Where's the beef?
Where’s the beef? I’m sure you remember this great ad campaign from Wendy’s. The little old lady in the commercial was looking for the beef as the hamburger kept shrinking. Investors today may have the same feeling when they look at interest rates. Where’s the rate?
Interest rates continue to drop. The yield on the U.S. Ten Year Treasury is 1.77% a drop of 21% for 2016. Individuals looking for income continue to be frustrated by the lack of opportunities. One idea is to turn an equity investment into an income producing asset.
How can you take advantage of the long term trend of the stock market to generate income from your funds? A strategy that works well is the systematic withdrawal plan. This strategy allows you to sell a fixed dollar or fixed percentage from your mutual fund holding. The amount sold can be sent to you monthly.
As an example, you invest $100,000 in XYZ mutual fund. After you invest, you decide to withdraw 5% of the account balance on an annual basis. This, initially, will generate $5,000 per year or $416 per month. If your fund is growing at 8% per year and you’re receiving 5%, your investment is growing at 3%.
Let’s look at a real world example. The Vanguard Standard & Poor 500 Index Fund (VFINX) has been around since August 31, 1976. An investment of $100,000 in 1976 has grown to $699,350. Applying a 5% systematic withdrawal plan to your original investment produced $843,697 in total distributions! Your first year amount was $5,120. In 2015 your distribution was $36,254. This is an increase of 608% from your original amount. The systematic withdrawal plan is a total return strategy using all the resources of your mutual fund holding.
For this strategy to work it helps to be a buy and hold investor. If you invested in this fund from the start you endured Black Monday, the Tech Wreck and Great Recession. However, after all the drops, this fund has had an average annual return of 12.02%.
If you are looking for income generating ideas, look beyond traditional bond investments and focus on your equity holdings.
It is better to have a permanent income than to be fascinating. Oscar Wilde.
Bill Parrott is the President and CEO of Parrott Wealth Management, LLC. www.parrottwealth.com.
Source: Morningstar Hypothetical. The average annual return for the Vanguard S&P 500 index fund averaged 12.02% in this hypothetical.