supposed to take 100, subtract your age, and have that percentage in bonds or something like that?" 

There are all kinds of rules of thumb running around the industry of how much you should have in bonds and conservative investments. I explained to her these two things. 

Understanding Bond Performance 

First things first: the last 30-40 years of bond performance is not going to equal the next 30 or 40 years of bond performance. Here's why.

The reason bonds are not going to perform over the next 30 or 40 years as the conservative asset class that they have been is that for the last 40 years, since about 1980, interest rates have been coming down.

When interest rates drop, bond values go up, therefore, bond performance is above long-term averages as interest rates are going down.

Interest rates have bottomed out. Given the dynamics of inflation, given the dynamics of the valuation of assets, interest rates over the next 10-30 years are going to go up from here, not down. Therefore, bonds are not going to be the safe harbor asset that they have been for our parents.

The next generation is going to have a real problem owning bonds and thinking they're going to get that nice steady 4-6% per year rate of return. Statistically, it's not going to happen given where interest rates are now.

The Formula at Vizionary (A+B+5C)

What I explained to my client yesterday is that we use a formula. It's not of what percentage of your assets should be in the bond investments. We use a formula called A + B + 5C.

"A" is how much cash you have on hand.

We generally want six to 12 months of your expenses in cash at any point in time during retirement or during your years of financial independence.

"B" is your conservative investment.

This is going to include some bonds, but there's a lot of other lower risk, lower volatility assets that we can bring to bear. They are not going to have that risk profile and interest rate sensitivity that bonds have as we move forward from here.

"5C" is your dividends and repeatable income.

Here we are talking about that repeatable, dependable cash flow from your existing portfolio. It's dividends from stocks, maybe blue-chip stocks, maybe companies that have growing dividends over time. It's interest and income from other kinds of assets like real estate or different kinds of bond funds.

A + B + 5C = 5 Years of Cashflow

We want A + B + 5C to equal five years of your needed cash flow. We also want to be able to identify A plus B plus 5C at a drop of a hat any time during your years of financial independence. 

Why? Where do we come up with that?

Well, look historically when the market goes into crisis: 1999 or 2000-2002 with three straight down years in the market. We get 2008 and we get a fall off a cliff. We get 2020 and witness a 40% drop in six weeks.

When the market goes into crisis, the average length of time for the market to get back to zero is about 28 months. So let's call it two and a half years.

What we're doing is planning to never have to sell a risk asset for five years. So we want A+B+5C to equal five years of your cash flow because we want at any point in time for us to say we're not selling a single share of a single stock for the next five years minimum.

I don't care if you're 52 and financially independent. If you're 62 and retired. If you're 82, I want to be able to lay our hands on five years of your cash flow. Why? Because that evaporates the conversation that as you get older, you should have more money in bonds or you should have more money in fixed income or lower-risk investments.

Now, if you're 88 years old and you have that five years' worth of cash flow, all the rest of your money can be in stocks. At that point, the question's not, "What is the stock market going to do this week, this month, or this year?" The question is focused on if the stock market going is going to be higher five years from now? Why?

Because at any point in time, you can stop spending, stop selling stocks if they go into crisis, and just live off the income that you've protected between A+B+5C.

We can do that for twice as long as the average recovery rate. So if it usually takes an average of two and a half years for the market to recover, we're planning for five years or two times.

Working with Vizionary Wealth

At Vizionary Wealth Management, that's the kind of strategy. That's the kind of thought process we bring to this. I know it's not common knowledge. I know it's not rules of thumb, but we think it enables people who have a higher net worth and who are seeking financial independence.

If you're not necessarily aiming for just a comfortable retirement, this allows you to think differently about your capital and allows you to think more strategically about leverage your capital. That may be leaving your wealth for your children, institutions, or organizations that you feel deeply about. It also allows you to dream in a way that perhaps you wouldn't otherwise feel comfortable dreaming.

Here at Vizionary Wealth Management, we're always here with perspective for the decisions ahead.
If this has been helpful, please reach out. Let's have a conversation.