My F&M

Are You a Chicken Farmer or an Egg Farmer?

Share This Article

The following article is an update of an article that first ran in our Review & Outlook about 4 years ago. But we think this is a very timely subject and worth another read.

Many years ago I read a financial planning article that posed the question: Are you a chicken farmer or an egg farmer? The theme of the article stuck with me like dried yoke on a plate. Chicken farmers really care about the price of chickens – obviously the higher the better. Egg farmers on the other hand, don’t care about the price of chickens, but focus on how many eggs they lay. As an investor desiring a cash flow to meet a stated goal, do you care about the day-to-day value of the portfolio or its ability to sustain cash flow to last your lifetime?

There is no shortage of worksheets with complex formulas and web based calculators to try and answer the question “will your money last your lifetime”? Of course, this question is essentially unanswerable because a very crucial variable – the length of your lifetime - is unknown. But that doesn’t mean it’s not worth pondering. We at Foster & Motley spend a considerable amount of time and energy doing just that – more than pondering actually. We attempt to build detailed scenarios and projections that can help our clients make critical decisions concerning their level of “financial independence” as we call it.

But the purpose of this brief article is to step back from the complex calculations and scenarios and look at the issue more broadly. Virtually everybody would say one of their key financial goals is to “retire comfortably”. Now, that can mean many things to many different people, but essentially it means that you would like to have a regular cash flow (monthly would be nice) to meet your living needs for the rest of your life. I suspect that for most of us, if we had some sort of guaranteed lifetime pension at retirement that adjusted with inflation we’d be quite pleased. No worrying about the stock market, credit crunches or global recessions. Just a steady check every month that will meet your living needs. Nice. Alas, for most of us that “pension” is mythical.

But I believe that tackling the problem – funding your retirement – with the pension analogy is instructive and beneficial to your long term financial well being. Your goal in retirement planning should be to create a pot of money large enough to meet the anticipated liability – the cash outflow to you over the years. You are simply trying to match an asset (your retirement savings pot) with a liability (your needed withdrawals). That is what large pension systems do. Their actuaries crunch all sorts of numbers to determine if their asset will fund their liability – if not, they continue to make contributions.

It’s human nature to get caught up in the size of the investment pot, and focus on the short term growth (or decline) of the pot’s value. While I don’t want to minimize the importance of investment returns, they are not as important as building a portfolio to support a cash flow. Let me give you a simple example.

You are 65 and your portfolio is 50% bonds and 50% equities. You have $1 million dollars. You need $50,000 per year to meet your living needs.

$500,000 bond portfolio yielding 4% = $20,000

$500,000 stock portfolio yielding 2% = $10,000

Total cash flow from dividend & interest = $30,000

There is a shortfall of $20,000 to meet your desired withdrawal. To meet that goal, and stay at the current $1,000,000 portfolio your stocks would need to grow by $20,000, or 4% (we are assuming that bonds will not experience real growth over the cash yield). 4% isn’t an unreasonable expectation for growth.

Ok – still with me? Now, let’s say stocks drop by 30%, so

what was worth $500,000 is now worth $350,000. But (and this is not a big stretch) the dividends are unchanged. Dividends are still $10,000 per year (now almost a 3% yield).

You still need to withdraw the $20,000 shortfall from principal, and hopefully that comes from the growth in the stock portfolio. Before the market drop the required growth on stocks was 4% - not unreasonable. What about now after a 30% drop in values? The new required growth rate is 5.7%. That is a significant jump up from 4% but it’s not a crazy number to expect either. A higher future expected return is a more logical expectation after a market drop than before.

That’s a lot of numbers and a long example, but the idea is to focus on the cash flow of the portfolio not the market value. Clearly this slightly altered view is important for retirees and others who are currently relying on their portfolio for withdrawals. But I believe it is very valid for younger folks who are accumulating assets as well. In summary, the point is to view investment accumulation and management as a tool to meet your unique goal. In retirement that goal should (generally) be a desired cash flow that will grow with inflation during your lifetime. Building and managing a portfolio with that goal in mind, as opposed to beating an arbitrary market index, will focus you on what really matters.

So, are you a chicken farmer or an egg farmer?