September Rally Continues into October; Have Re-entered the Market for Capital Gains

1. Summary

The market has been generally rising since the beginning of September. The rally has pulled the Timing Outlook to a strongly positive reading of 8.0, up from 6.0 last time.

For over four months, the S&P 500 had stayed stuck in a trading range of 1,040 to 1,130, essentially going sideways. The index finally passed through and stayed above 1130 on September 20, and it has stayed above that level ever since, slowly drifting upward in fits and starts. (See the chart below. Click on it to enlarge it.)

As frequent readers know, I require not only a positive Timing Outlook but also the satisfaction of a separate set of criteria to invest money in my Capital Gains Portfolio. The additional criteria, again, are:
• 9% rise over two weeks, with at least 7/10 days positive
• 3% rise over 3 weeks, with at least 10/15 days positive
• 4% rise over 4 weeks, with at least 14/20 days positive
• 5% rise over 5 weeks, with at least 17/25 days positive
• Etc.

The criteria were finally met on September 14, and I invested 10% of the portfolio’s funds on that day and another 10% a week later. There have been enough “down” days sprinkled in since then, however, to keep me from investing any more. This has cost me some gains as 80% of the portfolio sits in cash, but I will continue to require the additional margin of safety that the second criteria provide. Long term, that discipline has served me well.

Because I am hard at work on 2011’s edition of The Top 40 Dividend Stocks, I do not have up-to-date Easy-Rate™ sheets for capital-gains stocks. Therefore, for re-entering the market, I have purchased shares of SPY, one of the ETFs that tracks the S&P 500. I am following the market at the end of each day, and if the second set of criteria are satisfied, I will make another purchase.

The market’s action for the past three months is shown on the chart. It shows that the S&P 500 has risen about 11% since the beginning of September. It also shows the number of “down” days (red candlesticks) that frustrate the second criteria, even though the overall direction has been upwards.

My Dividend Portfolio remains 100% invested after the changes described last time. By the way, I have begun to work on the 2011 edition of The Top 40 Dividend Stocks. I will keep you up to date on its progress. I hope to release it in January.

2. Market Performance Since Last Outlook
(“now” figures are as of mid-morning, Monday, October 11, 2010)

Last Outlook (9/13/10): 6.0 (positive)
S&P 500 last time (9/13/10): 1122
S&P 500 now: 1167 Change: +4%

S&P 500 at beginning of 2010: 1115
S&P 500 now: 1167 Change in 2010: +5%

S&P 500 at close 3/9/09 (beginning of bull market): 677
S&P 500 now: 1167 Change since 3/9/09: +72%

3. Indicators in Detail

• Conference Board Index of Leading Economic Indicators: The most recent report (September 23) showed an increase in this index, the second in a row. I require three straight monthly increases or decreases to label this as positive or negative, so this indicator remains neutral. +5

• Fed Funds Rate: No change. With the Federal Funds rate near zero, this indicator remains positive. +10

• S&P 500 Market Valuation (P/E): Morningstar pegs the current P/E of the S&P 500 at 14.7, up from 13.7 last time, but still well within positive territory at any value below 17.4. +10

• Morningstar’s Market Valuation Graph. Morningstar’s proprietary market valuation graph is at 1.00, up from 0.96 last time and suggesting that the market is exactly at “fair value” right now. For our purposes, that means neutral. +5

• S&P 500 Short Term Technical Trend: This short-term technical indicator uses the two shorter simple moving averages (SMAs) of the S&P 500. The configuration (see the chart) is Index > 20-day > 50-day. That suggests rally mode, with the index “pulling up” the shorter SMA, which in turn is “pulling up” the longer SMA. Positive. +10

• S&P 500 Medium Term Technical Trend: The mid-term indicator remains ambiguous, as the 200-day SMA is still higher than the 50-day SMA. If (when) the 50-day crosses through and above the 200-day, that will be known as a “golden cross,’ which many consider to be one of the strongest technical indicators. Until then (if it happens), this indicator remains neutral. +5

• DJIA Short Term Technical Trend: This chart looks similar to the S&P 500 chart. Positive. +10

• DJIA Medium Term Technical Trend: On the Dow, the “golden cross” took place a few days ago. Positive. +10

• NASDAQ Short Term Technical Trend: The NASDAQ’s chart has the same configuration as the S&P’s for both trends. Positive. +10

• NASDAQ Medium Term Technical Trend: Neutral. +5

TOTAL POINTS: 80
NEW READING: 80 / 10 = 8.0 = POSITIVE

September Rally Pulls Timing Outlook Back To Positive, But Still Not Re-Entering Market

1. Summary

An early September rally has pulled the Timing Outlook back into positive territory, up to 6.0 this time from a negative 4.5 last time.

For over four months, the S&P 500 has been stuck in a trading range of 1040 to 1130. The Timing Outlook has not performed well during this period, as the market’s drifts up and down have been timed nearly perfectly to repeatedly reverse the Timing Outlook, which I re-compute about every other week. So the Timing Outlook has been out of phase with the market’s short-term “trends.” There has been no long-term trend up or down; it has been sideways.

While the short drifts up and down have been long enough to keep the Timing Outlook off balance, they have been too short to pass my other criteria for being invested in stocks, so my Capital Gains Portfolio has been 100% cash since early May. The additional criteria, again, are:

• 9% rise over two weeks, with at least 7/10 days positive
• 3% rise over 3 weeks, with at least 10/15 days positive
• 4% rise over 4 weeks, with at least 14/20 days positive
• 5% rise over 5 weeks, with at least 17/25 days positive
• Etc.

The criteria are close to being met. Check out the chart above (click on it to enlarge it). It shows that the S&P 500 has risen about 6% during the past 10 trading sessions, with 8 of the past 10 sessions being positive. If the market’s rally continues a few more days, the criteria go to the three-week line, requiring a 3% rise with 10 out of 15 days being positive. We’re almost there. But patience is the watch-word. Don’t plug in hope as a substitute for actual performance. Waiting for the right entry point can be tedious, but avoiding losses is as important to overall success in investing for capital appreciation as scoring gains.

My Dividend Portfolio remains 100% invested after the changes described last time. By the way, I have begun to work on the 2011 edition of The Top 40 Dividend Stocks. I will keep you up to date on its progress. I hope to release it in January.

2. Market Performance Since Last Outlook
(“now” figures are as mid-day, Monday, September 13, 2010)

Last Outlook (8/25/10): 4.5 (negative)
S&P 500 last time (8/25/10): 1048
S&P 500 now: 1122 Change: +7%

S&P 500 at beginning of 2010: 1115
S&P 500 now: 1122 Change in 2010: +1%

S&P 500 at close 3/9/09 (beginning of bull market): 677
S&P 500 now: 1122 Change since 3/9/09: +66%

3. Indicators in Detail

• Conference Board Index of Leading Economic Indicators: No new report since last time. This index has been gyrating the past few months, rendering it ambiguous for our purposes. I require three straight monthly increases or decreases to label this as positive or negative. Indicator remains neutral. +5

• Fed Funds Rate: No change. With the Federal Funds rate near zero, this indicator remains positive. +10

• S&P 500 Market Valuation (P/E): Morningstar pegs the current P/E of the S&P 500 at 13.7, down from 15.2 last time. This indicator is in positive territory at any value below 17.4. +10

• Morningstar’s Market Valuation Graph: Morningstar’s proprietary market valuation graph is at 0.96, up from 0.91 last time. It is still in the neutral range, which is any value between 0.90 and 1.10. +5

• S&P 500 Short Term Technical Trend: This short-term technical indicator uses the two shorter simple moving averages (SMAs) of the S&P 500. The configuration (see the blue and green lines on the chart) is Index > 50-day > 20-day. That is ambiguous, reflecting the back-and-forth nature of the market over the past several months. Neutral. +5

• S&P 500 Medium Term Technical Trend: The mid-term indicator uses the two longer SMAs (50-day and 200-day, the blue and red lines on the chart). The lineup is Index > 200-day > 50-day. The recent 2-week rally has flipped this from last time, moving the indicator from negative to neutral. +5

• DJIA Short Term Technical Trend: This chart looks similar to the S&P 500 chart. Neutral. +5

• DJIA Medium Term Technical Trend: Same as the S&P 500. Neutral. +5

• NASDAQ Short Term Technical Trend: The NASDAQ’s chart has the same configuration as the other two. Neutral. +5

• NASDAQ Medium Term Technical Trend: Same as the other two. Neutral. +5

TOTAL POINTS: 60
NEW READING: 60 / 10 = 6.0 = POSITIVE

Buffett May Not Pay Dividends, But He Sure Likes Them

Berkshire Hathaway (BRK), aka Warren Buffett, has paid only one dividend since Buffett gained control. In 1967, Berkshire paid a dividend of 10 cents on its shares. It’s never happened again. Buffett has said he "must have been in the bathroom when the dividend was declared.”

Berkshire Hathaway is famous for not paying dividends despite having billions of dollars in cash. The company has many critics who believe that the company should “reward” or “return money to” shareholders. I am not one of those critics. I believe that Bershire/Buffett has proved itself to be perhaps the best allocator of capital on the planet, and I do not question that they can allocate their capital as well as or better than I could if they gave me some of it. I love dividends, but I don’t think Berkshire should pay a dividend.

Berkshire, while known mainly as an insurance company, is actually a conglomerate. It has a dizzying array of wholly owned companies in businesses as diverse as railroads, carpeting, candy, furniture, and jewelry. It also owns huge stakes in several public companies. It is the latter that I want to focus on, because Berkshire/Buffett has shown a great liking for companies that pay dividends.
Berkshire’s stock holdings are published quarterly. For the most recent quarter (ending June 30), here are its largest holdings, the percent of Berkshire’s stock portfolio represented by that holding, and the stock’s projected yield based on current payout. All information is from Morningstar.

• Coca-Cola (KO), 22%, yield = 3.2%
• Wells Fargo (WFC), 18%, yield = 0.9%
• American Express (AXP), 13%, yield = 1.8%
• Procter & Gamble (PG), 10%, yield = 3.3%
• Kraft (KFT), 6%, yield = 3.9%
• Johnson & Johnson (JNJ), 5%, yield = 3.8%
• Wal-Mart (WMT), 4%, yield = 2.4%
• Wesco Financial (WSC), 4%, yield = 0.5%
• U. S. Bancorp (USB), 3%, yield = 1.0%
• ConocoPhillips (COP), 3%, yield = 4.2%

These top 10 holdings account for 88% of all of Berkshire’s stock holdings—a very concentrated portfolio, especially considering its size. Overall, the company owns more than $46 billion in stocks, spread out over 37 different positions. (These figures do not include foreign investments held abroad.)

In Q2, Berkshire purchased about 17 million shares of Johnson & Johnson, adding to the 24 million it already owned. The total spent was about $1 billion, or about $58 per share. This was the biggest increase in any holding in Berkshire’s portfolio, raising its stake by 70%. What’s that worth in dividends? In June, J&J raised its dividend from $0.49 per share per quarter to $0.54, or $2.16 per year. A year’s worth of dividends at that rate for 24 million shares is $51,840,000. Actually, Berkshire will get more than that in the next 12 months, because J&J will raise its dividend again next June, as it has for 48 straight years.

In fact, 5 of those 10 companies are Dividend Champions—companies that have increased their payouts for 25 years or more consecutively: Procter & Gamble (54 years), Coca-Cola (48), J&J (48), Wesco (38), and Wal-Mart (36). ConocoPhillips has a 10-year streak going. In Q2, the second-largest increase in shares held by Berkshire was in Becton Dickinson (BDX), in which Berkshire increased its position by 8%. Becton Dickinson is a Dividend Champion with a 37-year streak.

Charlie Munger, Buffett’s sidekick at Berkshire, has been quoted as saying, “Investing is where you find a few great companies and then sit on your ass." While dividend-raising companies require attention just as any stock holdings do, it is clear that Berkshire/Buffett have found several great companies with a common characteristic—they pay consistently rising dividends. They have helped make Buffett the richest investor in the world.

Portfolio Forensics

From time to time, one runs across pointless arguments about whether buy-and-hold is dead. Most long-term stock holders know that buy-and-hold really means buy-and-monitor, or buy-and-homework, or some similar phrase that indicates that reasons can arise to sell a long-term holding. The days of the dying grandfather telling his family “Never sell the AT&T” are long gone. While the ideal might be to hold each stock “forever,” life happens, and in doing so it can create reasons to sell any stock.

How do you decide? I advocate periodic Portfolio Reviews. In my Dividend Portfolio, which is devoted to dividend growth stocks and does not require real close attention, I aim to conduct a review twice per year. The point is to impose upon yourself the discipline to really examine your stock portfolio periodically, apply standards designed to reveal whether each stock still deserves a place in your portfolio, and take action on what you find out.

In my Dividend Portfolio, normally the presumption is that each dividend stock will not be sold. But that presumption can be overcome. During a Portfolio Review, the burden shifts to the company to prove why it should be kept. Here are some of the questions I ask:

• What is its yield on cost (YOC)? I don’t penalize a dividend growth stock solely because its current yield may have dropped below qualifying levels. That may be only because the stock’s price has jumped way up. If I purchased it years ago, and I am still satisfied with how it is growing its dividend, the reliability of the dividend, etc., I normally would keep it. It is doing its job. By the way, the formula for YOC is: Yield on Cost = (Current Yield x Current Price) / Acquisition Price. An equivalent formula is Last 12 Months’ Dividends / Acquisition Price.

• Should some profits be taken? If the company’s price has skyrocketed, that may present an opportunity to cash out some or all of it and purchase another stock selling at a better price and offering a higher yield. The goal would be to have the total dividend stream increase after the transactions are completed. Notice that if you have held a stock a long time, its current yield may be low but its YOC may be quite high, difficult to match with a new purchase.

• Is the safety of its dividend in question? As soon as BP’s oil rig blew up, the safety of its dividend became perilous for anyone who thought about it. In a Portfolio Review, update your information on each company and give serious thought to the ongoing reliability of its dividend.

• Is there a chance to improve your portfolio by making a stock swap? There are various ways to improve your portfolio, such as increasing its total yield, increasing the rate of dividend growth, diversifying it, and so on. As to increasing yield, note the discussion above (second bullet) about making sure that the initial yield on a new purchase would exceed the YOC of the stock you would sell. If it wouldn’t, it’s hard to justify the swap. A higher expected rate of increase may tip the scales.

• Did the company cut or freeze its dividend? If so, it is subject to immediate examination. You will probably decide to sell most stocks that cut or freeze their dividend. The main goal of my Dividend Portfolio is to deliver an ever-increasing dividend stream, so obviously a cut or freeze hurts that goal. Also, a cut or freeze often portends a price drop. Confident management teams adhere to established dividend-growth patterns. A company that cuts or freezes its dividend is conserving cash for some reason. Find out why. The company may be in difficulty, and its price may be in for a drop too. Selling early usually brings in the most money you will be able to get for that stock for a long time to come.

• Has the company’s current yield risen above 10 percent? If so, it is subject to immediate review, but this is not an automatic reason to sell. An extremely high yield is usually the result of an extremely low price. Find out why the market has devalued the stock. It may be a clue that the company is having major problems, and upon examination you may discover that the dividend itself is in peril. This may be dividends’ equivalent of a “dead-cat bounce” in price.

• Has the rate of growth of the dividend taken a turn for the worse? Can you figure out why? Many dividend investors regard dividend growth as a key indicator of future prospects, because it reflects management’s view of and confidence in the next few years, often based upon information available to them but not to you.

Let’s look at some examples. Here is how these principles played out for six stocks in a recent Portfolio Review of my Dividend Portfolio.

Abbott Labs (ABT): I own two slugs, purchased in 2008 and 2009. Their yields on cost are 3.2% and 3.7%, respectively. Abbott increased its dividend 10% this year. The stock is working fine. Decision: Hold

Alliant Energy (LNT): Initiated position early in 2010, and it has worked out well. The stock has a 9% price increase and a 4.9% YOC after a 5% dividend hike this year. Decision: Hold.

Diageo (DEO): I bought this in 2008. Diageo is a foreign stock (Britain), and like many foreign stocks, it does not adhere to a predictable dividend-raising schedule. It makes two payments per year, and the first payment is typically less than the second payment, making the total year’s dividend impossible to predict. In its native currency, Diageo has been a steady dividend raiser, but with varying exchange rates, that has sometimes translated into fewer $US, as if it had cut its dividend. Too many headaches to keep track of, despite the company’s strengths. My position was small, and I had a 14% long-term price gain on the stock. Decision: Sell and put the money to work elsewhere.

Emerson Electric (EMR): Also purchased in 2008, EMR has disappointed lately with small dividend increases, just 2% in 2010. Its 2.7% yield on cost (YOC) was pulling the portfolio’s YOC down. Last year, I put it on sort of probation, sticking a 10% trailing sell-stop under it. It survived by steadily moving up in price from what had been a significant capital loss. After nearly hitting the breakeven point, its price began to weaken again. The lousy dividend increase motivated me to put a tighter stop under it (5%), which it hit a couple of weeks later. Decision: Put tight stop under it; the stop was hit, so stock sold.

McDonalds (MCD): Purchased in 2008 and again in 2009. YOC is 3.7% and 4.1% respectively. Blended price increase is more than 20%. Raised its dividend 26% in 2009; awaiting 2010’s increase (which typically comes with the final payment of the year). What’s not to like? Decision: Hold.

Royal Bank of Canada (RY): Purchased in 2008, the stock survived the financial crisis and is a solid, stable bank. But it has not increased its dividend since 2008. I decided to put this small position’s money to work elsewhere. Decision: Sell.

The Dividend Portfolio contained 12 stocks when I did the Portfolio Review. The 3 sells mentioned above are a little misleading, because I wanted to show examples of reasons to sell. Those were the only 3 sales resulting from this review. The other 9 stocks were held. In dollar terms, there is typically less than 10% turnover per year in this portfolio. Sometimes there is none.

A good practice is to keep a Shopping List ready—stocks that will help improve your portfolio in some way and that meet all your criteria for buying a stock. For my Dividend Portfolio, I use my e-book, The Top 40 Dividend Stocks for 2010, as my Shopping List. I make sure to update the information, especially any target’s yield and valuation, before making any purchase. With the proceeds from the 2 immediate sales, I increased my stake in Alliant Energy. At a current yield of 4.5%, that gave a nice boost to the portfolio’s overall YOC (which was 4.1%). When Emerson Electric hit its sell-stop, I used those proceeds to initiate a position in Johnson & Johnson (JNJ), whose price seems depressed, at a 3.6% initial yield. I was pleased to see that Warrren Buffett—through Berkshire Hathaway (BRK)—had made JNJ his single largest stock purchase in Q2, adding 17 million shares to the 24 million he already owned, spending about $1 billion on the purchase. I picked up 50 shares myself. What the hell. Always glad to be in agreement with Mr. Buffett.

August's Market Swoon Pulls Timing Outlook Back To Negative

1. Summary

After the stock market’s rally in July, which pulled the Timing Outlook up into positive territory, August has seen a nearly equal but opposite slide. Today’s Timing Outlook is negative at 4.5, significantly down from 7.5 last time. Today’s S&P 500 value (at mid-day) of about 1048, is a value that has been crossed through several times in the last few months as the market see-saws up and down. In other words, the market has overall been sideways for three months, but with significant volatility that has looked like trend-starts, but turned out to be false hopes.

This kind of yo-yo action causes the Timing Outlook to jump around too. The last five readings, including today’s, have been Negative-Positive-Negative-Negative-Positive-Negative. Short-term (2-3 week) market reversals are the worst conditions for discerning an investable trend. The Timing Outlook is least useful under these conditions, as swings to-and-fro with the market.

My Capital Appreciation Portfolio has remained 100% in cash since early May. That means that it has gained nothing, but in so doing it has outperformed the S&P 500, which has an overall loss since that time. In the last report, the July rally led me to review the criteria for re-entering the market.

• 9% rise over two weeks, with at least 7/10 days positive
• 3% rise over 3 weeks, with at least 10/15 days positive
• 4% rise over 4 weeks, with at least 14/20 days positive
• Etc.

The market’s August drop has put these criteria out of reach again, at least for a while. It is hard to see the catalyst that would trigger a sustained rally. Q2 earnings came in strong: 66% of companies in the S&P 500 beat earnings estimates, and 63% beat revenue estimates. But that good news has been offset by poor economic news. Corporations are doing well, but individuals are not. It seems that every day, some negative report is issued about housing, manufacturing, unemployment, a “jobless recovery,” troubles in Europe, the possibility of a double-dip recession, or the possibility that we’ve never actually exited the Great Recession. Ben Bernanke stated recently that the economy is displaying “unusual uncertainty.” Traditionally, markets hate uncertainty.

My Dividend Portfolio is 100% invested, but I made some changes this month. I completed a Portfolio Review, which led me to sell three stocks (Diageo, Emerson Electric, and Royal Bank of Canada) and replace them with two others (added to position in Alliant Energy and initiated position in Johnson & Johnson). These are the first changes to the portfolio in a year. Hopefully they will strengthen the portfolio for its key objective: To generate ever-increasing income streams. The holdings in the Dividend Portfolio are not protected by sell stops. Risk management is accomplished by means of the Portfolio Reviews.

2. Market Performance Since Last Outlook
(“now” figures are as mid-day, Wednesday, August 25, 2010)

Last Outlook (8/5/10): 7.5 (positive)

S&P 500 last time (8/5/10): 1126
S&P 500 now: 1048 Change: -7%

S&P 500 at beginning of 2010: 1115
S&P 500 now: 1048 Change in 2010: -6%

S&P 500 at close 3/9/09 (beginning of bull market): 677
S&P 500 now: 1048 Change since 3/9/09: +55%

3. Indicators in Detail

• Conference Board Index of Leading Economic Indicators: The most recent report last week showed a tiny increase in this index. The index has been gyrating the past few months (displaying “unusual uncertainty” too, I guess), rendering it ambiguous. I require three straight monthly increases or decreases to label this as positive or negative. Indicator remains neutral. +5

• Fed Funds Rate: No change. The Fed continues to reinforce the idea that rates will not be raised anytime soon. In a nutshell, they seem to see “unusual uncertainty” in the economic recovery combined with little possibility for inflation in the next few months. With the Federal Funds rate near zero, this indicator remains positive. +10

• S&P 500 Market Valuation (P/E): Morningstar pegs the current P/E of the S&P 500 at 15.2, same as last time. This indicator stays in positive territory at any value below 17.4. +10

• Morningstar’s Market Valuation Graph. Morningstar’s proprietary market valuation graph is at 0.91, down significantly from 0.98 last time and close to the 0.90 level that would move this indicator into positive territory. For now, the indicator remains in the neutral range, which is any value between 0.90 and 1.10. +5

• S&P 500 Short Term Technical Trend: This short-term technical indicator uses the two shorter simple moving averages (SMAs). The configuration is 20-day > 50-day > Index. That is ambiguous, reflecting the yo-yoing in the market. Neutral. +5

• S&P 500 Medium Term Technical Trend: The mid-term indicator uses the two longer SMAs (50-day and 200-day). The lineup is 200-day > 50-day > Index. This is exactly the opposite of an uptrend. Negative. +0

• DJIA Short Term Technical Trend: This chart looks similar to the S&P 500 chart. Neutral. +5

• DJIA Medium Term Technical Trend: Same as the S&P 500. Negative. +0

• NASDAQ Short Term Technical Trend: The NASDAQ’s chart has the same configuration as the other two. Neutral. +5

• NASDAQ Medium Term Technical Trend: Same as the other two. Negative. +0

TOTAL POINTS: 45
NEW READING: 45 / 10 = 4.5 = NEGATIVE

Financing Retirement V: The Cistern Model

This is the final article in my series on retirement.

Essentially all strategies for financing retirement—even those as philosophically opposed as maximizing capital vs. maximizing income rights—use the same “plumbing.” I like to think of it in terms of cisterns, with pipes running in and out, and leaks. The idea comes from those old algebra questions where A could fill his cistern at a certain rate, B’s cistern filled more slowly and also had a leak in it, and poor C’s cistern was a veritable symphony of problems. As a 12-year-old, you had to create formulas to figure out how long the water in each cistern would last. See Stephen Leacock’s hilarious short story, “A, B, and C—The Human Element in Mathematics.” (For younger readers: A cistern is a big barrel to collect rainwater.)

Here’s the analogy: Your retirement assets are in the cistern. There are two goals:

          · The cistern must fund your retirement adequately.
          · The cistern must never go empty. In fact, it must never get even close enough to empty that you worry about it or lose sleep over the possibility. You want a nice, abundant cistern that inspires confidence.

There is continual change in your cistern. It is not a static thing, which is why I prefer this analogy to the more common “nest egg.” The cistern’s contents expand and contract throughout your life, both before you retire (the so-called accumulation years) and after you retire (the decumulation years).

What goes into your cistern? Mostly assets that you decide to put in there. Some inflows to your retirement cistern begin early in life, while others come along later. Typical inflows include savings, 401(k) contributions, dividends, royalties, Social Security, pensions, interest, inheritances, etc.

Note that I count as inflows some items (such as Social Security) that a retiree may just spend directly. I will explain why I do this in a minute. Note also that, with the exception of old-fashioned pensions and Social Security, inflows require a positive decision on your part. You must decide to put assets into your cistern (or not).

Besides expanding from the contributions that you make into your cistern, the level in your cistern also goes up when you experience increases in the market value of assets already there. Examples of assets that may enjoy value expansion include:

          · Stocks, ETFs, mutual funds, and the like
          · Your house
          · Increasing dividends from companies that raise dividends regularly
          · A small business you may own

What about declines? It is important to note that declines in the level of the assets in your retirement cistern take place not only after retirement via actual withdrawals, but earlier in life as well. Some people “raid” their cistern prior to retirement to cope with emergencies or to make large purchases. Taking out a home equity loan to buy a boat, for example, decreases the level of your cistern in two ways: First, the value of the loan lowers your equity in your home and thus decreases its value in your cistern. Second, the additional debt creates interest obligations that reduce the amount you can put into your cistern for some time into the future.

The level in your cistern also goes down if the value of the assets in it declines. Significant declines in the value of your stocks or your home obviously can have a major impact on the level in your cistern. During the recent financial crisis, some people have been forced to delay long-planned retirements, because the levels in their cisterns went down so far that the two major goals—seemingly within their grasp—suddenly were moved out of reach.

And everybody’s cistern has a leak: Inflation. That is a continuing outflow, sometimes rapid, sometimes slow, that insidiously reduces the value of the contents of your cistern. Only if we go into a period of deflation would the value-of-money dynamic actually cause the value of what’s in your cistern to expand. It would become like an inflow rather than a leak.

I said that I would explain why I count as inflows monies that go directly to spending, such as Social Security payments. The reason is that if we visualize that everything runs through the cistern, even if only briefly, it puts all assets on an equal footing for analysis. The value of income rights can be directly compared to the value of capital, for example.

Viewed this way, everyone makes withdrawals from their cisterns. Thus, someone who spends his Social Security check upon arrival must acknowledge that if he did not spend all of it, he could deposit the balance in his cistern for a future day. And the debate between income-maximizing strategies and capital-maximizing strategies can be seen for what it really is, which is an assessment of two strategies, both of whose goals are the goals stated at the beginning of this article. In both cases, the retirees are betting that their strategy will both provide sufficiently for retirement and that their cistern will never run dry.

Say someone maximizes income during their accumulation years by loading up on dividend-paying stocks, then lives off the income in retirement. We can picture the dividends as flowing into the cistern through a dividend pipe, but flowing right back out through a dividend-withdrawal pipe. Such a person might say that she is not making “withdrawals” if they just take the dividends directly, but she really is, because if not taken immediately as cash, the money would flow into the cistern. The same reasoning applies to pension or Social Security income. You may take it directly, but it is helpful to view it as flowing into and out of the cistern. It provides a better picture of the dynamics of retirement funding.

Similarly, someone who loads up on growth stocks during their accumulation years, then converts those assets into income by selling portions to fund retirement, is clearly making withdrawals. The “bet” is whether the unsold assets remaining in the cistern will simultaneously expand enough to make up for the assets sold. Similar reasoning applies to someone who buys an annuity: She makes a big withdrawal to buy the annuity, but the annuity itself then creates an inflow of income that lasts the rest of her life. The “bet” is whether the income will eventually exceed what it cost to purchase the annuity.

So the cistern analogy is strategy-neutral. I believe that viewing retirement funding in this way allows for more reasoned comparisons of strategies. It’s no secret that I believe in the efficacy of accumulating assets that bear rights to receive increasing dividends, and that I think that it is a superior retirement strategy to relying principally on accumulating assets that hopefully will expand in value via increasing prices to offset withdrawals. But I do not kid myself that when I spend those incoming dividends or Social Security checks, I am not really draining a little bit out of my cistern each time too.