The Ultimate Income Portfolio

Includes: AGG, CVY, HYG, LQD, VIG, VYM
by: Dale Roberts

What does it take to create the ultimate income portfolio? Well lots of income for starters. That juicy yield is not available in large doses these days. Yields from dividends, and even the typical large cap dividend champions, are a little on the slim side. The magic of dividend growth may need more time than many investors have on their side. Many investors are "stretching for yield". They may want to look in some traditional areas of income production.

In a recent series of articles I went in search of income growth and portfolio price protection. An investor can (somewhat have it all). In a series of three articles I examined the income streams of a combination of two dividend and dividend growth ETF stalwarts from Vanguard (NYSEARCA:VIG) and (NYSEARCA:VYM) combined in equal amounts with two bond ETFs (NYSEARCA:AGG) and (NYSEARCA:LQD). I first looked at that combination and how it would hold up in the draw down phase.

And then in this article here I examined that portfolio in the accumulation phase. The basic scenario is that we generally have increasing income from the dividend growth component as would be expected, and falling income from the bonds as also would be expected. Those falling rates have been great for bonds on the price side, but they're the proverbial downer when it comes to income on the bond front.

So why not direct that modestly juicy bond income toward the growing dividend stream? Why not go with what's working? Admittedly, dividends from companies that have a history of increasing their dividends over longer periods are a much better bet than income from bonds. A company's dividends are supported by their business success. Bond income is at the mercy of interest rates, government agency control and government manipulation of those rates.

In this article I looked at reinvesting all of the income from the equity ETFs and the bond ETFs back into VYM and VIG. As you can read in that article, it didn't take long for that switch to work its magic. The dividends are now driving that bus. And in fact, it's the income strategy that I employ in two of our self directed retirement accounts. I call that move the Cranky Maneuver.

But wait there's more. A true income investor looks for generous income. The broad based AGG and very decent LQD provided some nice portfolio price protection (in a balanced portfolio) and yield, but what happens when we go looking for even more yield, and use all of the weapons available? What if we bring out the big guns such as REITs and high yield bonds and preferred shares, MLPs and more? We can find them all in one neat basket.

For example there is the multi asset class ETF from Guggenheim - (NYSEARCA:CVY).

This from Guggenheim … The Fund, using a low cost "passive" or "indexing" investment approach, seeks to replicate, before fees and expenses, the performance of the Zacks Multi Asset Income Index. The Zacks Multi Asset Income Index is comprised of approximately 125 to 150 securities selected, based on investment and other criteria, from a universe of domestic and international companies. The universe of securities within the Index includes:

  • U.S.-listed common stocks
  • American depositary receipts ("ADRs") paying dividends
  • Real estate investment trusts ("REITs")
  • Master limited partnerships ("MLPs")
  • Closed-end funds
  • Canadian royalty trusts
  • Traditional preferred stocks

I then added a high yield component with the high yield bond fund from iShares (NYSEARCA:HYG). In the initial study I allocation $10,000 each to the four ETFs. In this case I did not want to overweight the high yield bonds, so on the non dividend front I allocation $14,000 to CVY and $6000 to HYG. HYG was launched in April of 2007, I used the average of the period to estimate the distribution for the first quarter.

The benefit of course is more cash driving the dividend growth. We know we have increasing dividends from our dividend growth companies and ETFs. It then comes down to what we want to put in that tank - regular unleaded or some high octane fuel?

Here's the income differential between CVY plus HYG (TOT CVY) vs. AGG and LQD (TOT BND).

Start Date of January of 2007

Income TOT CVY Yield TOT BND Yield
Totals 1152 5.7% 992 4.9%
Totals 1216 6.1% 987 4.9%
Totals 1078 5.4% 882 4.4%
Totals 960 4.8% 875 4.4%
Totals 1000 5.0% 805 4.0%
Totals 1248 6.2% 742 3.7%
Totals 1066 5.3% 656 3.3%
Grand 7720 5.5% avg 5939 4.2% avg

As we can see, there's more yield and more funds available each year to invest in the dividend ETFs. In fact over the several years there was 30% more total income to reinvest. And that spread is widening, in favour of team CVY/HYG. That high yield combo even had its best year on the income front in 2012.

So what happens when we now use this added income to drive the dividend growth? For this income obsessed exploration I also dumped VIG and reinvested the income exclusively into VYM - as VYM had a higher initial yield than VIG and it still delivers on dividend growth coming out of the recession.

Total CVY / HYG Income Reinvested to VYM.

Start Date of January of 2007

ETF Dividends CVY Total
TOT 07 566 1152 1718
TOT 08 687 1216 1903
TOT 09 591 1078 1669
TOT 10 595 960 1555
TOT 11 783 1000 1783
TOT 12 956 1248 2204
TOT 13 1170 1066 2236

And here's how that compared to the total bond income of AGG and LQD reinvested to Dividend ETFs.

Start Date of January of 2007

ETF Dividends Bonds Total
TOT 07 435 991 1426
TOT 08 501 969 1470
TOT 09 470 927 1290
TOT 10 511 883 1394
TOT 11 630 853 1483
TOT 12 794 743 1538
TOT 13 932 656 1588

That additional 30% income has translated into an increase of 40% more income available in 2013 (estimates). For the CVY HYG combination we now have total portfolio income growth rates of 12.9% CAGR from 2010 over 3 years and a 7.6% CAGR from 2009 over 4 years. We have a CAGR of 4.5% from inception, moving through the Great Recession.

The CAGR of the dividends from inception is 12.9%. The dividend growth rate of the last 4 years is now 18.6%.

If we extrapolate those recent dividend growth rates another 9 years, making it a 15 year venture, we would then have an estimated $4,100 of annual income from the dividends alone from that initial $20,000 investment. Dreaming? Who knows? If this strategy does work out I will certainly be updating you in 9 years, from my sailboat docked in the Greek Islands.

And now if you'll excuse me, I have a few thousand dollars of income that just came in courtesy of my multi asset class ETF and dividends. VYM, here they come.

Final thoughts.

The Cranky Maneuver that utilizes some traditional high yield products is a very useful way to generate generous income right from the get-go. It also generates very strong total portfolio income growth. On total income, I'd bet that it will beat a traditional dividend growth portfolio in the short to midterm. That appears to be the case at first blush. This may be a strategy that more purist dividend growth investors might want to employ, even on a modest scale. For those approaching retirement and with limited years of income creation, getting out some bigger guns might help you get there. This strategy certainly offers some horsepower in drag car racing fashion. It gets off the line in a hurry.

An investor may certainly even be able to juice the yields available by searching for their own baskets of REITs, Utilities, MLPs, Bonds or higher yielding stocks. I used CVY for demonstration purposes and the simplicity of having to input data on one ETF. That said, CVY is a fine multi asset mix.


An investor may also choose to manage price volatility as well with the addition of a traditional bonds and Treasuries. The above mix is rated with a beta of .7 according to CNN Money. That may or may not hold up in a true correction. Always ensure that you understand the risks involved with all of your investments. It is also wise to investigate any tax implications.

Disclosure: I am long VYM, DIA. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article. Dale Roberts aka cranky is a Streetwise Coach at ING Direct Mutual Funds. The Streetwise Portfolios offer index-based complete portfolios to Canadians. Dale’s commentary does not constitute investment advice. The opinions and information should only be factored into an investor's overall opinion forming process.