Harold Evensky CFP® , AIF® Chairman
Charlie Jacobs (CJ): Hello, Harold. May I call you Harold?
Harold Evensky: I guess it depends. Who are you and how did you end up in my office?
CJ: My name is Charlie Jacobs. I’m a wholesaler for the Special Income Portfolio.
HE: Charlie, I have to ask you this: how did you get past the receptionist? I don’t normally take cold meetings with mutual fund wholesalers or fund salespeople. I prefer to speak to them after I’ve done my own preliminary analysis.
CJ: Actually, I waited until your receptionist was distracted by another guest, and then I crawled along the floor until I reached the hallway and slipped past the doors of your other coworkers as soon as they turned their heads away from the door.
HE: That’s quite remarkable. All right, Ninja wholesaler, now that you’re here, have a seat. What can I do for you?
CJ: I’m here to convince you to recommend the Special Income Portfolio to all of your clients. I even brought some golf balls as a nice gift to get the conversation started.
HE: You can keep the golf balls. Just tell me the facts about your fund. This could turn into a very quick visit.
CJ: It’s an income fund. Some of your clients are retired, aren’t they?
HE: Yes, they are.
CJ: And they need income from their investments to supplement their pension and Social Security to support their lifestyle. By the way, if you don’t play golf, I brought candy. Or maybe you’re interested in one of these cute little jump drives with our company’s logo on it.
HE: My retired clients need cash flow from their investments to supplement their other income sources, and I don’t want or need candy or one of those jump drives.
CJ: Well, the Special Income Portfolio is carefully designed to give your clients exactly what they need in the form of dividends and interest. It’s invested in companies that pay high dividends and bonds that pay high income. I have a little form you can fill out so you can start moving your clients’ assets over right away—
HE: Hold on a minute. You just hit one of my hot buttons. Maybe you should sit back and relax. This could take longer than either of us expected.
CJ: What do you mean?
HE: I have to confess that I’ve got a lot of pet peeves about the kind of nonsense that gets foisted on the public as good investment advice. But one of my biggest is what I call the myth of dividends and interest.
CJ: I can assure you that our portfolio manager doesn’t invest in myths.
HE: What you’re saying probably sounds plausible to 99 percent of the investing public. Of course, many investors need cash flow from their portfolio. So you put the words income fund in the name of a mutual fund, and it sounds exactly like what people need.
CJ: It is what people need.
HE: I disagree. We plan for a lot more than a fixed income. We plan for a consistent real income.
CJ: I’m not sure I follow you.
HE: I’ll make it easy. Does the carton of milk you bought last week, your last doctor’s visit, or your last new car cost more than it did five, ten, or fifteen years ago?
CJ: Of course.
HE: And do you think all those things and everything else will cost more in the next twenty to thirty years?
CJ: Probably lots more.
HE: Today’s dollar isn’t what it used to be and tomorrow it won’t be worth what it is today. Do you agree? Don’t you think you and I and everyone else will need more of those greenbacks in the future just to hold our own?
CJ: Yes, I suppose we will.
HE: How long have you been doing this work as a wholesaler?
CJ: Oh, I have weeks of experience. I know my way around, let me assure you.
HE: Somewhere in your sales training, you heard that professionals use the term real dollars to mean an amount of money that will buy the same goods and services (milk, doctor’s visits, and cars) in the future as it will today. A real dollar means the same purchasing power going forward.
CJ: I think I have that somewhere in my notes, yes. But I think you’re missing the point. When someone retires, he or she needs a fixed income.
HE: What horsepucky!
CJ: Excuse me?
HE: Dangerous advice like that really infuriates me. If people plan a retirement based on a fixed income, they had better be planning on changing their diet from steaks to cat food throughout the balance of their lifetime. What retirees need is an income that will increase every year by the inflation rate. Other than winning the lottery, that’s the only way people can maintain their standard of living.
CJ: We also have a lottery fund that invests in a diversified portfolio of state lottery tickets that I could show you—
HE: Let’s go back to deciding what kind of investments my clients need to make in order to supplement their pension and Social Security income. Suppose they buy into this myth you’re selling and construct an “income” portfolio.
CJ: Great idea! That’s exactly the fund I want to talk to you about.
HE: Now they have a portfolio bond/stock allocation that is largely fixed by design—inappropriate design. In almost all cases, it will cause an inferior portfolio for two reasons: Not only will the portfolio not allow them to accomplish their goals in real dollars, but it will also be inefficient.
CJ: Okay, I understand that you have objections.
HE: What do you mean?
CJ: The sales training said that I should overcome your objections, and the first step is to get your objections out in the open. So tell me your objections.
HE: With pleasure. In fact, I’ll draw you a picture. Here’s an example I use when discussing this issue with my clients. Consider a simple world in which you have only three investment choices—a money market, Bond Fund A, and Stock Fund B. In this world, the investments will provide exactly the returns I’m writing down in this simple table:
Does that look right?
CJ: It could be.
HE: Now suppose you’ve saved $200,000 for retirement and you need $14,000 a year from your savings to add to your Social Security and pension income. If you planned to get your needed $14,000 cash flow from dividends and interest, you would have to invest 100 percent in the Bond Fund. The reason is because, as you can see from this table I’m now drawing, the cash flow from Stock Fund B’s dividend payments is so low, any amount invested in stocks would drop your cash flow to an amount less than the $14,000 you need.
Bond A Cash Flow Stock B Cash Flow
Allocation from Bond Allocation from Stock Total Cash Flow
90 percent $12,600 10 percent $ 600 $13,200
50 percent $7,000 50 percent $3,000 $10,000
40 percent $5,600 60 percent $3,600 $9,200
CJ: Doesn’t that make my point?
HE: No. Because if you look at the future, then the purchasing power of that $14,000 starts to decline. Let’s say you’re retired, and I recommend the all Bond Fund. You might feel good today receiving the $14,000 you need; however, how would you feel ten years later if inflation had been 3 percent and your $14,000 only bought $10,417 worth of stuff?
CJ: I’d be calling my attorney to see if I had grounds for a lawsuit against you.
HE: And what happens twenty years later, when your diet has switched from steak to cat food, because that’s all you can afford?
CJ: I don’t like where this is going.
HE: I don’t want to give my clients fixed income when they need real income from a long-term portfolio that has an allocation to investments that are likely to rise in value and provide protection against inflation. In other words, I don’t want to guarantee that my clients will suffer losses in real-dollar terms. And that’s what you’re offering me.
CJ: Is that your objection?
HE: My objection is that investors do not need dividends or interest—they need real cash flow. So they shouldn’t fall for this myth that you’re selling about dividends and interest. Now you can feel free to overcome my objections, if you want. And please put those golf balls away.
CJ: Actually, I was wondering if I should move my money out of the fund.
HE: If you’re planning to live more than a couple of years, you might think about it.
CJ: Thanks, Harold. Thanks for the advice. Are you sure you don’t want one of these jump drives?
This blog is a chapter from Harold Evensky’s “Hello Harold: A Veteran Financial Advisor Shares Stories to Help Make You Be a Better Investor”. Available for purchase on Amazon.
Evensky & Katz / Foldes Financial 