Alternatives to Buy and Hold for Income Investors

by: Scott's Investments

In previous articles, I have detailed some sample portfolios that can be used in conjunction with a tactical asset allocation moving average strategy. For many readers who are nearing or in the early stages of retirement, however, the sample portfolios may not reflect their risk tolerance or desired allocation. This article lays out one example of a dividend focused ETF portfolio with a 40% allocation to bonds. There are numerous other considerations and alternatives in constructing a retirement portfolio (taxes, cash allocation, CD laddering, tax-free investments, age, etc.), but for those looking for a sample of a income generating investment portfolio, the chart below can serve as a starting point. Combined with a moving average strategy presented by professionals such as Mebane Faber, Tom Lydon, and others, an investor with a lower risk tolerance can use a more conservation asset allocation model to further increase risk-adjusted returns.

As if market participants needed a further reminder about the limits of relying exclusively on diversification for risk management, summed up 2008 by reminding us that 'diversification works...until it doesn't'. Most retirees or near-retirees cannot afford to see a 40-50% reduction in the equity portion of their portfolio, which for many of these investors still accounts (or accounted) for 40-60% of their holdings. Due to the power of compounding, that 50% loss requires a 100% gain to make back lost money. Capital preservation is critical for investors who need to rely on their capital to generate a monthly paycheck. Given the choice between losing 40% in one year on an investment yielding 5% or allocating that money for a year to risk free cash yielding 1-2%, every investor would choose the latter.

What is a conservative, or any, investor to do? One option is to follow a tactical asset allocation model. If one had followed a simple tactical asset allocation model in 2008, the portion of one's portfolio slated for equities would have been transitioned to cash early in the year as the major indexes fell below most long term moving averages and thus precious capital would have been preserved. Yield is critical for retirees to generate income, but even more critical and that which one cannot lose sight in the search for income is the need to avoid substantial drawdowns in capital due to significant market fluctations. A tactical asset allocation model is designed to do just that – avoid the major declines of bear markets and catch the majority, albeit not the entirety, of a bull market.

A simple ETF portfolio with an income focus could look like following. If one was using the 200-day EMA to determine buy/sell signals and updating positions on a monthly basis, the positions highlighted in bold would be long positions. The allocations dedicated to the non-bold postions would be in cash. As you can see below, it would be a relatively boring portfolio today with only 4 long positions out of a possible 19. Then again, a portfolio constructed along a moving average strategy would have had a positive return for 2008.

For further research and links to other resources, please visit my previous articles here and here as well as those I have cited in my articles. Also, Mebane Faber has a new book available discussing this very strategy, I have not read it yet but I think it would be well worth your time to check it out.

*Claymore plans a momentum based commodities ETF according to As I've previously written, LSC (or RYMFX) was used as a suggestion for a portion of commodity allocation due to its low correlation to equity markets and commodity markets. The downfall with LSC, however, was that it was an ETN and thus there is an element of credit risk. For those worried about the credit risk of ETNs but were intrigued by LSC, the new Claymore ETF could serve as a viable alternative.

Disclosure: None.